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FL: Lease Optionality

It’s common perception that leases for mall retailers have zero optionality. I agree from an asset sale vantage point. But there’s more wiggle room with accounting and margins.

The wiggle room Foot Locker has with its real estate profile over the next five years should not be underestimated. I think that this provides the company with some downside margin support to the extent that I am wrong in my view that margins will recover over the next 12-18 months due to stronger business levels over a leaner cost structure.

Specifically, FL’s operating lease commitments decline to 55% in five years. Seems intuitive given that FL is a zero square footage growth retailer and leases are coming due faster than new ones are being signed. But the reality is that there’s no shortage of retailers that have a severe (negative) mismatch between growth and rents. There’s Dick’s, DSW, Whole Foods, and CVS, to name a few. Foot Locker is at the opposite end of the spectrum.

Think of this ratio as you would a discount rate on retirement assets. A company can choose to account for them with a high expected rate of return, hence requiring lower annual accruals and setting a high hurdle going forward. Or they can do the opposite and go with an ultra-conservative rate, booking higher annual payments but depressing margins. That’s Foot Locker.

I can’t ignore the fact that minimums coming down so much outlines how many of FL’s leases expire over 5 years – which means that management will need to be smart about whether it renews, relocates, or shuts down. The company’s history is spotty at best in that regard.

But my point on this one is that if FL so chooses, it can more aggressively tackle its leases and pad its margins. It won’t be pretty, but it’s an option. Other companies don’t have that option.

I’ll take conservative lease accounting at trough margins over aggressive accounting at peak margins any day.
FL's year 1 rent payments divided by year 5 contractual minimums are far more favorable than peers.

The Global Macro Pants

Waking up in the early morning to a global macro investment process that you can hang your hat on will pay off in 2008. As many US centric investors are being forced to realize, many more factors affect global markets than their recent “one on one” with a US company’s CFO. It’s “Macro Time”, and successes will be born where proactive investment preparation meets opportunity.

Let’s put the global macro pants on and take a walk to Asia. Yesterday, we called out Thailand’s developing economic problems. This morning, in a sentence, I can show you the domestic political unrest associated with those problems. If you want to find where people’s emotions rest, follow the money. This morning’s headline from Bloomberg out of Thailand is as follows: “Thai protesters stormed Prime Minister Samak Sundaravej's office compound and occupied a state- run television station, meeting little police resistance as the government avoided violent clashes that might force its collapse”…

Thailand’s stock market closed down another -2% over night, and the Thai Baht hits new year to date lows, daily. While China’s stock market lost another -2.6% last night, taking its fall from the “its global this time” October 2007 highs to -61%, the point here is that the contagion associated with slowing growth and accelerating Asian inflation is starting to spread. The Thai Stock Exchange is down -25% now since May 21st. This is Southeast Asia’s 2nd largest economy. This chase to the Chinese YTD percentage declines is called geographic mean reversion.

Maybe we should all run out and “buy the dip” and scoop up some of them Asian Country ETF’s (Exchange Traded Funds) – uh, no. From Japan (EWJ), to Korea (EWY), to Taiwan (EWT), these snake oil salesman index products have provided everyone from the Harvard Endowment to Joe Globally Diversified nothing but headaches in the last 3 months. Does anyone remember the Asian currency crisis? The Korean Won is down -7.3% since mid July alone, and hitting its lowest level since 2004 this morning. Those who do not respect history’s lessons, are unfortunately doomed to repeat them.

Global growth is slowing faster than Wall Street understands. Stock markets are leading indicators, and you can pull up any Asian ETF and run the math on how far they have fallen in 2008. If you’re more of a short term trading type, don’t bother with the YTD numbers. Try a 5 day chart of Pakistan since Musharraf left – that’s down -14.5%, in a straight line.

As Asia slows, Europe is feeling it, big time. That’s one reason why the Euro currency is hitting a 6 month low versus the US Dollar this morning. London was closed for trading yesterday, but opened this morning’s session down -2%, breaking my short term momentum support level. The S&P 500 did the same yesterday. That level in the FTSE is 5412, and for the S&P 500 its 1274. When it’s “Macro Time”, I respect the math, above all else.

The Minister of Finance in Copenhagen definitely respects the math. This morning he is cutting Denmark’s economic growth forecasts well into 2009. His outlook suggests that economic stagflation is going to be a protracted process. Remember that Denmark was the 1st economy in the European Union to officially move into a recession. Now the dominos are falling. As cost of capital increases, globally, and access to it tightens, the “Trend” in Europe remains the same as that in the US. It’s negative, and deteriorating.

On a cheerier note, the full court media press is on Dick Fuld. So I won’t have to harp on his missing the macro call much longer, I hope. Fortunately, the short squeeze rumor of the Korean Development Bank buying Lehman didn’t come to fruition. The implications of Singapore owning Merrill Lynch, and Korea owning Lehman Brothers, are not those that will enhance Transparency in the US Financial system. As Asian growth slows, so will the currency adjusted growth of the cash in their “Sovereign” coffers. The US Dollar is now +8% since July 14th. I maintain that’s where you need to be. For now, US denominated cash, remains king.

Good luck out there today,
KM



MACAU: QUID PRO QUO ON VISA RESTRICTIONS?

Don’t be surprised to find out that there won’t be a 6 month visa restriction enacted for Macau visitors. The Macau Special Administration Region (SAR) government announced an agreement to provide significant aid to the government of the earthquake stricken Sichuan province. Beijing is a bit of a black box, but I don’t think the Central Government was very pleased with Macau’s lagging contribution to the rebuilding effort. With the Macau government now on board it will be interesting to see if the concessionaires make any “voluntary” contributions to the effort. I’m sure they can find it in their hearts.

Macau shorts: be a touch wary. I still think the trend is down but status quo on the visa restrictions would send these stocks on a nice little squeeze ride.

Daily Trading Ranges

20 Proprietary Risk Ranges

Daily Trading Ranges is designed to help you understand where you’re buying and selling within the risk range and help you make better sales at the top end of the range and purchases at the low end.

POPULISM AND GAMING: SUPPORT FOR NV HOTEL TAX REMAINS HIGH

Our friends at First Rain highlighted a Nevada poll showing 60% of Nevada voters approve a 3% tax increase to 13% of room revenues. The room tax issue will be on the ballot in a non-binding referendum. The referendum will likely apply pressure to legislators to actually enact a tax hike. This is consistent with our populism theme. As state budgets continue to deteriorate, look for legislators to attempt to hit up their favorite punching bags: the casinos; for the children, of course. Nevada, Illinois, and New Jersey remain in rough shape fiscally.

As can be seen in the chart, the impact to the Nevada gaming companies looks manageable. However, with 40,000 hotel rooms in the state, MGM would be hit the hardest, reducing 2009 EPS by about 7%.


MGM would be the hardest hit

MGM: Dubai bailout? Not today...

Suffice to say, the day trading community has had some fun whipping around in MGM the last few days. Up +20% on Friday, then down -9% today. Its a good thing my partner, Todd Jordan, has the edge here. Today's breakdown was a material one. This stock is a short to $26.20.
  • MGM closing below $30.99 is very bearish.
    KM
(chart courtesy of stockcharts.com)

MCD – Mapping the Response

Earlier this morning, I posted the results to the question I posed to MCD franchisees regarding their current level of contentment (relative to past periods) as it relates to how they feel Oak Brook is handling the issues facing franchisees today (please refer to my ‘The Question’ posting for more details). To recount, “1” is 100% contentment and “10” is wanting out as fast as you can.

When you match up that franchisee sentiment with MCD’s stock price, it becomes apparent that increased levels of franchisee anxiety does not bode well for the overall MCD system and its stock price. For reference, the late 1990’s to 2002 was one of the worst periods for McDonald’s franchisees and not surprisingly, MCD’s stock. This number has now crept up to 5.2 (above the 3.7 average)…Stay tuned!
MCD’s Stock Price Relative to Franchisee Sentiment

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