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TAGS: A Lesson In Key Customer Risk

Here’s a scary one. Tarrant Apparel Group, maker of private label apparel brands for department stores, was probably not happy with Mervyn’s Ch 11 filing. Mervyn’s is an 8% customer, and accounts for about $20mm in revenue. Not good when you consider that allowance for doubtful accounts was only $453k last year. Let’s say this business is lost at a 25-30% incremental margin, then that equates to about 2-3 points in margin. TAGS, unfortunately, has margins of only 0.9%, 94% debt to equity, and the majority of its debt due over the next 2 years. On one hand, I think that it is no wonder the market cap has nearly evaporated. On the flip side, there has been little meaningful change since Mervyn’s troubles became apparent. I’m no expert on this name, but I thought it worth pointing out.
Yes, Mervyn's exposure has been coming down. But it's still significant, and allowance for doubtful accounts has not budged.

Trichet's Chart: European Inflation Fighting

Euro zone inflation for the month of July surprised me to the upside this morning, coming in higher than July than June by 10 basis points at +4.1% year over year growth.

The chart that we put together below underscores the mapping of Trichet’s decision making process (raising nominal rates in line with reported inflation). Bernanke has chosen to roll the dice, and let inflation run away from the Fed funds rate, by a significant margin.

Inflation needs to be fought. Central bankers around the world are gaining credibility by the day by doing so. The US government should realize that it is global this time, and do the same.


No doubt the weak US dollar has contributed to an influx of international visitors to Las Vegas this year. “The US is on sale” is a phrase I’ve heard countless times. Jim Murren, President of MGM MIRAGE, recently said that 30% of Bellagio’s customers are now international. Those international customers are likely providing well over 30% of revenues to the property. Foreign visitation is great for the Las Vegas model over the long term for a variety of reasons. The problem is that domestic weakness has been masked somewhat by the effects of the weak dollar. By my calculations, Strip revenues were inflated by 5% in 2008 from the weak dollar. What happens if the dollar strengthens and the consumer remains soft? This is a very plausible scenario if the Fed gets serious about attacking inflation and is one more reason to be cautious on Las Vegas.

Weak dollar drives international visitation

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All That Glitters Is Not Gold

Goody’s Chapter 11 filing was the first of several large apparel retail chain casualties. That’s not news. What is news, however, is that the company tried to auction off 65 retail leases and its home-office lease. This represents 19% of its store base. The problem is that the of the 66 leases, there were bids for only 3. Yes, you heard that right – three.

What’s the conclusion? There is virtually zero optionality on many operating leases – for more companies than Goody’s. Their respective values are simply under water – or just so inflexible given anchor tenant status such that hurdles are too high to attract bidders. In other words, the properties need to be ‘marked to market’, instead of ‘marked to model’. Unfortunately, this is not done proactively by most CFOs, it is done in a bankruptcy court.

This is a great example as to why I look at more than debt levels in evaluating bankruptcy candidates. The key is to pinpoint REAL debt (capitalizing operating leases) and adjusting for the duration and/or flexibility of those leases. This is a key theme I discussed on our 7/16 bankruptcy conference call, and continue to think will be front and center for a while.

BWLD – Taking advantage of the financial crisis in the poultry industry

The critical issues facing the industry stem from the components of chicken feed. The two key components, corn and soybean meal, increased more than 30% over the past 12-months. In addition, fuel costs rose another 20% or more.

BWLD has clearly been a beneficiary of lower prices as the company has seen a significant decline in chicken wing prices. Additionally, over the past 12-months nearly every major QSR chain has announced new chicken based products. McDonald’s has been very aggressive, adding a southern style chicken sandwich at breakfast and lunch. As a result, demand for fillets has increased, while the value of the by-product of fillet production (trim) has declined, resulting in greater supplier losses.

As we wrote earlier this week on July 29, the poultry operations of the two largest poultry suppliers, Pilgrim's Pride and Tyson, reported significant losses for the first three months of this fiscal year. Not surprisingly, the outlook for the next quarter is for more of the same.

Nearly all chicken suppliers need to significantly reduce production levels in an effort to generate higher prices. A return to profitability is necessary to ensure solvency for some companies. On the TSN conference call, the company alluded to the fact that a lot of its contracts are cost-plus, which means parts of the restaurant industry, will be seeing higher chicken prices in 2H08.

The marketplace for chicken processors remains volatile, which is not good news for the restaurant industry.

Helicopter Ben Sighting...

Here is an hourly overlay of the timing of Bernanke extending the duration of the bailout window with commodity prices. The correlation is marked to market, and crystal clear.