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ASCA: LIBOR HELPS BUT NOT ENOUGH

We have ASCA pulling on every lever in their arsenal and, short of raising subordinated debt or amending its credit facility, we don’t see how the company avoids a covenant breach. The maximum senior leverage ratio allowed by the credit facility steps down from 5.25x in Q1 2009 to 5.00x in Q2. It is almost a mathematical certainty that ASCA will bust this covenant in Q2. Despite the incremental cash flow from LIBOR dropping to 1.12% this past week, and factoring in almost zero in maintenance capex in Q4 2008 and Q1 2009, we estimate the senior leverage ratio will reach 5.40x at the end of Q2.

It could get worse. ASCA will only barely escape the 5.25x in Q4 and will likely breach the covenant at the end of Q1, even before the step down. ASCA needs to act and act fast. The most likely course of action is a junk bond offering. Unfortunately, in today’s environment the interest rate will likely approach 20% versus ASCA’s current average borrowing rate of around 4.5%. Thus, on a $200 million subordinated debt offering, ASCA could incur an incremental $30 million in interest expense and a $0.30 hit to EPS.


ASCA could breach covenant in Q1 and most certainly in Q2

Not the Supply Chain Margin Flow I’d Expect

Despite anecdotes from athletic footwear/apparel brands and retailers about pricing pressures, we’ve not seen broad-based flow through of inflationary pressures disproportionately hit the US -- yet.

With so much capacity closing in Asia over the past 12 months (upwards of 1/3 of factories in China’s Pearl River Delta alone), my rather strong view was (and still is) that larger Asian manufacturers would begin to gain pricing power and push costs through the US supply chain (brands and retailers). Oddly enough, this has not proven to be the case as outlined by the chart below.

My sense is that the initial hit is enough to get lost in the smaller companies that do not show up in the sample of publicly traded companies. But it is a near-mathematical certainty that these pressures will work their way up the quality curve.

We can’t make any broad-based statements about who to own and not own in this context – other than to say that the key is to flag those companies that are managing through this proactively vs. reactively. On the proactive side, I like UA, NKE and HIBB. On the reactive side, it pretty much includes everyone else…


NO NEW GATES NEEDED HERE

McCarran Airport reported that the number of enplaned/deplaned passengers declined 14.1% in December 2008 versus 2007. This is the fourth consecutive double digit monthly decline, albeit slightly better than November’s 14.7% drop. November gaming revenues ultimately came in down 16%.

It’s tough to glean much positive out of this number but we will try. The comparison, particularly on slot revenue, is quite easy. The Strip casinos held way below normal on their slots last year in December. A normal hold percentage is around 7% while for December 2007 the percentage was only 5.9%. The table hold percentage was also low last year at 12.1% versus a normalized percentage of 13%.

So while we are forecasting a 19% drop in total gaming volume, the largest since 9/11, total revenue could fall by only an estimated 11%. Of course, this analysis assumes a normal hold percentage in December 2008, which is the best we can do since we don’t have inside information.

An 11% drop in revenues would not be good, but it could’ve been worse.

Another double digit drop in McCarran airport traffic
Revenues should look better than the airport data

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SP500 Levels Into The Close...

While the pundit patrol has been full of rumors today (“Obama” this, “bank bailout” that…), most of them, if not all of them get trumped by the math. Until we test my downside support level (see chart below) of 802.39, all rallies are to be sold.

There are two important lines of resistance, and the short covering out there took us all the way up to one of them (almost). The intraday high on the SP500 was 837, and I have a formidable line of immediate term “Trade” resistance at 842 (dotted red line). If we were to close above that line, there’s an even more relevant line of resistance developing at 877.11 (thick red line).

Have a great weekend,

Keith R. McCullough
CEO & Chief Investment Officer

Spanish Nightmare...

Spain’s Unemployment Tops the European Charts…

Spain’s unemployment in Q4 increased to 13.9% from 11.3% in Q3. Put in perspective this level is nearly double the average EU level; for example the UK reported on Wednesday its highest unemployment number since 1997 that came in at 6.1%. Spain’s level now accounts for the lions-share of euro region’s change in joblessness, per Eurostat.

And the trend does not look to be turning around anytime soon—the Spanish government said it expects the jobless rate to rise to 16% this year, which could be a conservative estimate as the ESADE business school predicts 20%.

The numbers are reflecting reality. Spain is transitioning from a decade-long boom to bust as a result of the leverage cycle finding her dark side. In particular, Spain’s housing industry, which fueled much of the country’s prosperity, is now being turned on its head as prices have depreciate precipitously. As it relates to unemployment, many of the unskilled construction workers that fed the boom are now out on the street, with companies across all industries cutting jobs. Nissan Motor Co. announced it would cut 38% of its workforce.

The government predicts that GDP will contract by 1.6% this year, and the budget deficit will soar to 5.8% of GDP, double the EU’s deficit target range of less than 3%. We think that government estimate is optimistic.

Matthew Hedrick
Analyst

Stymieing Re-flation: The US Dollar...

Notwithstanding this powerful move higher in Gold today, the US Dollar continues to be a meaningful headwind for both global equity and commodity markets alike.

Looking at the chart below I have painted the bullish/bearish lines of support/resistance for the US$ Index. Up At the 86.61 line, the US$ is overbought, and I suspect that it will signal an immediate term trading bottom in the SP500 as it tests that level. Until then, this newfound US$ strength will remain a major headwind for the stock market. Significant support has built itself up to the 83.78 line. With the SP500 down almost -10% for the year to date, this recent strengthening of the greenback makes sense – after all, during a Crisis of Credibility, cash remains king.

Re-flating gold is what FDR did, and that’s what you are seeing happen globally in the face of the Crisis of Credibility that remains in both the global banking system and the foreign currencies that trade within it. Gold may very well be signaling that we are setting up for another big “re-flation” rally in everything from oil to equities, but the questions of timing and price remains. I think we need to stress test that SP500 line of 800 before I start getting invested again.

Keith R. McCullough
CEO & Chief Investment Officer

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