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MCD – Slowing Global Sales Trends

MCD reported February same-store sales that came in better than street expectations in every geographic region except APMEA. That is where the bulk of the good news ended.

On a sequential basis from 4Q08, average underlying comparable sales trends for 1Q09 (adjusted for both the January and February calendar shifts) have slowed in every region except the U.S. Globally, same-store sales in January and February have slowed to 5.3% from 7.2% in 4Q08. This slowdown was driven by a 3.0% and 3.8% sequential decline in Europe and APMEA, respectively, while the U.S. has held in at about 5%.

Going forward, the March numbers will continue to be impacted by timing/calendar shifts, which will hurt results in each region by approximately 1.0% to 1.8%. Additionally, the timing of Easter, which falls in April this year versus March last year, will hurt Europe comparable sales by about 2% and should help U.S. numbers by less than 0.5%. For reference, MCD is lapping its easiest monthly and quarterly U.S. same-store sales comparison from 2008 in March and 1Q so MCD’s U.S. numbers should continue to look good in the near-term. I continue to believe, however, that the company’s McCafe strategy will not provide the incremental sales necessary in the U.S. to maintain this level of sales strength throughout 2009.

U.S. margins have been negative for the past 8 quarters and I expect this trend will continue as the company drives increased foot traffic with its dollar menu at the expense of average check (mix was negative each quarter in 2008) and margins. As stated in today’s sales release, commodity costs are expected to continue to pressure margin comparisons in the first quarter, which could further increase the declines in the U.S.

MCD reported that Europe’s February results were hurt by weakness in Germany, which is a trend that is continuing from the fourth quarter. For reference, Europe was MCD’s largest geographic region on a sales basis in 2008, representing 42% of total company sales, and France, Germany and the U.K. accounted for 55% of Europe’s revenues. That being said, the sequential slowdown in reported quarter-to-date same-store sales in Europe is of significance. During MCD’s 4Q earnings call, management stated that about 40% of Europe’s comparable sales number has been driven by traffic, which implies that average check makes up the remaining 60%. We knew going into 1Q09, that average check in Europe could come under pressure as management stated that it would not implement the same level of pricing in 1H09 that it typically would “because you’ve got to consider how the consumer is feeling and during these times the consumer is looking for deals and we want to make sure that we’re out there.” Specifically, management stated that the “German consumer is very sensitive to pricing.”

MCD attributed APMEA’s underperformance to weakness in China, which the company said was impacted by the timing shift of the celebration of the Chinese New Year (fell in January this year versus February last year). Although I am sure the timing shift did impact the YOY comparability, I would expect that underlying trends in China, which slowed during the fourth quarter, have remained weak. We learned in early February that MCD, like its competitors in China, cut its prices by more than 30% in response to the economic slowdown. I don’t think the company would have cuts its prices so drastically if demand was holding up.

Management also stated in its press release today that “unprecedented volatility in foreign currency exchange rates and commodity costs will continue to pressure revenue and margin comparisons in the first quarter.” The company stated that if foreign currency rates remain at current levels, that currency translation will negatively impact EPS results by $0.07-$0.09. The company had previously said that it expected the 1Q09 currency impact to be similar to that of 4Q08 when it hurt EPS by $0.07. The negative currency impact on total company systemwide sales has grown sequentially from 4Q08 through February. At the same time, however, systemwide sales growth on a constant currency basis has slowed rather significantly in February to 3.2% from 9.1% in January. This caused reported systemwides sales growth to turn negative in February.

Eye on Value: Companies Trading at a Discount to Net Cash

This weekend we did a screen to find U.S. traded companies that had a negative firm value. That is, companies where the net cash (cash + short term investments less total debt) was greater than the fully diluted market capitalization of the company. We removed companies that did not appear to have a real business, or were trading at high multiples of revenue, and those companies that appeared to have accounting issues. We also only screened companies north of $50MM in market capitalization.

The screen produced 19 companies that are currently trading at less than the net cash on their balance sheet. In most instances, we excluded long term investments. The assumption would be that many of the companies are either not profitable or have a very high burn rate of cash, so the implied future cash balance is a much lower number. While in some cases this is true, in many of the cases these companies are both profitable and not burning cash based on recent results.

We’ve outlined the list below and wanted to caveat that we do not cover these companies and are obviously not recommending the purchase of these stocks without further due diligence. Also, obviously, many of these companies have small market capitalizations ($50 - $200MM), so they may not be practical for large portfolios. In addition, we did not fully investigate off balance sheet obligations such as pensions, leases, and the like. Caveats aside, when a company is trading at a discount to the cash on its balance sheet, it should pique the interest of any value investor worth his salt.

The companies that we have highlighted in green appear the most promising based on this screen. They are trading at a discount to net cash, generated positive EBITDA in the last twelve months, and generated cash (so net cash increased) sequentially in the last two quarters. Interestingly, theStreet.com is on this list, despite positive EBITDA in the last twelve months. From a purely academic perspective, the implication may be that Jim Cramer has a negative net present value to his company. Booyah anyone?

If any of the companies below pique your interest, let us know and we’d be happy to work with you on a deep dive of the company.

Daryl G. Jones
Managing Director

Eye On Re-Regulation: Where There’s Smoke… Notes for the Week Ending Friday, March 6, 2009

Knock-Knock Joke
“Who dat?”
“Who dat say ‘Who dat’?”
“Who dat say ‘Who dat’ when I say ‘Who dat’?”

The SEC has just issued Release 2009-39 “warning investors and financial services firms about con-artists who may use the names of actual SEC employees to mislead potential victims. The agency also is providing information to help potential victims protect themselves from SEC impersonators.”

This is nothing new, but like other frauds that take advantage of disarray in the financial markets, it crops up with greater frequency when there is confusion in the air. We are aware of a number of instances over the years where trading desks have received phone calls during from individuals identifying themselves as being from Market Surveillance –whether SEC, NASDAQ, or NYSE. Head traders receive calls during market hours from someone using the name of an actual market regulator, and stating they are performing a market sweep. We have heard of traders being asked to run down their entire options or futures books over the phone, or to reveal the size of their long and short positions in a number of large stocks, or that day’s trades in certain names. Any instrument is fair game if you are looking to trade against a large desk’s liquidity.

For a private investor, the possible scope of fraud that can be perpetrated once someone gets your brokerage account and bank information makes our head spin.

As a public service, we provide the following information, from the SEC release: If a person contacts you claiming to be from the SEC, ask for their name, the SEC office in which they work, and their direct telephone number. Then call the SEC Personnel Locator Telephone Number: and ask to speak directly with the person who contacted you.

A tip: do not ask for a written request. While it may seem like a good way to establish identity – an SEC letterhead with a fax number by way of identification – it also creates a written record, which may unintentionally escalate a routine question to a formal inquiry. In fact, most phone calls purporting to be from the SEC are actually from the SEC. If a telephone inquiry is handled quickly and efficiently, that is often the end of it. A letter escalates the matter on the SEC’s own radar, and may end up taking up much more of your time and resources. Once you receive a letter from the SEC, you can not un-receive it.

You Get What You Pay For
What we obtain too cheap, we esteem too lightly.
- Thomas Paine

SEC budget for 2008: $913 million. Proposed increase for 2009: $119 million.

CFTC budget for 2008: $111 million. Proposed increase for 2009: $35 million.

The two government agencies charged with ensuring the transparency and stability – one might go so far as to say the Sanctity – of the US investment markets will be given a total of less than $1.2 billion to do a job that has been disastrously mishandled for a decade or more. Millions For Tribute But Not One Penny For Defense, as we toss more and more money at the stockbrokers, AIG and Citi, while nickel and diming our regulators.

And most of the nickels that will be given to Chairman Schapiro will likely be earmarked for junior lawyers. All of the work being done now to streamline the SEC’s process looks like Business As Usual on steroids. We are glad to see Chairman Schapiro bringing in people like Kayla Gillan (see our item from Friday 20 February, “She’s Baaaaack!”) but we fear there may not be enough political will in all Washington to upset the number of applecarts that will be required before the SEC becomes an effective regulator.

There are legitimate industry groups in the financial world, and Ms. Schapiro needs to identify the ones with the most credibility and cultivate relationships in order to create a real partnership with the industry. Otherwise she will accomplish nothing more than streamlining the inefficiencies of the old system.
This is no way to regulate the world’s most important marketplace.

Liar, Liar, Pants On Fire
“Young man, for this job we are looking for someone who is very responsible.”
“Then I’m your man, Sir. The last place I worked, whenever anything went wrong, I was responsible!”

There goes that pesky Sheila Bair again, not being a Team Player and referring publicly to the condition of imperial dishabille. This time around, she has offered a comment on President Obama’s proposed mortgage bailout. And since she is on her home turf, we think she should be listened to.

President Obama’s mantra looks less and less like “Yes we can”, and increasingly like “Ahammena-hammena-hammena…” His latest assurance to the markets, that only Responsible People will be rescued by the proposed Foreclosure prevention program, is too much Politics and not enough Policy. Pace Rush Limbaugh, we fear it won’t work.

We recognize that leadership requires deft footwork, and that what appear to be Presidential missteps may be head fakes. It is astute politics, for example, to have the debate about nationalizing the banks play out by having various high-profile figures ponder publicly the virtues of one side or the other. Chairman Greenspan, Aye. Chairman Bernanke, Nay. But the markets are not comfortable that President Obama is actually directing the process. We would have greater comfort in the President’s ability to gauge and manipulate public opinion – one of the key jobs of a leader – if not for the Bozo-gate that attended his Cabinet nominations, a first impression that will continue to dog his administration.

The normal political process entails sending up trial balloons, testing public sentiment, launching pilot programs, and listening to the push-me-pull-you of Congressional debate. In this fashion, a new president tries out public consensus and gauges how far he can push his programs in the face of majority sentiment. Today’s markets, however, are calling for immediate action that is strong, decisive and unambiguous. President Obama, please take note: the world will follow if you will lead decisively. It’s New Dealer’s choice, and it is America’s hand to lose.

In response to Big Picture Obama’s assurance that “Liar Loans” will not be bailed out, Ms. Bair said it is “simply impractical” to review old mortgage applications in an effort to determine which were legitimate, and which fraudulent. If Congress decides to take this political ball and run with it, we might as well write finis to the American banking system.

Before Treasury Secretary Geithner pulls out the Long Knife, we recommend you ask your compliance officer what is involved in this kind of review. Having a loan officer approve a mortgage app – as they are called in the biz – is one process; having credit experts perform a forensic investigation of a decade’s worth of old mortgage apps is quite a different matter.

First, how should this politically charged process run? Should the credit officers who originally approved the mortgages be required to re-paper them? In many cases this will mean bringing people back to prior places of employment and opening up files that are anywhere from two to… ten?... years old. And most of those files will have been sent to physical storage, in conformity with various record-keeping requirements.

President Obama’s program is described as benefitting up to 9 million homeowners. How many mortgage files will have to be vetted to identify nine million kosher loans for the program to assist? The physical work of retrieving several million cardboard boxes full of paper files – then identifying the files and routing them to the proper location for review – bringing in teams of reviewers – taking existing staff off their day-to-day responsibilities to run the support function for this extraordinary audit – all this represents a human and logistical task on the order of the building of the Pyramids.

Obviously, regulators are not going to manually review nine million files – although with the government in charge you never know. There will be a sampling process which, as it will be designed by regulators and signed off on by politicians, will not identify anything but the most egregious violators. Locating a single fraudulent mortgage file will lead them to dig deeper at the same lending institution. The way the vetting is likely to be set up, if a pattern of bad mortgages is discovered, the program will probably have to bypass the institution altogether and issue an Enforcement referral against the lender.

This means that legitimate mortgages could be swept aside, as the entire loan portfolio of the suspect institutions is classed as potentially fraudulent. This is potentially good news for lawyers who wish to file class action lawsuits against the government for legitimate borrowers who took out good faith mortgages from cheesy lenders, only to be automatically bypassed by the President’s homeowner bailout. The story of Keeping A Roof Over America’s Head has not even begun, and we already know it will not work.

The Wall Street Journal, in a recent editorial, (2 March, “Call Them Irresponsible”) quotes the following statistic: “Mortgage fraud exploded during the housing boom and appears to have continued even as home prices fall. In December the Mortgage Asset Research Institute reported that mortgage fraud increased 45% in the second quarter of 2008, compared to a year earlier. The Treasury's Financial Crimes Enforcement Network reports a similar rise for the full year ended in June of last year.”

Fraud thrives on bureaucratic inefficiency. Stepping up the pace and bringing in a forensic team will do nothing, as long as they are committed to promoting a politically attractive oversight model focused on getting the Bad Guys. In any agency, the sheer volume of day-to-day work that needs to be processed is overwhelming. Assigning new forensic investigators will create added burden on existing staff who, in addition to processing thousands of current files a day, will now also have to retrieve and assist in the review of millions of old files. Chairman Bair’s statement that this is “simply impractical” is worthy of an Oscar for Most Understated Utterance by a Government Official.

The FDIC actually has experience in running these accelerated reviews. In August of last year, the agency brought some eighty seasoned bank work-out professionals out of retirement, bolstering the staff of approximately 4600. These former agency staffers were formed into SWAT teams and sent across the country to address the spike in problem banks by identifying problems in loan portfolios and reassuring the public that their deposits are safe.

Viewers of CBS News’ “60 Minutes” were treated to a glimpse into the world of the FDIC in Sunday’s broadcast (8 March, “Your Bank Has Failed: What Happens Next?”). The news team followed an actual bank takeover, and interviewed FDIC staff as it was happening. To all appearances, the FDIC process was characterized by care, confidentiality, thoroughness and thoughtfulness. FDIC personnel, from Chairman Bair to the accounting staff on the ground, recognize that they are dealing with the most fragile, and most critical part of the Capitalist system: the individual whose money is on the line.

Chairman Bair related how painful it was to her to watch news broadcasts of frightened depositors standing in line outside of IndyMac branches, and agency staffers are well aware of the irony that big banks get bailed out, while small ones get wiped out. Ms. Bair was making our case on prime time: institutions that, by their very size, pose systemic risk, are not Too Big To Fail. They are Too Big To Regulate. Ms. Bair made the observation that Congress may be gearing up to legislate limits to the size and scope of financial institutions.

While this may sound like Communism at work, we used to have a law like that on the books. It was called Glass-Steagall. Not only did it work reasonably well, we trace the roots of the current global crisis to the process that undid that law’s restrictions. It was not that people all of a sudden got greedy. It was rather that the Government – from Congress, to the Presidents, to the Federal Reserve – all decided that Greed Was Good and should no longer be subject to legislative restrictions.
Chairman Bair and her agency come off looking more professional, more level headed – and certainly more truly concerned for the well-being of the people affected by this crisis – than anyone in Government, including the President.

For a bit of perspective on what the FDIC’s staffing and resources requirements are going to be: the program to temporarily bolster the FDIC staff was put in place to address the upsurge in bank failures. Three banks failed in 2007, while in 2008, there were 25 failures, costing the FDIC $18 billion. Reports indicate (CNNMoney.com, 27 February, “Bank Failures May Cost FDIC $80 Billion”) the agency is on a pace to seize one hundred banks in 2009, for which the $22 billion it has already budgeted may be far too little.

The good news: this is not taxpayer money. Yet. Chairman Bair has announced a stiff premium increase for the banks, in the face of the very real possibility that the agency could be wiped out before the end of 2010. She told “60 Minutes” that the agency has budgeted to lose $65 billion on bank closings over the next five years, but everyone assumes that is an extremely conservative figure.

The decision before the President is how to get the best result out of the agencies of his Administration. Abuses in the marketplace go largely unreported until there is a crisis. Unsuitable and unauthorized trading in retail brokerage accounts during the ‘nineties did not become an issue until the dotcom meltdown, when a rash of arbitrations and lawsuits were unleashed. Similarly, the Financial Times (4 March, “FDIC Braced For Surge In Mortgage Fraud”) reports “a 44% rise in reports of suspicious mortgage-related activities”. The tip of the iceberg of past years’ fraud is breaking the surface. And new fraud is charging ahead, with people gaming the government’s new emergency financing facilities. It’s going to get ugly. We hope President Obama will not permit the ugliness to spin out of control by forcing Chairman Bair into an impossible course of action for questionable political gain. Not when she is so well on course to get some real results.

President Obama is no longer Candidate Obama. He now has the political backing to address hard facts bluntly. The hard fact here is that these Liar Loans are largely water under the bridge. Unless they come to light through investigation of the rash of complaints flowing into the FDIC, no targeted review program will be effective in rooting them out.

Hard decisions must be made, and hard facts need to be put before America and the world. The markets are clamoring for it, and the world is waiting for the US to make its move. It will be better for all, and more effective in carrying out the real work of government, if President Obama takes the lead in pushing hard facts in our face.

On a related note, bank robberies in New York City are up more than 25% over last year. Caught on tape, one hapless bank robber hit three Chase branches without success before wandering into a TD Bank branch. Unlike Chase, TD tellers are not shielded by bulletproof partitions. The robber walked out with a fistful of cash and proceeded to hit other TD branches, where he repeated his success. TD management says it is unfair to single them out, though they must admit that they have certainly lived up to their advertising slogan: “America’s Most Convenient Bank”.


You are entitled to your uneducated opinion, just the same as Henry Kaufman is entitled to his uneducated opinion.
- Weintraub

Ken Lewis is flagellating himself over taking your money to pay for Merrill Lynch, saying it was a bad idea because B of A doesn’t need it, and has ended up with its activities being curtailed as a result. Mind you, in a show of confidence, Mr. Lewis spent two million dollars of his own money to buy 400,000 B of A shares in January and February. His dedication notwithstanding, Lewis is now being targeted for removal. CtW Group, an advisor to nearly $2 trillion in pension money, has sent a letter to Bank of America Lead Director O. Temple Sloan calling for Mr. Lewis to be sacked.

The CtW letter refers to a meeting held one year go, at which B of A’s directors promised CtW explicitly that they would responsibly oversee Mr. Lewis’ activities. Here’s a snippet: “… we indicated our intent to oppose the directors' re-election at BAC's 2008 annual meeting. In response, you invited us to a meeting in Charlotte during which you assured us the board was diligent in its oversight of management and had already taken steps to substantially improve risk management. Based on these assurances, we did not oppose the election of any BAC directors.

The board, however, subsequently allowed Mr. Lewis to take outsized, reckless risks by acquiring Merrill Lynch.” Heaven forefend anyone should actually be punished for this egregious violation of public trust – CtW is quick to lay aside any grievance against Sloan and other B of A directors for lying to them about holding Lewis to a responsible course of action. What the letter implies is, if you give us Lewis’ head, we won’t clamor for yours. In the world of market Realpolitik, this might be the best that B of A shareholders can hope for.

Meanwhile, Lewis has just announced that he will stay until the government money is paid back. Lest we take this as Mr. Lewis shouldering the burden, bear in mind that, as a Bailout recipient he can’t take a multi million-dollar bonus. He has now reassured us that he’s going to hang in there until he can. This matter remains for B of A and its squeaky-wheel shareholders to duke out, but overall it does not look good for the marketplace. B of A, as we mentioned last week, holds over 11% of all deposit money in the US. Wanna start somethin’’? Maybe not.

Meanwhile, lest you think the Government is having second thoughts about having given our money to Mr. Lewis so he could take down a size block of stockbrokers, we have just heard the ultimate sales pitch.
“What you’re now seeing is profit and earning ratios are starting to get to the point where buying stocks is a potentially good deal, if you’ve got a long-term perspective on it.”

We don’t know who is supervising Registered Representative Obama’s sales activities, but the compliance officer in us responds favorably to expressions such as “starting to get to the point”, “potentially”, and “long-term”. A balanced presentation. Bullish, yet without puffery.

With the President’s roots in Chicago, home of the Mercantile Exchange, we wonder whether we can ask them to list Kool-Aid futures. There seems to be a spike in demand for the underlying.

So tell us, Barack. What do you like in here?

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EYE ON EASTERN EUROPE: A Currency Respite for Hungary

The Hungarian Forint made gains today versus the Euro after the country’s central bank announced it will sell Euros from European Union grants.

The move comes in the wake of a tumbling Forint after the EU rejected Hungarian PM Ferenc Gyurcsany’s request for a $230 Billion aid package to distressed Eastern European countries and further fear that the country’s recession would deepen.

Hungary’s monetary move to bolster its currency follows our thesis – “When You Can’t Cut”, implying that the need of many nations in this region to strengthen their devalued currencies trumps the benefits associated with cutting interest rates.

The strengthening of the Forint is only a near-term solution for a country in its worst recession in 16 years. Hungary was the first country in the EU to take international assistance to avoid default last year, which on the margin is positive. The $35 Billion loan from the IMF has helped to shore up its banking system before the rest of the manic news about Eastern Europe hit the presses. We’re not close to deeming Hungary’s economy or growth potential as healthy, yet are actively differentiating its prospects with those of its neighbors.

Matthew Hedrick

G.I. Joe’s Finally Takes A Bath

This Northwest SG retailer, which has about 1.5% share of the sporting goods industry, has been on the skids for years. It finally filed Chapter 11 last week but appears to have done so in way that will allow it to operate as an ongoing concern for the near-term. That said, we’ve all seen this story before. First step is to look at the vendors and payables – which is outlined in the table below. Some key notables…

1. Columbia is the largest creditor, with about $888k at risk. This is about $0.02 per share in a quarter where the company guided to $0.06. I’m modeling closer to $0.20.

2. Under Armour is #4, with similar math as COLM. $648k, or just shy of a penny a share in a quarter where the Street is at $0.03. I’ve got UA earnings about twice that.

3. Perhaps the biggest notable… Where’s Nike? Joe’s is based in Nike’s backyard, and there’s no exposure here at all. Team USA at Nike did a great job keeping this one on a tight leash.

SP500 Levels, Refreshed...

This morning’s strength in the US stock market is more of the same – squeezing inexperienced short sellers in a market that is to be traded, and faded (on both sides) aggressively. Unfortunately, without the US Dollar having a down day, immediate term strength in stocks is fleeting, so we sold into the strength…

Selling strength? Yes, that’s what you do in raging bear markets – buy when no one is allowed to, and sell the short term rips. In this morning’s Early Look, I wasn’t making a call on the next bull market – I was making one that A) this isn’t a Depression and B) oversold bear market bottoming processes can be traded.

Below I have outlined what I think is turning into a trading range that is starting to assert itself. The shaded green zone is the “BUY for a Trade” zone (or the no fly zone for short sellers), while the dotted red line at SPX 713 is what we call the “Shark Line” (the line that matters from an immediate term price momentum perspective – if we close above it, the shorts get eaten all the way up to 770… if we close below it, whatever bulls are left will continue to get frustrated).

Keep moving out there,

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