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Eye on Shipping - Baltic Dry Rates Moving Higher...

Eye on Shipping – Baltic Dry Rates Moving Higher

Winston Churchill once famously said:

“If you have an important point to make, don't try to be subtle or clever. Use a pile driver. Hit the point once. Then come back and hit it again. Then hit it a third time - a tremendous whack.”

In that vein, we want to hammer home the price performance of the Baltic Dry Index over the last three weeks, which is outlined in the chart below.

The rates for shipping dried goods globally, as measured by the Baltic Dry Index and its derivatives, have close to doubled over the last three weeks. This is an important leading indicator for the sequential reacceleration of global economic activity, even if off of low levels. Based on our research, a large part of this recent surge in Baltic Dry Rates is a function of increased iron ore and wheat demand from China. While we were early, and non-consensus in our bullish thesis on China heading into 2009, that thesis is obviously less contrarian with the Shanghai Composite up 24.5%+ year-to-date.

Our view on the Baltic Dry Index as a leading indicator for the sequential acceleration in economic activity in H1 2009 versus Q4 2008, on the other hand, still appears to be contrarian, as the following two headlines appear to suggest:

• “Is the Rise in the Baltic Dry Index a Fakeout”, U.S. News and World Report, February 10th, 2009
• “Is the Rally in Baltic Index a Storm Surge”, Wall Street Journal, February 10th, 2009

The consensus financial media appears to be solidly in the camp that the stability in copper pricing, the increase in shipping rates, and the dramatic outperformance of the Chinese stock market year-to-date are a head fake. These facts tell a different story to us.

Auto-correlation amongst global equity markets is dead. China can power forward, leaving plenty of levered long investors both in the US and abroad behind.

Daryl G. Jones
Managing Director


January CPI & PPI data released by the National Bureau of Statistics in China last night showed a continued decline in price inflation with Consumer Prices declining to a year-over-year growth rate of 1% while Producer Prices registered at -3.3%, the largest contraction in more than five years. The Chinese bond and equity markets rallied on speculation that the central bank will cut rates again in the wake of the data.

Declining CPI brings a mixed blessing to leaders in Beijing. On one hand, just 6 months after grave concerns about skyrocketing food costs were dominating headlines, the most recent data shows that collapsing commodity prices have removed much of the pain for consumers at the register (see below).


The dilemma facing the central bank now is how to coax consumers to loosen their purse strings. Governor Zhou Xiaochuan was quoted yesterday saying that the Central bank will balance interest rate and FX policy to get people shopping. Although a rate cut in the near term now seems likely, the overlapping cultural and economic incentives for Chinese consumers to save rather than spend –particularly members of the fragile emerging middle class who have been watching job losses among the lower wage earning classes warily, will not be overcome simply through rate cuts.

The falloff in prices for energy commodities and base metals drove PPI to its lowest Y/Y levels since March 2002. The breakout in component costs below clearly reflects this decline in commodity prices (with the notable exception of coal which continued to show relative price pressure into year-end, though recent production cutbacks of as much at 20% by generators on the state electricity grid should soon provide some temporary demand respite).


The recent increase in iron ore inventories reported by trade publications suggest that mills are taking advantage of lower prices as they gear up in anticipation of the massive stimulus programs which will begin to break ground in Q2.

Unlike the US and Europe, China has liquidity and the potential for massive growth in domestic demand; the question now is whether they can capitalize on this position of strength. We will have our Eyes trained on the Chinese Ox in the coming weeks as we look for more signs that Beijing’s leadership is working on solutions, both near and long term, to both drive growth and sustain it.

Andrew Barber

Who Is Worse?

Tim Geithner is 10 minutes into his speech, and he is scaring me.

I didn't think this was possible, but this reminds me that anything in life is... but Geithner may be worse (or at least as bad) than Hank "The Market Tank" Paulson.

Paulson would stutter, but at least the man didn't look frightened by the camera. What this country needs is confidence. That all starts with leadership. We can't have Geithner be You Tubed by the world like this. Our country is better than this. Give this guy the hook!

The US Dollar won’t budge, and the US stock market is reminding us that, for now at least, cash remains king.

America has voted.

Keith R. McCullough
CEO & Chief Investment Officer

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Geithner's Greenback...

The market has now absorbed Tim Geithner’s prepared remarks. These US Treasury Secretary’s pre-speech comments weren’t enough to break the buck and, as a result, we have ourselves a problem in the US stock market. The market’s immediate term inverse correlation between the US$ and the SP500 continues to hold.

I still don’t think that the groupthink crowd agrees with me on this, but the reality is that if the USA wants to compete for China’s business, she is going to have to do it from a lower adjusted currency rate. Without it, the USA is hostage to her domestic growth in horse and buggy whip industries like financial services – this country has a very hard time growing in these sectors on an UNLEVERED basis.
Unlevered growth is best found from earning Brazilian and Chinese orders. In this organic growth environment, liquidity is king. Leverage is our disease. The only way to improve the American patient’s health is to de-value and “re-flate”.

My line in the sand on the US Dollar index is now $84.51. After Geithner is done with his speech, he should go back to his office and focus on breaking that line in the buck. I’d appreciate it if someone would send him and his new boss, President Obama, this note.

Keith R. McCullough
CEO & Chief Investment Officer

PFCB – Getting Closer and Closer

PFCB is one of the better concepts in the restaurant industry. It has a good management team; though it did hang around the growth camp just a little too long. Management also committed the same mistake that nearly every successful restaurant company makes - diversification. We all make mistakes and should be forgiven when we correct the sins of the past.

Over the past four years, I have always looked at CAKE and PFCB the same way. Great concepts, but both management teams were growing the core concepts too fast. Both companies unsuccessfully diversified away from their core businesses to an inferior concept and as a result, margins and returns declined. Now, both CAKE and PFCB have slowed growth and are generating significant free cash flow. Additionally, PFCB announced on its 3Q earnings call that it would immediately close 10 underperforming Pei Wei units, which it expects will improve the concept’s restaurant margins by 70-80 bps in 2009. Management is extremely focused on cost saving initiatives at Pei Wei and expects its project evolution initiatives to benefit margins by 200 bps by 2008 year end on top of the 100 bps of labor savings it expects to realize from its new labor scheduling tool, which will be fully implemented by the end of 1Q09. So the company is working to improve margins while slowing growth, which should help to reverse declining returns at its inferior concept.

Neither company has a balance sheet issue, but PFCB’s average ticket is in a precarious spot (Management has said that it has no plans to increase prices at either of its concepts in 2009). Like CAKE, PFCB’s core store base is located in the most economically challenged housing markets in the US, so we know same-store sales are going to be challenged. Co-CEO Bert Vivian confirmed this view when he presented at an investor conference back in early January and provided colorful commentary on business trends, saying, “Yesterday, RUTH reported that comparable sales declined over 18% for the fourth quarter. Don’t be surprised by these types of numbers. Whatever numbers you are expecting for the industry should most likely be ratcheted down” (please refer to my January 13, 2008 post titled “PFCB – New Co-CEO Provides a Dire Outlook for Casual Dining”).

Both concepts will benefit from lower YOY commodity price increases as we progress through 2009. Importantly, there is a real possibility that in the next 3-6 months same-store sales trends will look less bad, which is a positive. So why is the short interest on PFCB 33% and CAKE 6.5%? I guess the easy answer is that over the past six months EPS estimates have only declined 2% for PFCB versus 20% for CAKE and 8% for all full-service restaurants. Given that PFCB management has not yet provided 2009 EPS guidance and Co-CEO Bert Vivian's rather dismal view of the industry, either he is a big “sand bagger” or guidance will be below the consensus view. Even in the aftermath of lowered guidance, we would be far more constructive on PFCB.

The Research Quantitative Edge

Looking at the Research Edge quant models, PFCB is bearish from both a Trend and Trade perspective, but just barely. It looks like a very high-risk situation for the short sellers at this stage of the game. The model says that basically both Trend and the Trade momentum lines are starting to converge at $19.18 and that is a bullish sign. Essentially, this means that the range is narrowing as volatility is dampening. Importantly, if the market gets a sniff of better than expected or “less than toxic” news, the shorts are going to get eaten by the $19.18 SHARK LINE. From the SHARK LINE, there is no resistance until $23-$24. On the downside, if the stock fails to overcome that line, $17.15 is support unless there’s a disaster in the making here. PFCB looks like a lot of broken growth names, as it’s setting up to continue to make higher lows vs. November when the stock went to $15 and short interest was at 28.6% of the float.

It does not appear that there is a big payday being short PFCB. There is no insider activity of consequence. It is, however, important to note that the holder list has a high concentration factor, which could be a liability for the bulls if one or two of these big holders flinch. Under that scenario, the stock goes to the $17 level, expeditiously.


Low gas prices and especially the removal of the $500 loss limit more than offset the awful consumer environment and some very bad weather. ASCA, PNK, and PENN are the primary beneficiaries of the Missouri strength. These stocks have been strong as of late so some of the good news was anticipated. However, I am very encouraged by the relative recent strength of the regional markets, not just Missouri but Iowa, Indiana, and the racino markets such as Pennsylvania.

Pure gaming revenues are less discretionary than most consumer industries and are more sensitive to changes in gas prices. These traits are advantageous in this environment. Given the data, estimates are starting to look reasonable for some of the regional operators including BYD, PNK, and PENN. PENN recently provided 2009 EBITDA guidance in-line with the usually stale sell side estimates. That was a positive. Considering the incredibly depressed valuations, growing visibility on revenues and EBITDA could continue to drive some of these stocks towards more reasonable valuation levels.

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