Monday, April 12, 2010

4/12/10 Midday Report: S&P approaches 1,200, asks if it can come up and see it sometime

Earnings season is about to begin and Money McBags is more excited than Thomas Malthus at a pro-abstinence conference or Tiger Woods at a sleepover in Charlie Sheen's house.  The Street is going in to this earnings seasons with expectations higher than those of Elin Nordegren in October of 2004 so a few slip-ups could cause the market to sell off faster than the career of a VH1 reality show contestant.  Alcoa opens earnings season tonight with financial firms due to follow this week so keep your eyes on net interest margins, credit costs, and Lucy Pinder.

In international news, Europe has unified to bail out Greece with a line of aid in events less surprising than Michael Jackson dying of unnatural causes or a family values republican liking a little ding-a-ling.  It is the most unified Europe has been since Charlemagne took Italy or since the Keeley Hazell sex tape was released.  European leaders are offering Greece up to $40B at 5% interest which is a discount to market rates and will allow Greece to help cut their deficit and perhaps even improve their public works by adding more fire hydrants.  Along with the EU, the IMF is offering Greece $20B of assistance while NAMBLA is offering them a mature shoulder on which to cry.  Greek finance minister, George Papaconstantinou, and Greek Prime Minister George Papandreou, still think Greece can make it through this crisis without needing the capital infusion, while Greek cultural leader George Papasmurf couldn't be reached as he was busy hiding from Gargamel.

In stock news UBS is out saying they will earn $2.35B in profits this quarter as apparently they started selling tickets to the fountain of youth and hired Bernie Madoff's auditors.  UBS has been hit hard by the financial meltdown and it's nice to see they learned from it by not elaborating on how they swung to profitability.  So good on you UBS for continuing to not provide shareholders with information.  Also PALM continues to soar on takeout rumors.  Money McBags addressed this a bit on Friday but he doesn't understand why a PC company would want to buy the #6 player in the smartphone market, especially one whose estimates for the quarter were 50% below analyts guesses.  Sure they have decent technology, but going after AAPL and Blackberry is a bit like taking on Visa and Mastercard, Coke and Pepsi, or getting ass implants and going after Coco or Kim Kardashian.  Money McBags is guessing whoever buys PALM pays way too much for them unless they can somehow use PALM's operating system in their PCs.

In small cap news, most companies are getting ready for earnings so Money McBags will address a  reader named Richard who posted some thoughts on JOEZ in the comments section of Friday's post.  Money McBags will answer those questions here since the comment section handles long replies like the Meaghan Cheung handles ponzi scheme investigations.  In Friday's post, Money McBags broke down JOEZ quarter of strong growth but infinitesimal profitability and questioned whether they would earn more than $.07 this year.  Richard responded by questioning Money McBags' assumptions saying that 40% sales growth is too low due to an improving economy and operating leverage should drop to 36% with those improving sales and thus JOEZ could earn $.13.  Now look, Money McBags has no position in JOEZ but would like to pursue this because it could be a great long or short and he is happy to collect all information in what right now is strictly an intellectual pursuit, like debating the existence of God or pondering why people drive on parkways and park on driveways.

So let Money McBags test those numbers out a little and see if they are possible.  First of all, cost of goods sold in the last quarter rose to 51% as JOEZ either picked up their discounting to shed inventory or sold lower margin items.  Anyway, let's assume that doesn't degrade further even as competition increases when fashions potentially change which would cause further discounting (and remember, consumers of fashionable items are more fickle than Hugh Hefner at a casting call).  So call COGS 51% leaving gross margin at 49%.  Then we'll take Richard's assumption that they can get their operating margins down to 36% and assume interest and any other charges are non-existent as Money McBags wants to keep this simpler than a Texas high school science class (you know, because the answer to everything is "God did it").  So before taxes, JOEZ has an at best 13% pre-tax margin (51% COGS + 36% operating costs).  Now their tax rate is more inflated than Oprah Winfrey's ego (and her gut) as the earnout from the acquisition of Joe's is going to cause them to be taxed ~45% this year.  So that brings their net margin down to ~7.2%.  They have 63MM diluted shares so in order to hit $.13 eps for this calendar year (and remember, Money McBags thinks they will earn $.07), they need to earn $8.2MM in net income which means they need to earn $.12 or $7.6MM over the next 3 quarters.  Now it doesn't take Norman Einstein to see that in order to get to $7.6MM in net income over the next 3Qs with 7.2% net margins, they need to do >$100MM of revenue (~$105MM to be more exact).  In the last 3 calendar Qs of last year they had $63MM of revenue, so in order to hit $105MM of revenue, they need to grow sales by 66%.  To put that in perspective, these are the annual growth rates starting with 2006: 30%, 35%, 10%, 16%.  So sure, there was a recession and sales sucked donkey dick through it (though to JOEZ credit they were still able to grow when most retail stores were taking it deeper in the yingus than Alexis Texas in Ass Titans 3) but 66% growth is above anything they have done in the past 4 years and there is something called the law of large fucking numbers which tends to hinder growth rates.  While they grew 40% this last Q, Money McBags doesn't get how that growth accelerates even more unless they open a fuckload more stores and institute blumpkin Wednesdays or just discount the shit out of everything, which would kill their gross margins.  So it is doubtful that this year they earn $.13 even with an extrememly generous 36% operating cost assumption.

Of course it is possible Richard was talking about fiscal 2011 since he mentions an assumption of $30MM sales for Fiscal Q1 2011 (Q ending in November 2010), but he also mentions 12 month earnings, so it's not quite clear which 12 months he was talkng about.  As a result, Money McBags will go through this as if Richard were talking about fiscal 2011 and not calendar 2010.  If so, to hit $30MM in revenue in fiscal Q1, they would need sales to just increase by 20%, which seems infinitely reasonable and would earn them ~$.03 (at 51% COGS and 36% op costs) which would annualize to ~.12 eps, which is exactly where we started.  Of course if they keep growing that top line and keep margins at least flat, that $.12 could turn in to $.15-$.16 for fiscal 2011.  The big question is, is the 36% SG&A reasonable or is that way too low?  As companies grow, they should be able to get leverage out of their infrastructure since they don't need to buy new computers porportional to sales and they don't need to add another administrative assistant just because revenue was up (though sometimes two admin assistants are preferable).  Since 2005, as a % of sales, SG&A has been running at 51%, 46%, 37%, 38%, and 39%. So is it reasonable to think 36% margins are achievable?  Maybe.  Though if they are launching new stores and promoting new products, margins will have trouble dropping as we saw in this last Q where there was a $700k "one-time" charge for promotional spend which led to a 43% all inclusive operating cost margin.  Now Richard argues that the changing sales channels should help drop margins because JOEZ' own stores somehow have a lower cost structure than pushing their product through department stores, but Money McBags does not know the difference in margin between the channels nor how many stores they plan to open (it may be public, but fuck if Money McBags is going to dig for it, so if you know the answer, kindly post it in the comments section).  The point is, there has been no proof that JOEZ can hit 36% oparting cost margins and if that number stays in the 38% range, they will struggle to earn $.13 for fiscal 2011.

To wrap this all up, even taking aggressive margin assumptions, JOEZ would need to grow 66% in the remaining 9 months of this calendar year to earn $.13.  That said, if they can get margins down to the 36% level as Richard suggests, with moderate growth $.15 looks possible for fiscal 2011.  So best case scenario, JOEZ is now trading at about 20x that number which isn't a horrible multiple for the growth rate, but to get there, you have to bet that management can lower the cost structure (something they haven't done in 3 years despite top line growth) and that fashion trends continue.  Money McBags prefers to stay on the sideline here (though he would prefer it more if Alice Eve joined him on the sideline) until a management team that thought a 7 year earnout causing a 40%+ income tax rate and a management team that has created more negative leverage than Emmanuel Lewis trapped under an avalanche, can start showing they can manage a business and not just grow revenue.

4 comments:

Anonymous said...

Care to take a stab at ambac? It would appear to be a short soon, unless I'm blinded by the smoke and mirrors and accounting hokus pocus!

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Money McBags said...

Anonymous,

Sorry, but Money McBags would rather have unprotected sex with an AIDS ridden porcupine than touch ABK.

Money McBags used to cover them years ago when he worked for the man and he has learned that there is absolutely no way to evalute them because their financials are more obfuscated than Tiger Woods' dignity.

You are right, the accounting is likely all smoke and mirrors, hocus pocus, flotsam and jetsam, Siegfried and Roy. There is just no way for an investor not inside ABK to properly understand or evaluate their risks. While it's fun to be in the action, Money McBags would rather play russian roulette with 5 bullets and two shots than go near ABK.

Sorry Money McBags can't be more helpful, but perhaps this will be of some consolation to you.

If you have other small cap names of interest, Money McBags is always happy to take a peek.

Bottoms up,

Money McBags

Anonymous said...

Mr. Money Mc Bags,
Abk was a great short term trade (long til 11am, short or puts thereafter) That being said, your remarks are understandable regarding ABK. There were rumors of a split up of the company, in which they would somehow shed their toxic assets, followed by commentary by an analyst at JP Morgan who said the shares had no value. At the end of the day, 700 mil shares traded, options gyrated like beyonce and Lady Gaga doin "ta ta ta ta, telephone," and the fat cats had a merry time trading in and out, hoping the trading wouldn't ge halted like schoolkids playing musical chairs...