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On the surface, RCL is a short seller’s dream: 1) lousy fundamentals,2) high leverage, and 3) liquidity/covenant issues comprise the bulk of the negative thesis. With 31% of the share sold short and a forward p/e ratio of 5.5x, shorting RCL is indeed the consensus call.

We have no response to the high leverage argument. We calculate leverage at 8x in 2010, although it will decline materially once the new ships come on line. Our only counter to the fundamental argument is that near term bookings appear better than investors may be expecting and Europe has been resilient. Where we may differ with consensus is on point number 3.

RCL really doesn’t have any covenant issues:

• Fixed Charge coverage test is actually negative (cash flow from operations/ (sum of dividends + scheduled principal payments – new financings)
• Net Debt to Capitalization Ratio was below 50% at 12/31/2008, and we project it peaking at 57% at the end of 2010, still below the 62.5% max
• Minimum Shareholder’s Equity was $4.7BN vs an actual of $6.6BN at 12/31/2008.

RCL may have some liquidity issues, but not until 2010. We are well below 2009 consensus earnings and cash flow estimates yet RCL maintains more than enough liquidity to fund its significant capex. See the chart below. 2010 will be awfully tight, however. Here are our assumptions:

• They will get the financing for Oasis and Allure in 2009
• By the end of 2009 all ship commitments should be fully financed removing that overhang
• $600MM funding need from: cash flow from operations of $800MM – capex of $2.2BN + new ship financings of $1.7BN – maturities on 2008 debt of $800MM – maturities on 2009 debt of $100MM
• Sources at 12/31/2009 of $650MM: R/C capacity of $400MM + cash on hand of $250MM

A 2010 funding shortfall is a real possibility, a 50% probability in our estimation. However, even in this scenario, RCL would likely procure an extension on one its 2010 maturities, albeit at a higher interest cost:

• Alternative would trigger a cross default and most of the lenders have exposure on multiple pieces of debt
• Last thing unsecured lenders want is for RCL to have to raise secured debt under its carve out
• RCL could always monetize it’s in the money hedges

The good news is that 2010 is truly a bridge year. Capex steps down materially in 2011 and presumably RCL will be in the clear in terms of liquidity. Now if only RCL can sustain the recent “less bad” operating momentum there could be a nice near term story here.

Plenty of 2009 liquidity but 2010 is tight

MCD - Changing the rules in the middle of the game

I have long been a critic of MCD’s coffee strategy because it never made sense to me. The original strategy called for MCD to spend $100,000 per store, to incorporate separate “McCafes” in each restaurant that would serve a new line of espresso-based products and assorted baked goods. At the time, the project was the largest corporate initiative ever undertaken by MCD. Late in 2008, I documented that the company was clearly behind plan in converting restaurants to McCafes in order to nationally promote the product by mid-2009.

Guess what, the original strategy has changed! Even though the original plan never worked, MCD continues to maintain that it is not slowing down the roll out – they can’t! The 2009-2010 business plan calls for the “beverage strategy” roll out! It is how management plans to drive incremental transaction counts, and without beverage sales, trends are going to slow for MCD. As an aside, it’s interesting to see that MCD is starting to test the “high-end” Angus burger in more markets. I guess if McCafe is not working, they need to go to plan B…

More than 7,000 of the 14,000 U.S. McDonald's restaurants have been retrofitted to include the separate “McCafes” that offer espresso based coffees, with the balance expected to be complete by mid-2009. Going forward, however, the espresso machines are being integrated into the front counter rather than moving ahead with the “McCafe” strategy! Are you kidding me! This is the strategy that was going to hurt Starbucks. Not even!

Lastly, I know management needs to tow the corporate line, but they almost sound delusional when it comes to the coffee strategy. A McDonald’s executive is quoted as saying; "That's the great part about McDonald's is that we are actually offering affordable luxuries, so for us we know our customers are looking for those affordable luxuries." Over the past year, McDonald’s US average check growth has been fueled solely by price increases as mix was negative in each of the last four quarters with the Dollar menu growing in popularity. This just magnifies the point that the same McDonald’s customers that are coming to eat off the Dollar menu are not going to pay $3.50-$3.75 for a cup of coffee.

On Monday, MCD will release February same-store sales. Consensus estimates for MCD are; Global +0.4%, United States (0.6%), Europe (0.4%) and APMEA +3.8%. The reported February numbers will be negatively impacted by about 4% as last year’s numbers included one extra day due to the leap year. The January results, on the other hand, were helped by about 2% from a calendar shift. That being said, neither month alone provides a good indication of the underlying trends. The February numbers need to be taken in context with January to get a better feel for what trends look like in 1Q09. Taking the two months together (and adjusting both for calendar shifts), the underlying 1Q same-store sales trends look like; Global +4.8%, United States +3.4%, Europe +4.4% and APMEA +8.0%. If the consensus numbers are close to being right, this would represent a slowdown across each region from 4Q08 when Global +7.2%, United States +5%, Europe +7.6% and APMEA +10%.

The headline on Monday will not look good, the overall trends are slowing and coffee is not working. This is not the MICKEY DEES the street is in love with.

The Great Recession: Why I'm Not Depressed...

This morning’s horrendous 8.1% US unemployment rate is going to wind up being a big positive for the stock market. The only way for this stock market to stop going down is to over-deliver on the misguided apocalyptic expectations that the Great Depression cometh…

Finally, the economic data is terrible enough for the revisionist economic historians (or “economists”) from Washington to Wall Street to absolutely freak-out. As they freak-out, they’ll freak out everyone else… and hopefully break the confidence that global investors have in the US Dollar while doing so…

If the US$ stops going up, you’re going to observe some very itchy trigger fingers in both the short books of wanna be short sellers, and levered long only managers who are sitting on piles of cash. You saw that on today’s market open, and you saw it again when we rallied from down to up again on the day…

Cash? Yes, that stuff that we allocated 96% of our Asset Allocation Model to 6 months ago (September 2008 - before unemployment ripped from 6.2% to 8.1%). Back then, some of Wall Street’s finest savants accused me of “hiding in cash”. Now (after the crash of course) I walk around meeting both existing and prospective clients in NYC and Portfolio Managers are boasting to me how large of a position in cash they have…

You know what this all means - I better start taking down my Cash position from the 70% I was holding prior to this morning’s market opening. I’m doing that more aggressively than I have in a long time, today…

Why? Well, primarily because I am now understanding that what we have here is The Great Recession. While some people on Wall Street are rightly expressing their personal depression, they are wrongly straight-lining that statistically insignificant personal position across a globally interconnected economy. Fortunately, as Dr. Copper, Wal-Mart, and China reminded me this week, Wall Street is no longer going to own the debate as to where this economy is headed next – the clients will. Some of them have blue collars… some of them are Chinese… I know, I know – very weird stuff I am talking about here…

Why I’m Not Depressed: It’s all about the delta. The revisionists are straight-lining the record setting acceleration in unemployment into becoming a repeatable rate of growth – mathematically speaking at least, that’s silly. Whether you want to look at this relative to the mid 1970’s when year-over-year trough to peak unemployment last ramped this quickly (up 300-400 basis points year over year), or in terms of percentage accelerations across different durations, my conclusions are the same – the rate of growth in the US unemployment rate is setting up to SLOW… right as the manic media worries people about it most.

This Is How a Depressionista Can Get To His/Her Numbers: the February 2008 to February 2009 acceleration in the unemployment rate was 330 basis points (from 4.8% to 8.1%, see charts below) – that’s a 69% acceleration of the nominal level of unemployment in this country. If we were to straight line that steep curve (chart) and project the same rate of growth in unemployment to February 2010, you’re looking at a 13.7% US unemployment rate. That would err on the side of a Great Depression type number. Using a shorter duration model, maintaining the current pace of growth in monthly unemployment gets you a 8.6% unemployment rate by the end of March – that too would be depressing, but I don’t think we see that number – if we don’t, the growth rate of unemployment will have SLOWED sequentially.

How Do You Slow The Pace of Growth? Socialize The Country, and Break The Buck: Since The Great Recession began, the USA has lost 4.4M jobs. Obama’s plan is to add back 4M jobs – how convenient is that linear conclusion? In the face of finally adding jobs to the baseline number, can the US unemployment rate continue on this accelerating Trend line? That would be tough math for me to see adding up – and if we get that kind of a Great Depression, I too will join the lines of those who are depressed.

Keith R. McCullough
CEO & Chief Investment Officer

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"Today is the tomorrow you worried about yesterday."
- Unknown

It's human nature to lose confidence when you become seriously ill.  You feel worthless and it feels like anything you say is meaningless and everything you do is pointless.   Everything you do is just plain wrong!  Yes, that is ANIXIETY!  Anxiety robs you of your personality, kills your confidence and thus, you lose your identity.  Sound like a typical description of the US stock market!
The good news is your confidence and personality gradually return, building up in layers, until eventually you feel like the person you were before you became ill. In the end, you grow into a stronger person. So today is tomorrow - Nice.
This is a metaphor for how most people feel about the US stock market.  Everywhere you turn and everything you read increases your anxiety level.  "The loss of confidence is pervasive" is one of the headlines on Bloomberg this morning!  "Whether it's GM or C, warnings of possible bankruptcy and concerns about the banking system's fate reinforce the reluctance to take on risk of being a failure" - The Wall Street Journal.  Ok, so GM and C are done, therefore, I need to feel like a failure.  Not going to happen!  
After yesterday's -9.4% decline in the financial sector, the ETF is now down 50% year-to-date.  I get it - Citi and a few others are bankrupt and now owned by the government... but guess what, consumers are still shopping at WMT and a few other "cheep chic" stores.  WMT even said yesterday, ""We believe falling gas prices significantly boosted household disposable income in February and therefore allowed for both more trips and more spending towards discretionary categories."  
Over the past week there are some leading indicators that things might be bottoming, like retail sales, the move in copper prices and the news from the early cycle technology names.
Unfortunately, we are not in control of our own destiny any more.  Without the Chinese, we would likely go down a lot more.  How high does your anxiety level go, knowing that we need the Chinese to fund our deficits and without further stimulus, the global economy suffers?  Talk about a position of strength! The next politician who thinks he can bad mouth the Chinese or push them around needs to be given a "time out", like a child who hasn't learned discipline.  The Chinese own us!
This morning it looks like we are going to get a horrific jobs number with expectations that payrolls could decline by 650,000, the most in a generation.  Since the Chinese control us we need to think more like they do.  Someone in the Labor department needs to "make up" a really horrific number and get all of the bad news on the table so we can move on.  
Anticipating a really bad jobs number, early indication is that the dollar is declining, which will help to stabilize, if not allow the market to rally today.  That's been the US Strategy trade of 2009, US Dollar UP = SP500 DOWN. Reverse that intermediate Trend of US$ strength, and stocks find stability. That's how "re-flation" works.
Last night as I drove home from New Haven, I listened to a debate on Bloomberg Radio about whether Obama is to blame for the decline in the market this year.  He definitely didn't create this mess, but he was elected to fix it... and the market discounting mechanism suggests he's not getting the job done.  
I know my anxiety level increases knowing that we are dependent on the politics of Washington to get us out of this mess.  In the end, pointing fingers is a waste of time, I just want results!
At this point, it is hard to tell which sector is going to lead us out of the doldrums!  There is not a single sector in the S&P that looks good.  The "safe and boring" sectors like Consumer staples are not working in a down tape.  We are dependent on Washington to restore consumer confidence, which will help the discretionary names. Utilities are not going up as interest rates go up.  Healthcare is re-testing the lows and is in a cloud of uncertainty, but a rally from here would be very bullish. The Financials continue to be a toxic waste land. Energy and Materials are not going up unless the Chinese re-flate the global economy.  
That leaves us with Technology....  On a relative basis, Technology is starting to outperform more consistently, but most are closet industrials.  Who wants to own an industrial?
This unemployment report is due out in 30 minutes - it's time to get back on that Wall.
Function in disaster; finish in style...
Howard Penney
Managing Director



  • QQQQ - PowerShares NASDAQ 100 - We bought QQQQ on a down day on Monday.

  • SPY - SPDR S&P500- We bought the etf perhaps a smidgen early with the S&P500 at 715, yet will take it at a discount.  The market is also close to three standard deviations oversold.

  • CAF - Morgan Stanley China fund - The Shanghai Stock Exchange is up +20.4% for 2009 to-date. We're long China as a growth story, especially relative to other large economies. We believe the country's domestic appetite for raw materials will continue throughout 2009 as the country re-flates. From the initial stimulus package to cutting taxes, the Chinese have shown leadership and a proactive response to the credit crisis.

  • GLD - SPDR Gold- We bought gold last Thursday with the S&P500 in the red and gold down. We believe gold will re-find its bullish trend.

  • TIP - iShares TIPS- The U.S. government will have to continue to sell Treasuries at record levels to fund domestic stimulus programs. The Chinese will continue to be the largest buyer of U.S. Treasuries, albeit at a price.  The implication being that terms will have to be more compelling for foreign funders of U.S. debt, which is why long term rates are trending upwards. This is negative for both Treasuries and corporate bonds.

  • DVY - Dow Jones Select Dividend -We like DVY's high dividend yield of 5.85%.

  • VYM - Vanguard High Dividend Yield -VYM yields a healthy 4.31%, and tracks the FTSE/High Dividend Yield Index which is a benchmark of stocks issued by US companies that pay dividends that are higher than average.
  • EWY-iShares South Korea- Despite initial efforts by the Bank of Korea to weaken the Won to spur exports, Korea's new finance minister Yoon Jeung Hyun has proposed strengthening the Won to improve the domestic market. Yet South Korea is export-dependent economy. We see no catalyst in sight to drive external or internal demand to the levels necessary to stimulate recovery, especially with a stronger Won. South Korea's exports fell for a fourth month in February 17.1% Y/Y.

  • LQD -iShares Corporate Bonds- Corporate bonds have had a huge move off their 2008 lows and we expect with the eventual rising of interest rates in the back half of 2009 that bonds will give some of that move back. Moody's estimates US corporate bond default rates to climb to 15.1% in 2009, up from a previous 2009 estimate of 10.4%.

  • SHY -iShares 1-3 Year Treasury Bonds- On Thursday of last week we witnessed 2-Year Treasuries climb 10 bps to 1.09%. Anywhere north of +0.97% moves the bonds that trade on those yields into a negative intermediate "Trend." If you pull up a three year chart of 2-Year Treasuries you'll see the massive macro Trend of interest rates starting to move in the opposite direction. We call this chart the "Queen Mary" and its new-found positive slope means that America's cost of capital will start to go up, implying that access to capital will tighten. Yield is inversely correlated to bond price, so the rising yield is bearish for Treasuries.

  • UUP - U.S. Dollar Index - We believe that the US Dollar is the leading indicator for the US stock market. In the immediate term, what is bad for the US Dollar should be good for the stock market. The Euro is up versus the USD at $1.2678. The USD is down versus the Yen at 96.7040 and down versus the Pound at $1.4228 as of 6am today.


If I’m a retiree then Nevada has to be looking attractive right now. Last I checked it’s still very warm there. Importantly, Las Vegas housing has cracked with pricing down 43% peak-to-trough, much more than the national average, off 19%. By way of example, my new colleague at Research Edge, Todd Enders, points out: rather than finding a job to compensate for the lost value in their house and higher cost of living, his retired parents could just move to Nevada from California.

The first chart shows the peak to trough housing price decline in Las Vegas versus the “snowbird” cities and the national average. The 43% decline in Las Vegas is steeper than any of the cities shown, and by a wide margin with the exception of Cleveland. Las Vegas is suddenly a much more affordable place to live. As long as government doesn’t eliminate the Nevada income tax advantages (there are no income taxes) and the climate stays favorable, the relative appeal of living in Nevada will continue to rise in these difficult economic times. Of course, if you believe the “end of the world” crowd, I suppose we need to worry what global climate change will do the comparative weather advantage.

The second chart details the projected population growth in the retiree age group of 65 and over. The Nevada Small Business Development Center appropriately projects nice long term growth in this segment. However, migration in to Nevada based on the state’s comparative advantages is not reflected in those estimates. We believe migration will push that growth rate higher.

The upshot to this discussion of population growth, demographics, and retirees is that the Las Vegas metro area is likely to sustain population growth (both retirees and workers) at a rate higher than the national average, potentially much higher. This is the primary reason we are bullish (non-consensus) long-term on the locals Las Vegas gaming market, despite the near-term issues. In fact, as we discussed in our 02/05/09 post, “THE LAS VEGAS LOCALS MACRO MODEL”, gaming revenue growth could resume as soon as 2010.

The play on this analysis is clearly Boyd Gaming. Not only would BYD benefit from the market growth, LV locals is its largest, but with the market’s largest player Station Casinos in dire straits, BYD could end up a much bigger player by picking off some or all of Station’s assets. The synergies would be immense in our opinion, and only fractured competition would remain.

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