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Another Positive UA Nugget

While we'll never hear a retailer outwardy bash UA, the tone on the DKS call supports my view on the health of the brand and near-term success of running launch.
No mention of brands in prepared remarks. But In answer to the first question on Q&A...

a. Not reducing any of the major brands (e.g. NKE, UA, etc.) - it's the other brands that they've scaled back on

b. UA running shoes have done quite well

BYD: DEVIL’S IN THE DETAILS

Boyd responded to the rejection of its offer to buy Station Casino’s OpCo assets by reaffirming its offer. Station’s Board rejected BYD’s offer last week, citing concerns surrounding BYD’s financial position and the risk of sharing sensitive financial information with a competitor.

This situation is not likely to be settled soon and the decision will ultimately reside with STN’s bondholders. The most important near term takeaway, however, may be the strength of BYD’s financial position as discussed in BYD’s response filed as an 8k with the SEC yesterday:

“Boyd Gaming reiterates that it has sufficient liquidity under its credit facility to finance a cash transaction, and contemplates that no amendment to its credit facility would be required under the proposed transaction structure.”

What should be noted here is that BYD would not require any amendment to its credit facility to complete the transaction. This is critical to the BYD story. Clearly, unlike the Street, BYD is comfortable with its covenant situation, and more importantly, so are the banks. I’m pretty sure the banks were consulted, and gave their consent, before the offer was made.

I recognize the challenging fundamentals facing BYD this year. However, given the increasingly apparent strength of its financial position, the stock probably should not trade as an option. The regional markets are stabilizing and there is reason to be optimistic about the Las Vegas locals market in 2010. Picking off some of the Station assets would be gravy.

SHAKE AND BREAK

"Gentlemen Prefer Bonds"
-Andrew Mellon
 
With all due respect to Mr. Mellon's legacy of philanthropy, I'll continue to take the other side of that "safety" trade in 2009. I'm not lending my money to the US government and US Corporates. They have resorted to begging for the world to buy into that old saying... it is un-American, and quite sad altogether.
 
Both US corporate bonds and now US Treasury bonds have gone from shaking in my macro model to breaking. For some time now, I've expressed our short thesis on what Wall Street storytellers call "corporate high yield" (it is actually junk) via a short position in the LQD (corporate bond ETF). I am also short shorter-duration US Treasuries (1-3 year bonds) via the SHY exchange traded fund. While plenty of gentlemen are still long these bonds, they aren't working out for them like they have forever.
 
Today, the US government will issue another staggering $34B worth of 3-year Treasuries. This is the other side of Paulson and Geithner's free money program - it doesn't come out of thin air. As the said leaders of this country continue to socialize Wall Street's losses with debt issuance, bonds are breaking down, and yields are breaking out.
 
As yields breakout from their longstanding low cost of capital Trend line, over-geared business models start to Shake and Break. While it has the same ring to it, do not mistake this for Will Farrell's "Shake and Bake" move in 'Talladega Nights' - this isn't a go to move for those addicted to leverage! This is more like a leading indicator for their investment vehicles getting wrecked.
 
As cost of global capital continues to accelerate and the access to it continues to tighten, you end up with a marked-to-market value of equity that is lower than what it was before. Whether that equity is "Private" or GE's, it doesn't matter - returns go down on said "equity" when your financing costs go up.
 
No, this isn't that complicated to understand, but it's very difficult for those who lust for leverage to explain. For the last 25 years, the cost of capital in America was conveniently politicized (decreased) at every sniff of an economic growth yellow flag. The go to "Shake and Bake" move by many executives was simply to step on the gas, raise more equity, and pile it on top of losing positions, and/or sell it high to some other poor soul at a private equity shop who didn't do global macro who was perfectly willing to earn a fee to do the same...
 
Ask the folks in the fur coats up in Iceland how this scheme ends. When the debt burden starts to Shake and Break, it's over. Iceland's stock market is obviously a gong show that comes into focus from time to time. Yesterday, it crashed for another -15% down move. These Icelandic guys once fancied themselves as capitalists, like the old American kind who are watching West Texas crude oil breakout of its base alongside these higher interest rates (we're long Oil)... but make no mistake, there is nothing that focuses the mind like a good ole fashioned hanging used to in the wild West ... Shake and Break anyone?
 
The worst part about the Shaking and Breaking in the Treasury market is that we have an incompetent team running the US Treasury (or is there anyone on the team - they can't seem to find Timmy any teammates). No wonder why the deer in headlights (Timmy Geithner) has only found one US market savant to support him (Jimmy Cramer).
 
I wrote an Early Look called "Jimmy and Timmy" a few weeks back, and poor Cramer felt obliged to bust out his Shake and Bake move of an op-Ed in the New York Times - for those of you who'd like to hold Jimmy accountable, I am sure you can find a reprint of that wonderful piece of whatever that was...
 
The New Reality is this: The New York Times ran a headline article on the US Dollar's strength yesterday, and that was equally as relevant, from a contrarian's perspective, as Cramer getting air time on making a macro call - when these things happen, in unison, at a bare minimum, get out of the way.
 
As the US Treasury market continues to break down, the US Dollar (and support for Timmy) will wane. This is good. As the US Dollar strength loses its momentum, US stocks should continue to lose their downward price momentum - on the margin, this is one more reason why stocks are looking to put in an immediate term bottom here.
 
To be clear, this is a Trading bottom. Especially in raging bear markets, bottoms are processes, not points. As the US stock market's volume readings continue to decline, and volatility (VIX) continues to dampen, we're getting closer to that Shake and Bake move called the short squeeze.
 
Immediate term price momentum in the US Dollar index will break at the 88.53 line. We have tested and tried the 89.00 US$ Index level on 3 separate occasions in 2009 - a third failure to break-out of that sound barrier will force people to look at this through our cross asset class lenses...
 
My immediate term upside target in the SP500 is 711. If we close above that line in the face of a US Dollar finally being de-valued (and you're short this market), my advice would be to make sure you have your chin strap done up. Above that line, the short seller of US equities is going to Shake and Break.
 
Gentlemen, start your engines...



LONG ETFS

EWA - iShares Australia-EWA has a nice dividend yield of 7.54% on the trailing 12-months.  With interest rates at 3.25% (further room to stimulate) and a $26.5BN stimulus package in place, plus a commodity based economy with proximity to China's H1 reacceleration, there are a lot of ways to win being long Australia.

USO - Oil Fund- We bought oil on Friday (3/6) with the US dollar breaking down and the S&P500 rallying to the upside. With declining contango in the futures curve and evidence that OPEC cuts are beginning to work, we believe the oil trade may have fundamental legs from this level.
QQQQ - PowerShares NASDAQ 100 - We bought QQQQ on a down day on 3/2 and again on Friday of last week.

SPY - SPDR S&P500- We bought the etf a smidgen early, yet the market indicated close to three standard deviation oversold.

CAF - Morgan Stanley China fund - The Shanghai Stock Exchange is up +18.5% 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 on a down day. 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.

SHORT ETFS

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 2/26 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 $1.2688. The USD is down versus the Yen at 98.3480 and down versus the Pound at $1.3834 as of 6am today.


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PSS: Thoughts Into the Quarter

Here’s our detailed EPS/Margin Walk highlighting the puts and takes to watch out for vs. last year. Fundamentally, this is a name that will be tough to ignore in 2Q/3Q.

Here’s our margin walk for PSS, which reports after the close tomorrow. This name has been one of our favorites for a while fundamentally (Rubell is one of the best CEOs in retail), but the price has not aligned with our timing/sizing models. I’ll let Keith speak separately on the price, but I think we’re getting closer to the point where this story is tough to ignore. I think PSS will start beating EPS expectations more consistently, and that estimates for the upcoming year will prove too low (we’ve got EPS growth of 10% vs. the Street at -2%). Most of the juice in the model starts in 2Q/3Q – when the duplicative DC comes off line at the end of Q1, Saucony and Sperry benefit from investments made in ’08, direct sourced and branded product hit more of a critical mass in the stores, and we start to anniversary poor P&L and Cash Flow numbers. In the meantime, I think the quarter tomorrow looks good relative to expectations (i.e. the number should be abysmal, but ‘less toxic’ than the Street is modeling). See our overview below and call me for any follow up on the assumptions.

Casey Flavin
Director



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

Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.28%
  • SHORT SIGNALS 78.51%
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