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Trouble Brewing in Europe?

China’s renewed pricing power in apparel/footwear exports is showing up left and right. China imported 211,000 tons of Cotton in June –off 16% vs last year. Why the decline? It probably has something to do with the fact that 50% of the 20,000 factories in the Dongguan province in China have closed year-to-date. It does not take much to do the math there. Lower production = diminished need for inputs. This plays into my theme of China passing pricing power through to marginal US players. I should note that India, Thailand and other Asian countries are picking up the slack production, but thus far are following China’s pricing lead. I’ll be keeping a close eye on whether anyone breaks rank.

An interesting call out is the rather meaningful shift we’re seeing over the past few months in Chinese exports by destination. The growth rate in shipments to the US is slowing meaningfully, but we’re not seeing carry through into the EU. The European retail environment has been strong enough to accept price increase to a certain degree, but that’s starting to turn. I’m starting to scout out potential losers vs. winners in Europe. Stay tuned.
EU and US imports from China are diverging at the wrong time for European retailers and those with exposure to the region.

CURRENT TRENDS IN CASUAL DINING

The current NPD data suggest that despite the gloomy economic situation, Casual Dining posted a 1% increase in traffic this quarter (The Knapp data suggest a 3.8% decline in traffic trends). Two key factors are driving the trends at casual dining.

First, the consumer environment looks bleak (consumer confidence hit a 16-year low) and consumers have very little disposable income in their pockets. Contributing to slightly better trends in the most recent quarter was the government’s stimulus package, which supported a +4.0% increase in Real Disposable Personal Income in Q2. Second, restaurant operators increased their promotional efforts and consumers took advantage of them.

  • According to NPD, customer deal traffic rose 6% while non-deal traffic was down slightly. Looking at Casual Dining, the segment was weak during its core business segments with no growth at the important dinner daypart. Lunch traffic grew significantly with 4% more customer visits this quarter. The increase at lunch included improvement on both the weekday and the weekend time periods.
  • Importantly, discounting and Combo Meal visits accounted for half of Casual Dining growth this quarter supported by promotions from major chains and increased visits with kids. The Bar and Grill category posted the largest gains this quarter. The casual dining “varied menu” lost traffic, which suggested a trade off to Bar and Grill. When consumers decided to go out to eat, side dish items were left off, while beverages posted solid growth supported by gains in healthier beverage options. Consumers are also cutting back on consumption of alcoholic beverages.
  • Some areas to consider looking forward: 1) it’s unlikely that another stimulus package will be passed by congress to help buoy consumer spending. Fortunately, gas prices have begun to ease up a little, which may help improve consumer confidence and free up some discretionary dollars. 2) Consumers will continue to look for promotions, a trend that was evident over the past three months. It’s critical that restaurant operators engineer promotions to provide attractive offers to consumers (possibly with new offerings) while trying to preserve margins.
  • My guess is that EAT’s quarter will look better than most in the casual dining space.

PENN: “BASSET” SWAPS AND VALUE CREATION

Gaming companies have a problem. Business risk is high, balance sheets are highly leveraged, credit markets are closed, and liquidity begins to dry up in 2010. PENN has a different problem. While PENN maintains the best balance sheet and liquidity to make a value creating acquisition, gaming companies are probably unwilling to sell assets or their companies at the bottom. There may be a solution: a bond for asset (“Basset”) swap. Theoretically, PENN could buy discounted bonds in the open market and trade them back to the Issuer in exchange for an asset, presumably a casino/hotel. PENN effectively buys the property at a discount and the seller deleverages at par. It seems like a win/win situation; maybe not for the bank who holds the credit facility, but certainly for the direct counterparties.

Conceptually, swapping discounted bonds for a coveted asset makes a lot of sense. There are a couple of issues, however. First, the covenants in all indentures and credit facilities senior to the purchased bonds cannot restrict the use of proceeds from asset sales. Second, as with most casino asset sales there are always tax issues. It is unclear whether the seller would be able to make a tax free exchange but that would certainly seal the deal.

In the following table, I’ve outlined a generic analysis of how this transaction would look to the buyer and seller assuming no covenant or tax issues. Clearly, PENN benefits from buying a property worth 10x EBITDA for 7.5x. The seller sees its leverage fall 4x to 3.3x and is now in a better position to obtain new liquidity from the credit markets.

This is by no means an exhaustive study of “Basset” swaps but it does indicate that there may be options for PENN to expedite an attractive acquisition. Alternatively, the company will be patient to get what it wants at fire sale levels. Presumably, potential sellers will get more desperate as we approach the beginning of what could be a gaming liquidity crisis beginning in 2010. PENN seems to be alone in dealing with this high class problem.

Hypothetical "Basset" Sale

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Missing BRIC's In The Walls: Russian and Brazilian ETF's

The Russian Stock Market lost almost -6% of its value today, and now the RSX is chasing its consensus momentum ETF friend in Brazil (EWZ) down to the bottom of the July performance barrel.

These levered plays on commodity inflation are down -21% and -22% since mid May, when we made our "Fading Fast Money" call (see chart).

It may be time to call your broker and ask them what exactly resides within these ingenious ETF instruments.

KM
Charts by Andrew Barber, Director - Research Edge, LLC

Republicans Are Going To Love This Picture

Post the Berlin love fest yesterday, and plenty of Republican distaste. We thought we'd highlight the similarities between Hollywood's finest and rock star Bon J-Obama.

Keith McCullough & Andrew Barber

Charting Japan: Breaking Down - Short It

The Nikkei in Japan lost another -2% overnight closing down at 13,334. Fundamental and quantitative factors in Japan continued to break down this week. Yes, I know Japan is “cheap”, but I also know that this is still the world’s 2nd largest economy, and that it wont be forever. With each passing day, the Japanese government puts themselves in a higher probability position of losing global market share.

I highlighted yesterday’s abysmal export data released by Japan, so I won’t rehash that note. I will however remind you that this is an island country that continues to pander to the socialist demands associated with economic stagnation and deteriorating population growth.

The Nikkei is broken. I have a near term downside target of 12,501.

*Full Disclosure: I am short Japan via the country ETF (EWJ)
KM
(chart courtesy of Stockcharts.com)

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