Unfortunately, if commodity prices decline significantly, we could see another significant problem develop as most American farmers would incur huge losses if commodity prices returned to historical averages. According to a University of Illinois study, farmers are facing significantly higher production costs in 2009. As a result of the increase in input cost, higher breakeven prices are required for corn, wheat and soybeans.

  • According to the study, for corn, non-land production costs for 2009 are projected at $529 per acre, a $141 per acre increase from 2008 levels of $388 per acre and an 85% increase from the average $286 per acre cost incurred in the 2003 to 2007 time period. For soybeans, non-land production costs for 2009 are projected at $321 per acre, up by $82 over 2008 costs of $239 per acre and up 78% from the average 2003-07 level.

  • Looking at input costs, farmers are seeing the largest cost increase in fertilizer. For corn, fertilizer costs in 2009 are projected at $215 per acre, an increase of $97 per acre over the 2008 projected level of $118 per acre. For soybeans, fertilizer costs in 2009 are projected at $98 per acre, a $53 increase over the 2008 level of $45 per acre. In addition, seed costs are projected to increase significantly.

  • The study suggested that based on yield expectations of 191 bushels per acre, the 2009 breakeven price for corn is $3.82 per bushel. The soybean breakeven price is $9.65 per bushel. Needless to say, these breakeven prices are significantly higher than historical commodity prices and appear to be going higher.

  • CORN
    Corn futures closed down sharply, amid widespread commodity declines and pressure from outside markets, including crude oil and soybeans. According to the CME, “seasonally we’re at the time of year where we generally decline and weather forecasts continue to offer little support to the market.”

    U.S. wheat futures closed lower on spillover pressure from weakness in other markets and on forecasts for increasing world production. Losses in corn, soybeans and crude oil weighed on wheat. It also was seen as bearish that the analytical report Strategy Grains raised its 2008-09 European Union soft wheat production forecast to 131.7 million metric tons, up 2.7 million tons from the June projection. From a fundamental standpoint, it would appear that a big world crop is getting bigger.

Dramatic Increases in Corn and Soybean Costs in 2009 Chart from the University of Illinois report

Play Some Offense!

“Ok McGough, we’re tired of you and your team sounding all gloom and doom.” Don’t think I have not heard that from several people. But the sheer downside that remains in this space from a ‘Trend’ perspective (i.e. 3 points of margin erosion over 2-3 years) coupled with the market’s misalignment with economic reality, have supported a very bearish view. But as my colleague Keith McCullough has pointed out starting with his 10:59a.m. posting on 7/15, the ‘Trade’ is serving up a great opportunity for us to be selectively bullish, and ultimately capture volatility on both ends of the spectrum. To all you stock pickers out there – this is when you earn your keep!

In that context, here are the names I like, as well as those that pose the biggest risk.
1. RL: Coming off an ‘investing mode’ period while the rest of retail was printing peaky margins. Now costs start to ebb when RL’s revenue starts to flow (Japan, handbags, dresses, Russia, leather goods, footwear to name a few initiatives). Numbers look very beatable, and cash flow trajectory is one of the best I can find in this group. Do I like valuation as much now given that so many other names have become so dang cheap? No. But the sustainability here is very impressive and numbers are low. I’ll take that, and I think the market will too.

2. TBL: The poster child for a company that invested in its business and took margins down when things got tough instead of cutting into muscle to keep margins high. I think that margins have hit bottom, and that this stock is a 2 year double.

3. FL: A massive industry shift over 4 years away from core athletic disproportionately hurt comps. Add on horrendous conversion and a boost in lower-margin Nike product as a percent of the mix, and margins went from 7% to 1%. Now performance trend is turning, and Under Armour will help on the margin. Layered over a lower cost structure and flexible lease terms, this much-hated name made it to my list of favorites.

4. LIZ: Management’s has a colossal task ahead. The good news is that cost cuts have been overinvested into the biz over the last two years. Now we’re at a point where either 1) LIZ harvests, 2) LIZ cuts, or 3) LIZ restructures massively. With cliff vesting for options in ’09 to jump start near term performance, I like how this is shaping up.

5. PSS: Not a name I’ve spoken about much recently, but one I like. Coming off a horrific year for the industry, an ill-timed acquisition, and a recent cash-draining lawsuit ruling. Not good for a zero square footage growth retailer. But all my math still tells me that this company can take up mix to the mid-teens from low-teens today. Also, with such broad distribution and with an arsenal of brands including Sperry, Keds, and Saucony, I think that PSS has the goods to be one of the winners in the new footwear landscape.

6. CRI: After being bearish on CRI’s model for a while, I pulled a 180 on CRI after the recent management change. Once earnings come down again this should shape up to be a good one.

1. WRC: Yes, it’s been a crowded short. But insiders are selling, inventory/sales spread is peaking, margin compares are getting tough, cotton costs are rising (vis/vis CK Underwear), and a cleaner P&L is making it tougher for WRC to sandbag. Not good.

2. ADI: Tough sales comps in ’09 due to European Championships ’09 and Beijing Olympics come in conjunction with frontal UA assault, Nike response, and almost zero consumer interest in Reebok. Add on extremely tough product cost increases and big FX risk, and it equates to being at the top of my short list.

3. GIL: One of the most misunderstood, and overly liked, companies in retail. A well executed offshoring strategy allowed GIL to take share and dominate its core category while improving margins by 30%. Now share is tapped out, and the strategy is changing to into a less defendable business. Sales are slowing, GM is tapped out, and SG&A is way too low to support meaningful growth. I think that every line item of this P&L is trending down on a multi-year basis.

4. VFC: I actually like the company. But sales growth is decelerating, margins are getting pinched, and capital spending is headed higher. Ultimately, it is very tough to make the leap in assumptions to get to a trajectory where cash flows don’t roll. Plus, it’s tough to argue with the stats that less than 5% of the shares are held short, the ‘buy rating ratio’ is at an all time high of 67%, and numbers don’t appear to be a slam dunk.

5. SKX: We’re hitting the end of a 4-year period where a shift towards fashion and away from performance footwear combined with sourcing tailwinds and FX benefit took up margins. Now biz is turning. Inventory is showing up in bad places (Goody’s), and management is selling stock. I think margins are cut by at least a third.

6. GES: I think that the margin trajectory at GES is unsustainable. While one of the better apparel companies, I think hindsight in 12 months will show lack of brand reinvestment at the top of the cycle. FX risk here is scary.

7. DKS: UA comp cycle + =rock solid consumer + easing competitive landscape + high vendor discounts = hidden impact from aggressive lease structure over the past three years. Now every one of those items has turned – except for the aggressive lease terms. Next Q looks ok, but DKS numbers should come down again. This is one I consistently revisit on pops, including a potential rally around a sandbagged 2Q.

8. PVH: A perennial favorite for the investment community, I can’t get over the risk of a 3-400bp deceleration in menswear sales – the likely fallout from the sheer magnitude of Wall Street jobs being cut (mens dress shirts and ties represent almost 50% of cash flow).

Old School

Another morning wakeup call – “feet on the floor”, as my Dad would say. It’s time to deal with some more market volatility.

At 1260, the S&P 500 has picked up a sharp +4.9% from its intraday low of 1201 on Tuesday, and is making its bid to close up for the first week in the last seven. This morning we have to deal with what I dare say is an improving macro picture, but a deteriorating micro one. Earnings season is in full swing – Google and Microsoft are trading down -7% respectively, pre market open. It’s time for some old school trading.

Actually one of my partners from my prior days in the hedge fund business called it that this week – “old school” – and it’s appropriate. He manages billions in long/short assets now, and he is up double digits year to date. He knows how to trade, and he definitely knows how to manage risk in a down tape. If you can combine those go to market strategies with some bottoms up stock picking, you’re going to get paid this year. There are plenty of stock specific alpha bits to chew on in and out of their respective earnings releases. An old school market of stocks is emerging from a stock market.

On the Global Macro front, I simply have to call the cards as they lay. My thesis that raising rates here in the US will fix a lot of what troubles the collective wisdom of the crowd is playing out this week. Bernanke has finally admitted to the US stagflation problem, reported Asian economic growth has slowed, and the implication of near term Fed rate hikes has pushed both short and long rates up. This has crushed US bonds and stabilized the US Dollar.

This 3 day “Macro” move should be understood as a “Trade”, however. We still have a lot of hay to bail before we can open up the barns doors that we had Sally lock down, and call this a fundamental “Trend.”

For a macro “Trend” to manifest, I need to see some follow through in Bernanke’s ostensibly changed rhetoric – following through like leaders do, putting some action behind his words. I think he can raise rates by 75-100 basis points and nothing changes in terms of how Main Street America wakes up in the morning. This will help stabilize what continues to look like a pending US Dollar crisis, crush short term commodity inflation, and washout the remaining business models in this country who depend on free money leverage to earn fabricated returns.

If the US Dollar Index can close above $72.61, the CRB Commodities Index break down through the 427.96 line, and Oil close under $125/barrel, we have ourselves the right cocktail to head into our summer weekends.

For now, we’re going to head into this weekend with oil finding it’s Middle Eastern geopolitical risk bid, and the “Bear” market winning the benefit of the doubt.

Yesterday’s resistance level in the S&P 500 now becomes my support. If we break down today, and close below 1245, we could see an expeditious 30 point decline in the index.

Mr. Bernanke, the timing is perfect to draw an old school line in the sand!

Have a great weekend.

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“All politics is local”. This quote is often attributed to former Speaker of the House Tip Oneill but actually was coined by his father. My analysis in the gaming sector has proved that “All economics is local”. Yes many components of the national economy are in rough shape, particularly consumer spending. However, the performance of the local economy is what is important. Gaming markets exposed to the energy economy (Louisiana via Texas) are outperforming others such as the Las Vegas locals market. Diving deeper I was quite surprised by the relative importance of individual economic factors.
  • The commonly held belief espoused by analysts and casino executives is that the unemployment rate is the major economic driver for gaming revenues. I think I’ve debunked that theory with some hard math. Over the last 10 years local median housing prices are more statistically significant in predicting local gaming revenues, not unemployment and not gross metro product (GMP).
  • The first chart clearly shows the strong correlation between average housing price changes across the locals casino markets (riverboat and LV locals) and average gaming revenue growth. With this in mind, look for LA to continue to outperform and the LV locals market to continue to struggle. In terms of stocks, PNK appears to be the prime beneficiary of the Texas regional strength with over 50% of its revenue derived from Louisiana.

  • The second chart provides a snapshot of the locals Las Vegas historical economic and revenue picture. Here, GMP actually proves to be the most important driver of gaming revenue historically in this market. Check out the economic volatility. Boom or bust in LV I guess. It’s no secret that Boyd Gaming and Station Casinos have been struggling during the local recession there.

    You can bet that we’ll continue to have our eye on local housing prices.

LEH: 72 Hours Later...

Lehman is up +52% from its closing price on July 14th. Was today’s +14% move the end of the pain trade, or just the beginning? I have a critical resistance level of $21.63, and would not be surprised to see LEH test that. If it fails there, on volume, it could go back to $10.11 in a hurry.

This stock epitomizes what we were talking about this morning. Very few US centric hedge funds have a risk management process to handle this kind of stock specific volatility. Winners and Losers will emerge.

If you’re not a trader. Don’t trade this stock.
  • LEH +14% Today on 72M shares
LEH 72 Hour Squeeze

Oil Futures Charts...

Contango remains in the Oil Futures market. Now things get really interesting.

Andrew Barber
Research Edge
The sell-off in oil hit the front month hardest with heavy volume in the August contracts.
Although the liquidity gap is profound, as volatility has driven out smaller speculators and larger players increasingly build capacity in the physical market, the divergence in liquidity between front and back month contracts has actually CONTRACTED over the long term historical -narrowing contango.

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