Christmas is coming, and that means two sets of flurries are on the horizon – snow and retail news. Now that the aftershocks of the 2008 financial collapse have had time to set in, this year will be a test to see how resilient consumers are in spending for the holidays. Retailers, for their part, have been preparing by slimming down; most are carrying record low levels of inventories to avoid the need for post-rush markdowns. But as the fundamentals are uncertain, retail stocks have been rallying with the rest of the market – the Retail HOLDRs ETF (RTH) is less than 13% off its all-time high in July 2007, led by large allocations to Wal-Mart (WMT), Home Depot (HD), Target (TGT), and Walgreen’s (WAG).

Large-cap, diversified retailers lack the appeal of a growing niche apparel company, for instance, but in many cases they look to be safer bets with decent upside in a market that’s looking increasingly overextended. Wal-Mart and Home Depot attract my attention with relatively stronger moats for the retail industry and a consistent history of posting ROEs in the double-digits, and although they trade at higher earnings multiples than a company like GameStop (GME), I believe the sustainability of earnings favors the stodgier retailers. Earlier this year, investment funds that I co-manage (BCIC) sold GameStop stock on a belief that it is a value trap with illusory single-digit forward earnings multiples, as competition for video game sales increases, and video game makers look to connect directly with consumers and disintermediate brick-and-mortar stores. That stock is down 15% in the last week and is close to its 52-week low, one of the exceptions in a market that is making new 52-week highs.

There will be plenty of news on short-term sales trends involving consumer spending in the month of December, but there might be limited comparability with past years because the paradigm may have shifted in this newly frugal economy. If you’re going to play with retail stocks, then, stay high quality and go with solidly entrenched middlemen. Bed Bath & Beyond (BBBY) is one retailer more off the beaten path that also fits that definition – a differentiated inventory strategy, improved pricing power after the Linens ‘n Things bankruptcy, and a modest valuation – and I’m happy BCIC owns it.
On the apparel front, Goldman Sachs (GS) analysts believe the sweater will be the go-to gift of 2009; while apparel is admittedly not my specialty, BCIC recently established a position in Ralph Lauren (RL).

Subscribe to our feed using your favorite service:

Originally posted here.

Stephen Frankola sends: Zachstocks published a piece on Chipotle Mexican Grill (CMG) right after they released earnings, expressing caution towards the company’s performance going forward, and its already-rich value.

Zachstocks was concerned that Chipotle’s results were helped by playing games with its store openings and advertising spending.

company significantly cut back on marketing and promotional spending which had a temporary effect of reducing expenses.

While the end result was impressive, the means to get TO this earnings level appears unsustainable. Obviously if you significantly cut marketing and promotional spending, over a short period of time you will begin to see sales dwindle. For that reason, management noted that 2009 marketing spending will mirror 2008 as a percentage of revenue. And since the second quarter was so light in this area, you can bet that the promotional spending will be very high in the third and fourth quarter. This will drive margins lower.

At the same time, management is guiding for 120 to 130 new store [openings] in 2009. With only 50 completed in the first half, that means investors can expect at least a 40% increase in new store openings in the second half. These new stores typically have lower margins until they have been opened long enough to become well established, and there are significant store opening costs associated with the locations.

I take interest as I always wanted to short CMG back in its pre-$100 days, but shares were impossible to borrow. I’m not sure whether or not it’s actually feasable to short now… but it may be worth a look. If the general market weakens, watch for the bloated CMG to lead the decline.

Subscribe to our feed using your favorite service:

This is a long overdue follow-up to a previous post on whether or not the ratings agencies are good candidates to be sold short. CalPERS is suing Moody’s (MCO), S&P, and Fitch, saying that their ratings “proved to be wildly inaccurate and unreasonably high.”

Hindsight is 20/20. Are the ratings agencies legally liable for misjudging the risks to instruments they rated? After all, the lawsuit documents say that CalPERS relied on the “AAA/Aaa” ratings given to the SIVs they purchased. The ratings agencies have the special privilege of a protected franchise, but if CalPERS is truthful that it only invested in SIVs because of the rating, it should have been damn sure that the ratings were appropriate.

CalPERS goes on to say that the assets held by their SIVs were confidential, so there is no way they could have known about the risks of their investment assets. Why were they investing in securities whose value was dependent on something unknowable to them? I’m not an expert on fiduciary responsibilities, but admitting an ignorance of what was owned seems like a pretty clear breach of some basic tenants.

The failings aren’t all on CalPERS. There’s plenty of blame to go around, and the ratings agencies certainly share in that blame. Recovering losses from them, however, crosses a new line and establishes that they have a legal liability for the losses suffered by those whose money they were not managing. Except in cases of fraud, asset managers are not held liable for investment losses; why should the ratings agencies be any different?

Maybe Moody’s looks like an attractive short because it has a negative book value. The value of Moody’s, though, has no relation whatsoever to book value; it’s all about the earnings to be had from acting as a toll between issuers and the debt markets. You can’t put that on a balance sheet, and it’s going to be hard to kill off that advantage for several more years at a minimum – and Moody’s will make a lot of money during that time (this, I assume, is why Buffett owns so much of the stock).

Regulators want to change the relationship between issuers and raters to make it appear more arms-length. As long as the emphasis is on that, and not on explicitly hurting the profitability of the ratings business (as it is with healthcare), I find it hard to believe Moody’s is an attractive short. Right now, the best hope for that is an off-the-wall jury verdict in favor of CalPERS, which looks improbable if not legally impossible.

Court Documents - CalPERS v. Moody’s

Subscribe to our feed:

Read the rest of this entry »

Read the rest of this entry »