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Marking To Market

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,
KM



Another Chapter 11 Coming?

When we conducted our Bankruptcy call on 7/16, someone asked me if we were late given that some companies had already filed. Well since then, we’ve had 2 more banks file, and one more retailer (Shoe Pavilion). In addition, now it appears that Boscov’s, the second largest private department store chain, may be headed in the same direction. The factoring arm of CIT’s trade finance group is still supporting backorders, but put a “hold” on future orders to fill fall/holiday inventory.

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.

Watch out For FX!!

Here’s a scary chart. My Jr Analyst, Zach Brown, backed-out the FX impact of the companies that have reported 2Q EPS thus far.

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.

Brian McGough
This chart shows FX impact to sales for each of the companies reporting EPS thus far. Pretty self explanatory, no?

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US Market Performance: Week Ended July 25, 2008...

Index Performance:

Week Ended 7/25/08:
Dow Jones (1.1%), SP500 (0.23%), Nasdaq +1.2%, Russell 2000 +2.5%

July 08’ To Date:
Dow Jones +0.18%; SP500 (1.7%); Nasdaq +0.77%; Russell 2000 +3.0%

2008 YTD:
Dow Jones (14.3%), SP500 (14.3%), Nasdaq (12.9%), Russell 2000 (7.3%)

Australia vs. Japan: Sobriety vs. Socialism

I am short Japan for a variety of reasons that I've discussed in prior portal postings. These two charts that we put together this weekend depict the Reserve Bank of Australia’s inflation fighting vigilance versus the Bank of Japan's easy money political pandering.

*Full Disclosure: I remain short Japan via the EWJ etf.
KM
Australian Sobriety
Japanese Socialism

Apple (AAPL): Macro Short?

Precisely 2 years ago, AAPL was trading at $50/share and plenty of doubt surrounded the company’s ability to continue to deliver product momentum. On Friday, the stock closed at $162/share (19x trailing cash flow!), and we’re looking at a company that is rightly the apple of every investors qualitative eye – pardon the pun.

I am very weary of letting our analysts hang their hats on qualitative thesis’. Research Edge was built on quantifying everything we can. From a quantitative factor perspective, AAPL is finally breaking down. We saw $189/share tested and tried on 3 separate occasions since mid May (May 13th, May 15th, and June 5th). Today, the stock is -14% lower, and it’s in a very precarious position, both fundamentally and technically.

From a fundamental modeling perspective, six months from now the Street will be forced to look a what was the best revenue quarter that a high growth consumer product company can deliver. Year over year growth will slow materially, and the momentum community will be out of this stock faster than they got in. Apple’s management gets this, and as our friend, Michelle Leder, at ‘Footnoted.Org’ called out this week, they are already preemptively calling out “macro” as the reason.

We’ll let you pull up the 10Q and read it, but Michelle’s posting on this does it for you just the same: “While some people continue to debate whether or not we’re actually in a recession, Apple went a step further in the 10Q it filed… using stark new language to describe the state of the economy in its risk factors section.”

This isn’t Apple’s fault. This is called macro – and it matters. Apple’s shareholder’s list is decorated with all of the top mutual funds in the world, and short interest is remarkably low at 2.2% of the float. Shorting Apple is far from consensus, and if it breaks down closing below $160.34, the institutional selling will look far from over.
KM
(Chart courtesy of stockcharts.com)

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