- At face, the math is simple—farmers in the US have been growing less cotton to concentrate on high-priced soy and corn while their counterparts in Brazil have also focused on soy as well as sugar cane. Poor weather in the subcontinent may reduce the harvest for India and Pakistan by as much as 10% -making for increased competition for a smaller US harvest.
Naturally the primary driver and biggest puzzle in this equation is the world’s largest producer and importer of cotton, China; and specifically the remote Western autonomous region of Xinjiang, where a third of Chinese cotton is grown.
It has been a tough year for cotton farmers in the Xinjiang. Skyrocketing rail transport costs and a rapidly tightening credit market saw inventory at east coast textile mills drop to levels as low as 15 days compared with 50 days or more at this time last year. In May, state media reported China Cotton Association estimates of 1 million tons of unsold cotton piled up in Xinjiang warehouses -by early July, that level had only reduced to 600,000. A rail subsidy announced two weeks ago by the NDRC should offset the total transport cost increase for wholesale dealers and finally get inventory flowing east again, although the exact implementation date is not clear.
Adding insult to injury, this summer has been one of the driest in decades in the Chinese North West, with some reports placing the number of hectares in Xinjiang impacted by drought at 4 million.
In sum, the harvest has been difficult and buyers scarce. With these mounting frustrations it’s no wonder that Wang Lequan, Party Secretariat of Xinjiang, has called for reduced dependence on cotton going forward by shifting some acreage into more lucrative livestock production.
Although I am always skeptical of bullish predictions coming from an exporter, Mr. Nicosia appears to have compelling data points to help support his thesis. Reduced domestic production in China combined with external price pressure could lead to higher demand for US exports despite the slowing global economy over the next harvest cycle.
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Back to the grind this morning – welcome back. Unfortunately, another two US banks went under this weekend. The US bankruptcy cycle that we’ve been focusing on as of late continues to build momentum – hammering home our theme that ‘Access to Capital’ continues to tighten, as ‘Cost of Capital’ continues to rise. Seven US banks have gone belly up in 2008; 3 of those 7 have had assets exceeding $1 Billion (see our updated ‘US Bank Failure 1’ chart on the portal for perspective).
This side of the investment cycle remains ominous for anything levered. Henry Kravis and KKR seem to agree that bank debt is virtually impossible to raise – they’ve moved to take over their Amsterdam based subsidiary this morning, assuring investors in their 2006 peak private equity cycle IPO that they’ll never see the offering price again. The stock is down -59% from that “deal”, but who’s counting? Goldman Sachs and Morgan Stanley bankers get to pick up the banking fees on this side of this morning’s announced deal anyway!
Marking assets to market here is basically the point. Whether it’s Lehman, KKR, a hedge fund, or your home – it’s all the same. Marking your assets to model is nothing but a listed price that you can choose to believe until you are forced to realize otherwise. The problem, of course, is that this is “global this time.” In the United Kingdom this morning we’re seeing the effects of local marking to market. The UK reported home prices down -4.4% year over year for the month of July – that’s the worst month reported since 2001. No more Lehman “Level 3” quotes on your homes or portfolios folks. Rising interest rates and marking assets to market will remain the “Trend”, for the foreseeable future.
European stock markets do not like the aftershock of this “Trend” either. A deflated US Dollar has equated to an inflated Euro, and decelerating European export growth. From a technical perspective, legacy European markets look worse than those here in the US. The FTSE is flat in London this morning, but faces stiff resistance at the 5448 level, and despite Obama’s rock concert in Berlin, German equities continue to act horribly, trading down another -0.80% this morning on another new low in their local confidence readings.
Asia continues to act better than both North American and European markets. I’m long China for a “Trade”, so I like that. Chinese stocks closed +1.3% overnight, taking their July rally to +9.4% to date. India closed up again overnight as well. India’s BSE Sensex Index has squeezed the shorts for an expedited +14.5% move since July 16th. Malaysian and Philippine equities closed up +1.3% and +1.1%, respectively, rounding out a positive session overall in Asia.
In the aggregate, deflating inflation was last week’s positive “Trade.” The CRB Commodities Index lost another -3.5% on the week, and is -13% from its all time high. Oil and gold were down -4.4% and -2.2%, respectively. Within the 19 components of the CRB Index, selling was broad based.
Reality is that inflation can deflate in tandem with growth here in the US. Most “growth” investors do not like that. Stock picking in this kind of an environment will emerge as king.
Good luck out there this week,
Some things you should know about (little-known) Boscov’s.
1) Largest family-owned dept store chain in the US, with revenue over $1 bn.
2) 49 stores in 6 states in the mid-Atlantic (from NY down through VA).
3) In 2Q06, Boscov’s bought 10 stores from Macy’s, in conjunction with satisfying anti-competitive claims when Federated bought May Dept stores.
4) The remainder of the portfolio used to be in line with the Macy’s of the world, but now competes more with JC Penney, Sears and other moderate retailers.
5) Also sells categories in addition to apparel – such as toys, candy, sporting goods, and stationary.
6) Inventory consists of virtually every publicly-traded wholesale brand.
Strategic issues to consider.
1) Could this be a positive as the industry right-sizes capacity to be in line with end demand? The answer is yes – but unfortunately we need about another 10 Boscov’s to put a dent in the macro call here.
2) A $1bn retailer acting desperate is not good. Excessive closeouts/promotions and striking more aggressive deals with vendors to secure any product to keep its head above water is not a positive sustainable trend. Note that this even holds outside of traditional. Dick’s Sporting Goods, for example, has a similar footprint and Boscov’s sells many of the same hardgoods and lower-end softgoods.
3) Keep in mind that it is often difficult for a bankrupt anchor tenant in a mall (which represents a fair proportion of Boscov’s stores) to actually end up as capacity being removed from the industry. Given the convoluted deals with the mall REITs, the property simply changes hands to others who fill the shelves with much of the same product.
We’ll be back soon with some deeper analysis on industry capacity.
As I’ve noted in outlining the thesis for companies that are most materially over-earning (including WRC, VFC, SKX, GES, COLM, ADS.DE, and others…) the key factor that will emerge is what the companies have been doing with the FX benefit. Reinvesting in their own business to build a better base for when FX goes south? Or printing on the P&L in the form of higher margins?
This will be a period that separates the winners – like RL, TBL, LIZ, and NKE, from the losers noted above.
Aside from my view that supply chain pressure will intensify meaningfully on the P&L by holiday, now we can add on the impact companies being exposed for aggressive and irresponsible FX strategies as well. Remember that 80% of the companies in this space (as they exist today) have not lived through a down FX cycle. Rarely is the first crack at managing FX pleasant.
Volatility is going up in this space, folks. The dispersion in cash flow trajectory between winners and losers will be massive. (Check out our prior post where Casey outlines how the consensus does not yet ‘get it’).
We’re going to be all over capturing that opportunity for clients here at Research Edge.
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