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GOT SCHALKS?

Gottschalks’ Ch 11 filing is theoretically a short-term negative and LT positive – that is, if capacity actually goes away (doubtful). ROST is the big loser, with JCP, M and TGT next in line.

Another retailer down. Gottschalks filed for bankruptcy last week after running out of gas on its $125mm debtor-in-possession financing from a group of lenders including GE Capital. The company says it will conduct business “as usual” during the process while it attempts to find a buyer. Good luck finding vendors that will ship ‘as usual.’

The common view is that when a retailer shuts its doors, there is a near-term margin hit for competitors due to irrational pricing, but that gives way to a cleaner and more sane market. My problem with this is that it simply does not usually work out that way. The stores usually end up simply switching hands or lingering in a state of mediocrity. This time around, I’d argue that creditors don’t want to own these stores, and those who are liquid long cash in retail are probably not looking and aged legacy department store assets. Let’s not forget that GOTT has meaningful overlap with Mervyn’s, which account for a combined $2.7bn in apparel/home furnishings sales.

Who are the losers? ROST takes first with roughly 3.5% of its stores overlapping a Gottschalks or Mervyn’s in a 5 mile radius. JC Penny and Macy’s have the next best exposure to the bankrupt stores.

US Market Performance: Week Ended 1/16/09...

Index Performance:

Week Ended 1/16/09:
DJ (3.7%), SP500 (4.5%), Nasdaq (-2.7%), Russell2000 (3.1%)

2009 Year To Date:
DJ (5.6%), SP500 (5.9%), Nasdaq (3.0%), Russell2000 (6.6%)

Keith R. McCullough
CEO / Chief Investment Officer

UNEMPLOYMENT: SOME OF THE SAME AND SOME DIFFERENT

Following up on our “THINK LOCALLY” post of 12/07, it is clear that environment is not ideal for gaming operators. For these stocks, unemployment matters and what we care about is what happens on the margin.

The chart below shows which areas have seen an increase in unemployment and also whether the rate of change of the unemployment trend in November was greater or lesser than that in October. Clearly, it is not a pretty picture; most metropolitan areas are seeing an increase in unemployment at a faster rate than last month. LA, NY, Vegas, and other are still suffering from severely negative trends. However, it seems that Shreveport and New Orleans have seen an improvement in unemployment figures during November.

With PNK deriving 75% of its EBITDA in Louisiana, this could signal an important slowing of the unemployment tide (LA had experienced a sharp October increase in unemployment). Even in Houston, an important feeder market for PNK’s Lake Charles operations, the rate of change stabilized in November.

The consensus view is decidedly negative so any positive delta could mean a big move in the stocks. Unfortunately, Louisiana appears to be the only remotely positive take away from the disturbing unemployment picture. Of course, the new government plans to spend like drunken sailors which could provide a temporary boost to employment. We’ll have our eye on that trade too.

Rory Green


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BYD: A NOT SO “RISKY BUSINESS”

Here is the consensus call: Short Boyd because business is terrible and they may bust a covenant or raise equity. My response to that is a) business is bad everywhere but that is “soooo consensus” and b) they have so many levers to pull that they will not bust a covenant nor raise equity.

So what are the levers?

1. Buy bonds at a discount – We’ve written on this extensively so all I will say is that BYD has bonds trading in the 60s so they can de-lever by about 20 cents (after tax) for every dollar they borrow from the credit facility to buy back bonds. If Senator Ensign delivers there will be not tax.
2. Cut costs – I think BYD has been very aggressive in this area and we should see it show up in their Q4 margins. Revenues are challenged but again that is the consensus view.
3. Cut Capex – Slots can wait. So can growth capex.

Management seems remarkably complacent about the covenant situation which leads me to believe that: a) recent results are better than expected, b) cost cutting is ahead of plan, c) capex is lower than projected, d) enough discounted bonds were bought back earlier in Q4 to appropriately de-lever. On a very positive note, an equity raise is not under consideration.

In the meantime, BYD will generate $175 million in net free cash flow over the next 12 months (after Q1). That is cash after all capex; growth and maintenance. The free cash flow yield on the stock is an astonishing 40%. Sometimes you just gotta say what the ….

With free cash flow like this, "sometimes you just gotta say what the ....:
Enough cushion but more levers

Commodity Nugget: The Spread Between Light Sweet and Brent

Commodity Nugget: The Spread Between Light Sweet and Brent

We posted two days ago on the steep contango curve in the oil futures curve and wanted to highlight another interesting discrepancy in the Oil market. As outlined in the chart below, the divergence between the price of West Texas Intermediate and Brent has reached an extreme at more than $10 currently.

Brent oil is pumped from the Brent formations in the North Sea, while West Texas Intermediate is pumped from, as the name denotes, the oilfields of Western Texas. The key differentiator between the two grades of oil is that West Texas Intermediate is lighter and sweeter, so is of higher quality than its North Sea counterpart.

All things being equal, consumers will use light sweet oil from West Texas before its heavy counterpart from the North Sea. As such, historically West Texas Intermediate has traded at a slight premium to Brent. Currently that spread has reversed, and as outlined in the chart below, the price of Brent is trading at an almost $10 premium. The implication of this is that oil demand in the U.S. is very weak relative to the rest of the world, which was also evidenced by this week’s DOE report.

As the divergence below suggests, determining the inflection point to a more balanced supply / demand picture in the U.S. will indeed be critical in determining the next up Trend move in oil. On the downside, we see USO (United States Oil Fund) testing the $28 level in the coming weeks.

Daryl G. Jones
Managing Director

EYE ON BRAZIL: WHY WE ARE LONG PART 1

EYE ON BRAZIL: WHY WE ARE LONG PART 1
November Retail Sales data rose by the lowest percentage in 2 years, and it still looks great!

People looking for a negative story in today’s retail sales data from Brazil had an easy time finding one. The ( by now completely stale) numbers show that retail sales in total only grew by 5.3% Y/Y * three months ago -which was seized upon by Brazil Bears as a sure signal of pain to come for an economy were consumer spending accounts for more than half of GDP.

Taken on a relative basis however, the data released today has an altogether different complexion (see table of several key index components below). On relative basis 5.3% looks very healthy, while the 2 and 3 year growth stats are still in double digit territory. While there is no denying that automotive sales have fallen off a cliff (what in this world didn’t in November!), the near term impact on the Brazilian economy is softened somewhat by the almost complete foreign ownership of the industry there (Ford, GM , Fiat and VW combined account for over 80% of car sales with the remainder primarily divided between Japanese brands).

Obviously the Brazilian economy is going to slow in sympathy with global markets, but we stand by the argument for sustainable sales growth driven by domestic demand in Brazil even if it is merely in single digits. We are long Brazil via the EWZ etf and continue to believe that Brazil and China will outperform the rest of the developing world in the coming year.

Andrew Barber
Brazil

*all data presented seasonally adjusted

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