Bullish on Beaver: Why We Like Canada On The Long Side

"Canada is the linchpin of the English-speaking world."
    - Winston Churchill


Positions: Recently sold our long position in Canada via EWC, but have a positive bias...


The lack of correlation continues to resonate in global equity markets.  While we can debate whether Churchill's quote above is still true, year-to-date Canadian equities have been the leaders versus their major English speaking counterparts, specifically the United States and the United Kingdom. As of yesterday's close, Canada's TSX was up +1.5% YTD, the SP500 in the U.S. was down -7.9%, and the FTSE 100 in the U.K. was down -10.0%, so we can accurately say that Canada is currently the linchpin of English speaking equity markets. 


We recently sold our position in Canadian equities, which we owned via the etf EWC, for a 12.6% gain.  This was a fortuitous sale as EWC is trading at $17.37, down 6.9% from last Friday's sale price.  Clearly, when commodities deflate, as they did on Monday, with oil down  ~-9%, it will be challenging for natural resource-rich Canada to outperform. 


The Canadian economy is heavily levered to both natural resources and financial services, which is reflected in the holdings of the EWC.  In the chart below, the top 10 holdings of the EWC are outlined - three are banks and six are resource-related companies.  While the Canadian banks have suffered in the global economic malaise they are much better capitalized than their American counterparts and have substantially lower exposure to bad debt either through housing or leveraged loans.  As a point of fact, no major Canadian bank has either gone bankrupt or been in any real risk of bankruptcy.


Bullish on Beaver: Why We Like Canada On The Long Side - can1


This morning the Bank of Canada followed their U.S. counterparts and effectively lowered interests to zero.  The BOC noted in their statement that:


"Today's decision to lower the policy rate by 25 basis points brings the cumulative monetary policy easing to 425 basis points since December 2007. It is the Bank's judgment that this cumulative easing, together with the conditional commitment, is the appropriate policy stance to move the economy back to full production capacity and to achieve the 2 per cent inflation target."


With the overnight rate at 0.25%, the Canadian government will have limited ability going forward to stimulate, which is not dissimilar to both the United States and the United Kingdom where the overnight rates are at all time lows.  Canada though, in contrast to its two counterparts, has a much healthier balance sheet and seemingly better growth prospects. 


According to the most recent data, Canada has $365BN in public debt, the United States has $11,152BN, and the United Kingdom is at $1,010.7BN.  On a per capita basis, this equates to $11,012 in Canada, $16, 595 in the United Kingdom, and $36,709 in the United States.  From a projected growth perspective, the IMF, which obviously is only one data point, projects Canadian GDP to decline at -1.2% in 2009, the United States to decline at -1.6% in 2009, and the United Kingdom to decline at -2.8%. 


As always, everything has a price, which is why we sold Canada on Friday, but with a healthier balance sheet, better growth prospects, and a banking system that remains largely intact, we will be revisiting it on the long side, particular vis-à-vis its English speaking brethren.


Daryl G. Jones
Managing Director


Bullish on Beaver: Why We Like Canada On The Long Side - can2

Squeezy Finds Meredith

As in Squeezy The Shark and the Meredith Whitney kind...


The financials are leading the market higher again intraday - this has basically been the tale of the tape since Meredith started her own firm under the flag of everything Depressionista. Financials straight up into the right, in classic contra indicator form. We appreciate the work you did Meredith, but is the bearish dogma perpetual?


My math has the bullish breakout line for the XLF (Financials ETF) at $9.31 (thick green line in the chart below), and TRADE lines of resistance up at $10.51 (we're a dime away from that chum line intraday here) and $11.69, respectively.


Keith R. McCullough
Chief Executive Officer


Squeezy Finds Meredith  - xlf


Let's start with the bad news.  Street estimates for 2010 are too high.  Our database of new casinos and expansions shows that industry slots into this market will decline almost 50% in 2010 from a down 2009.  Moreover, IGT's credit facility expires in November, 2010 and we believe the company will refinance by the end of this year at higher rates.  These two factors lead us to a 2010 EPS estimate significantly below the Street, $0.82 versus $1.09, respectively.  Lower EBITDA drives approximately $0.05-0.10 of the lower estimate with the remaining $0.17-0.22 generated mostly by higher interest expense.


The good news is that IGT has taken out $115 million in costs out of production (see our note from earlier today "IGT: COST CUTTING POTENTIAL") and could reduce SG&A and R&D by a total of $130 million if you believe they can revert back to 2006 levels.  IGT is manufacturing at about 35% capacity and with the leaner cost structure, the incremental flow through on accelerating replacement sale should be huge.  The question is when will replacement demand accelerate?  The North American slot floor is as old as it's been in 10 years.  Casino operators' balance sheets need to improve and distressed assets need to be turned over to better capitalized owners before demand picks back up.  We believe that won't happen until 2011.  By that time, pent up demand could generate huge increases in box sales.


In the following analysis, we attempt to provide a core earnings power estimate for IGT assuming: 

  • 1) the leaner SG&A/R&D cost structure
  • 2) the $100 million of production cost cuts is sustainable
  • 3) "normalized" replacement demand
  • 4) IGT's market share normalizes at 40%
  • 5) IGT refinances its credit facility at an all in rate of 6.5% and raises $500 million in new notes at 8.5%




As can be seen from the analysis, IGT has quite a bit of earnings power.  Given the pent up demand, IGT has the potential to "over earn" above the $1.40 for a couple of years should there be a v-shaped recovery. 


Investors playing the long-term recovery card could be handsomely rewarded but they may have to be patient.  Our 2010 estimate of $0.82 is well below the Street at $1.09.  Numbers need to come down before they go up.

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EWG: Why We Bought Germany Today

POSITION: Long Germany via the etf EWG


Despite GDP projections of negative 4-5% growth for Germany this year, we're bullish on the stimulus measures Chancellor Merkel and Co. have passed and believe Germany plays well as a long versus our short position on the financially levered and poorly managed countries of Switzerland (via EWL) and the UK (via EWU); the latter we just covered today.


Look for Germany to benefit from an uptick in export demand from China, especially if the Euro can stay below $1.32, and from Eurozone and US demand as the global recession moves out on the recovery curve.  In addition, the stimulus package may lead to economic growth that exceeds these dire expectations.


German investor confidence unexpectedly rose this month and the DAX is up 9.8% month-to-date, signaling that the pace of contraction is easing and the worst may be over, yet buyer beware. 


The ZEW Center for European Economic Research said its index of investor and analyst expectations for economic activity within six months rose to +13 from -3.5 in March, the highest reading since June 2007. Yet ZEW's gauge of current conditions fell to -91.6, the lowest since September 2003, from -89.4 in March.


Certainly the German economy looks to be improving, yet is not out of the darkness.  German industrial production fell 3.2% M/M in February, compared with a decline of 2.3% in Euro area, and improved sequentially over January's contraction of -5.9% M/M, according to Eurostat. The country's trade balance stood at +7.2 Billion EUR in January; exports declined 23% and imports fell 15% on an annual basis.


Although Germany's trade surplus is severely depressed from the previous year's surplus of 17.1 Billion EUR, the positive take-away is that despite declines in exports globally, Germany posted a positive balance.  In contrast, the UK posted a trade deficit of -8.9 Billion EUR in January and the majority of the EU came in with negative balances. 


German PPI yields a slightly unclear picture when examined on a monthly versus annual basis. The Federal Statistics Office said today that PPI declined 0.7% in March M/M and fell 0.5% Y/Y, after gaining 0.9% in February Y/Y. The numbers do help to confirm that inflation is slowing (as is the case across the EU) and that companies are either able to extend reduced energy costs to consumers or are forced to cut prices in response to waning demand. As PPI (and CPI) fall they'll put upward pressure on unemployment, which has risen sequentially on a monthly basis, currently at 8.6%  These fundamentals, especially from the Eurozone's largest economy, may help prompt the ECB to cut its interest rate from 1.25% when it meets next month.


Today Merkel met with finance and economic ministers to discuss a German "Bad" bank plan, which may be especially geared to its state banks (*Landesbanken). Proposals to clear some $1.1 Trillion of toxic assets from banks will be discussed in the next few days, which on the balance is positive.  As is often the norm, the Germans will take a "slow and steady" approach to a decision, with a government spokesman stating a decision could come shortly before parliament's July 3rd summer recess.


Matthew Hedrick


EWG: Why We Bought Germany Today - zewapr

Eye On India: Whole Lot of Nothing, So Far...

Rate cuts in India have not yet created real liquidity ...


The reserve bank reduced benchmark rates by 25 basis points today, the 6th cut in 6 months.  Although the timing of the cut was a surprise to most economists, collapsing wholesale inflation and declining production levels had clearly left the potential more cuts by the central bank baked in. 


At this point, the big question is not when there will be more rate cuts, but rather when that liquidity will pass through to the real economy. To date, the spread between average commercial rates and RBI benchmarks have hardly contracted while growth of commercial credit continues to decline on a sequential year-over-year basis.


Eye On India: Whole Lot of Nothing, So Far...  - india1


Eye On India: Whole Lot of Nothing, So Far...  - india2


To date, our opinion on prospects for India's recovery has diverged wildly from Street consensus because of a fundamental difference in how we interpret internal demand there: While our competitors see strength in India's lack of export dependence, we see weakness in a dependence on an agrarian sector which currently keeps over half the population employed on a bare subsistence level. One thing that both they and we can agree on however is the need for credit liquidity to help drive internal demand.


With the election cycle in full swing (a complex, manual process that will take weeks to conclude) political tail risk takes precedence in our model, but we will continue to watch the Indian market closely for signals that government measures are having an impact. Until we see some confirmation of that, we will retain our short bias on the India equity markets.


Andrew Barber

COH: Beware The Trifecta

I can drive a truck through the bull case and the bear case on this name. The bulls are winning today on the ‘better than toxic’ results. We’re the first to respect the premise that going from ‘toxic to bad’ is a positive event. And from a modeling standpoint, I think that COH has much in its favor for the next year. But I have too many concerns and questions that still need to be answered before I can get bulled-up over the long-haul. If I gain such confidence, I certainly won’t regret having missed out on another 10-20% move in the stock, so long as it’s clear to me that it will not be cut in half.


Bull Case:  Coach is perceived to be one of the best brands in retail, with meaningful growth opportunity on a global scale. North American comps are getting less bad, with the latest quarter down only 4% yy in a horrible high end retail climate. That’s happening at the same time where we’re seeing a ‘financial’ trifecta on the P&L and balance sheet. Check out the SIGMA chart below, it shows how Gross Margins have been dropping like a stone as SG&A has gone right up in each of the past four quarters. This is at the same time both working capital was squeezed AND capex headed higher. Now each of those factors gets better on the margin for the next year barring a massive stumble by the company.  Tack on the new dividend announcement and accelerated stock repo and the stock looks cheapish at 6x EBITDA.


Bear Case: Comps getting ‘less bad’ will only take the company so far given a secularly challenged wholesale business, and the fact that the company is stepping up its efforts to cut costs out of the system. Yes, this helps ’09 optically, but will it be at the expense of ‘10/’11 revenue and Gross Margins?  Maybe, maybe not. But the risk will certainly remain, and with margins still at a lofty 30%, there’s no structural support that would preclude them from going much lower. The kicker there is that COH generates 26% of sales in Japan. While many people like the US diversification and the exposure to the Japanese luxury consumer, I’m not in the camp that likes such heavy exposure to an economy that is terminally ill.  And this all comes from a management team that does not ‘do macro,’ and has argued in the past that women still need six handbags apiece regardless of the economy. That part of the narrative scares the heck out of me. Has management changed its tune and embraced the cyclicality of its business? Yes. But I have zero evidence or confidence that they are proactively managing it.


COH: Beware The Trifecta - 4 21 2009 8 18 23 AM



Brian McGough


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