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Winning

Three more American gold medals were won in the pool last night, with Michael Phelps adding his 6th, pushing Team USA ahead of the Chinese in total medals by a score of 44 to 37. The Canadians have no medals.

My fellow Canadians and I can stay awake well into the night hoping for a bronze in synchronized diving or whatever it is that has less global competition, but our hopes are just that - hopes. Hope is neither an investment process nor a winning strategy when competing in a global grudge match. Confidence in a repeatable and disciplined daily research regimen is however, and that’s primarily why I come across overly proud of ours every morning.

As you might imagine, my morning thoughts elicit plenty of responses. Usually, the highest octane criticisms I receive land in my inbox within 3 minutes of the note’s distribution. Yesterday, I had one that said “good research, but hard to read”. On many counts, I think that view is fair. I am very aware that my writing style is overly confident.

We’re not in this game to appease personalities. We are in it to win it. If we score, we want you to, alongside us. My teammates are much more humble than I. Thank God for that! That gives us balance. The only way I know how to play is on the edge – that’s why our firm bears the name. I feel “smart” every morning because my teammates are. The underpinnings of the knowledge transfer mechanism in Wall Street Research are changing. Our highest conviction “idea” today, is that we know what this paradigm shift will look like tomorrow.

This morning’s pre market news is looking as light as yesterday’s trading volume did. What remains of the bullish “Trade” formation we are in should play out quietly as we move to the high end of my range. The most impressive moves remain in the deflating inflation “Trade”. The US Dollar’s positive correlation with the US stock market remains the most relevant macro factor to watch. The US$ Index is trading higher again this morning at 77.12, +7.3% since July 14th. Currencies in Asia and Europe continue their decline alongside commodity prices. I am going to bump up the high end of my S&P 500 range to 1316, from 1312 prior. Deflating commodity inflation is undoubtedly bullish in the immediate term. If we test the aforementioned 1316 line, the question will be what matters more from there, global growth or inflation slowing?

On the growth front, Asian markets were weak again on both an absolute and relative basis to global equities because Hong Kong joined Singapore and Japan as the latest Asian economy to report a major slowdown in GDP growth. Hong Kong reported a +4.3% growth rate for Q2, down sharply from +7.3% in Q1 of this year, and well below consensus expectations of a number closer to +6%. Singapore and Japan told us they are both running negative export growth this week, and now the lead article in the Wall Street Journal this morning goes something like ‘US Economic Slowdown Spreading Globally’. Gee, thanks for the proactive prediction ahead of time.

I have been penning my thoughts and themes about Asian growth slowing since Q4 of last year. This was in the face of Wall Street misleading Main Street and then ultimately itself. It was supposed to be “global this time” and the world economies were supposed to “decouple”… remember? In an investment community where I have sat at the most relevant tables of debate, am I proud to have raised my hand on the other side of this macro trade? You bet. If its “hard to read” good research, that’s better than having an easy time reading what was plain bad research back then.

Einstein said, “great spirits have always encountered violent opposition from mediocre minds”, and it’s hard to disagree with that. Ask Michael Phelps how much adversity he has faced in his life. Gold is minted in it.

Have a great weekend,
KM



ASCA: TOEING THE COVENANT LINE

ASCA’s liquidity situation reminds me of the U.S. women’s gymnastics team performance at the Olympics. They were in great shape heading into the floor routine when everything fell apart. Facing a much younger competitor in China, they couldn’t even stay in bounds, costing them the Gold. With Ameristar East Chicago about to taking a pounding from a new and improved Horseshoe, ASCA will struggle to stay in the bounds of its credit facility covenants. Of particular concern is the senior leverage covenant restricting the company to 5.25 to 1.00 debt to EBITDA until Q2 2009 when the ratio drops to 5.00 to 1.00. As the chart indicates, ASCA will toe the covenant line and could cross it in any of the next 3 quarters. A Q2 2009 violation is almost a mathematical certainty.

I’ve commented in the past that ASCA has been over earning due to its low but unsustainable cost of borrowing. The company’s entire debt structure is comprised of borrowings off the credit facility currently paying only LIBOR plus 1.625%. Although they did recently fix some of the debt through interest rate swaps. EPS is about to be deflated as ASCA will need to refinance a portion of the credit facility with fixed rate bonds. The rate they pay will be dictated by the proximity to the covenant restriction and the credit environment. Brunswick recently issued $250 million of 9.75% bonds. With that as a proxy, ASCA could experience a 5% higher incremental rate on whatever they borrow, presumably at least $200 million. That’s a 10% hit to EPS at minimum. Remember that the credit facility matures in 2010 and will need to be renegotiated in its entirety before then. I maintain that ASCA could be over earning by 50-100% in terms of EPS.

I believe the company is making a big push internally to cut costs and capex to stay in bounds. The long-term danger of this strategy is declining service levels and deteriorating facilities. Indeed, through termination, attrition, and scheduling cuts, ASCA has reduced its workforce by about 5%. More disconcerting is the dramatic drop-off in maintenance capital expenditures. The company should and has historically spent 5-6% of its revenues on maintenance capex. I estimate that percent has declined sequentially since Q1 2007 and was only 1.7% of revenues in Q2 2008. These levels of cuts will be noticed quickly by customers.

Ameristar may be the first gaming company to fall off the balance beam because of the the credit crunch, but it won’t be the last.


ASCA trying to stay in bounds the leverage restriction of its credit facility

WRC: Bracing Myself

I have a high conviction bear case on Warnaco’s margins. But we’ve got to respect timing. That’s Keith’s job. Unfortunately, momentum favors bulls. His next stop = 54.65.

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Allergan (AGN): Staying Long The Headache

My Partner, Tom Tobin, has been in and out of this stock for a long time. Since his portal is still on free trial you can see the AGN call he made last weekend titled "Trading Long Into The Headache Data".

My models have this "Trade" going to $59.34 in the immediate term, at least.
KM
  • AGN short term target $59.34
(chart courtesy of StockCharts.com)

M: Look Through Near Term Share Gain

On its 2Q conference call, Macy’s played-down potential impact from the recent string of bankruptcies in the department store space. I think the company was right to play it down, because quite frankly it does not have the infrastructure/ clue (few retailers do) to know why a customer is or is not shopping in its stores. What is certain is that the store overlap is quite meaningful.

My Jr Analyst Zac has turned into quite the cartographer of late. His analysis below shows that about 20% of Macy’s stores overlap with either a Mervyn’s, Boscov’s, or Goody’s within a 3-5 mile radius. The initial hit is/was likely to have been negative given the aggressive promotional activity, but as with most bankruptcies, the business siphons away in subsequent quarters to competitors. In this economy, it is not unrealistic to assume that the business is lost forever. But my sense is that Macy’s sees a bump. My math suggests something in the 0.5-1% comp range is not out of question. Not huge, but enough to cling on to for a zero growth retailer that is in a secular decline.

When I stack that up against cycling extremely weak gross margins last year, and the fact that Macy’s SG&A ratio is trending down despite zero sales growth (i.e., this is bad behavior as the company is cutting into muscle), this puppy might actually shape up to show a decent cash flow trajectory in the coming quarters.

It’s tough for me to make any kind of positive fundamental call given that I believe margins will be 2-3 points lower at this company in another 3 years. Also, from a tactical standpoint, how can I ignore Keith’s comment that ‘if it fails to close above 21.24, short it with impunity.’ Today’s close was 2 cents shy… (Yes, his timing models have proven to be accurate to the penny).

Ralph (RL): Collars Up Boys!

Short the white T's (GIL) and long the pink collars (RL). Brian McGough wears pastels, and the shorts who are still in this stock are wearing red faces.

I'm taking my new squeeze target up to $76.99/share. Short interest here remains way too high.
KM
  • RL is going higher...
(chart courtesy of stockcharts.com)

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