Friday, July 16, 2010

7/16/10 Midnight Report: A load of Bears hit

The market tumbled today like a broke Boy George on a floor covered with dong as consumer confidence continues to fade like LeBron James' Q score or Haiti.  Consumer sentiment fell to 66.5 which is the lowest since August and below the most pessimistic guesses of those not paying attention (also known as economists).  The drop in sentiment from June's made up reading of 76 was the biggest drop in two years and was well below the 75 guessed at by economists who eventually will understand that the old data they used to calibrate their regression models no longer holds in our fat tailed society.  Newsflash economists:  The world has fucking changed, people are all connected, and whatever correlations you saw in the past are now likely more spurious and outdated than civility, manners, and landing strips.  Basically everything in the consumer sentiment survey got worse and that is as bad of a sign for future consumer spend as a "You must be 18 to enter" sign is at a NAMBLA convention.

According to a Bloomberg poll, seven out of ten Americans believe we are in a recession, but then again, four in ten believe in alien abductions and six in ten believe that Kathy Griffin is a woman, so whatever.  The economic data has gone from marginal to whatever is worse than marginal and it's not clear what is going to stimulate the economy out of this except for maybe a Bobbi Eden promise to take care of businesses if they hire.  In other macro news, inflation continues to be modest as consumer prices were down .1% spurring louder whispers about deflation where cash will be king, and not some lame ass king like George III, but a cool one like Henry VIII or Kong.

In other US news, the SEC pulled themselves away from their tranny porn just long enough to settle with Goldman for $550MM as related to GS's shady dealings with their Abacus mortgage CDO.  The settlement will be among the largest in the history of the SEC with $15MM a result of the money GS made on the deal and $535MM as a punishment for GS being a bunch of asshats for the past 140 years.  Of the fine, $300MM will go directly to the US Treasury where they can either buy 3 new planes for congress, help Timothey Geithner pay his back taxes, or hire Cintia Dicker to massage their data before they stick it in to a GDP model.

Along with a consumer nudging closer to life support (and unfortunately with a pre-existing spending condition, the consumer is no longer eligible for insurance to help them survive), earnings reports were marginally bad at best.  BAC plummeted 9% and C dropped 6% after they released decent earnings but showed revenues to be more lacking than rhythm at a Republican convention or diction in an NBA lockerroom.  BAC's revenues were down 11% and C's were flat but most worrisome was that the earnings beats were a result of reserving less for credit issues with BAC reserving $5B fewer than last year because apparently they developed retrograde amnesia sometime in June.  Ugh.  This is going to get uglier than an Amy Winehouse-Michael Berryman love child.

In other stock news, GOOG revenue beat guesses but EPS fell short by $.06 as they earned $6.45 per share vs. analyst guesses of $6.51.   That <1% miss of made up numbers was enough to drop the stock 7% and the company has said the are going back in to investment mode which spooked investors as if investment mode were a book and investors were Dexter Manley.  Even though the 24% rate of growth was a bit lower than last Q's, this company is still the dominant player in one of the biggest and growing industries on the planet (right after hand set makers, gold mines, and porn) so while Money McBags is scratching his head a bit at GOOG's continued fourth mover push in to things like handsets and social media, he is still a long term owner because if the consumer dies, they are still going to spend time online guessing muffs as a way for cheap entertainment, so online advertising is only going to get stronger.

In small cap news, everything was down today.  JOEZ was out with their quarter and it was mostly inline with analyst guesses of $.01 eps but 50% below Money McBags guess of $.02 eps (and see how Money McBags used 50%, instead of $.01 to make it sound much worse than it was?).  Anyway, JOEZ put up a nice topline number, growing revenue by 51% to $26MM but once again had earnings leverage more negative than the reviews for an M. Night Shyamalan movie.  That's right, despite growing revenue 51%, net income dropped by greater than 50% from $1.3MM to $500k defying the laws of common sense and business savvy.  With that kind of inverse operating performance, it's a good thing JOEZ didn't grow their business 75% because then they might have lost money.

It would be easy to blame the drop in net income on the tax rate which grew to 48% over last year's 14% thanks to a shareholder unfriendly earnout struck by management when they acquired Joes, so thanks for that guys, really (oh wait, Money McBags isn't a shareholder, so he doesn't really give a fuck that JOEZ management treated their stock owners like second class citizens in a third world country when structuring the acquisition), but operating income BEFORE TAXES was down 25% from $1.6MM to $1.2MM.  So on the extra $8.7MM of revenue JOEZ brought in this Q compared to Q2 2009, they lost $400K before taxes.  Wow.  Now look, Money McBags is no Jack Welch (though he did manipulate his earnings this morning to Brooklyn Decker), but losing money on incremental revenue is so obviously bad that even business school professors know it is a failing strategy.  It's ok to have a loss leader, but when your whole business is a loss leader, you may have a problem.

Anyway, the reason for the operating earnings decline was threefold:  1.  Gross margins declined worse than Louis XVI's power in 1792 France or Yasmine Bleeth's career after Baywatch.  2.  Operating costs jumped up as if they had seen a mouse, or Kevin Federline, scurry across their kitchen floor.  3.  Their core denim business is witnessing a second derivative decline in growth.

As for gross margins, which continued their descent, this time from 51% to 44%, the company said that the drop resulted from the addition of new lower margin product categories such as the T, the Pant, and the Top.  CEO Marc Crossman did say that as volume grows for these products, margins should go back up as they can take better advantage of the factories and thus he expects meaningful margin expansion.

As for the increase in operating costs, that is a bit more troubling as costs jumped up to ~$10MM from ~$7MM which they said was the result of new worker salaries, rent costs, and a big night out at their local Rick's Cabaret (ok, maybe not the third one, but whatever).  The confusing thing though is that costs were up $400k sequentially when last Q JOEZ said operating costs were artificially higher due to $850k of one-time advertising  expenses and the moving of their headquarters.  If we strip out those numbers, operating costs were up by ~$1.2MM from Q1 or ~15% while sequential revenue was up only ~12%.  So basically this company manages their cost structure about as well as Alan Greenspan managed interest rates, Bernie Madoff managed money, or Magic Johnson managed a condom.  The company said with their new lines built out they don't expect operating costs to rise, but again, last Q they pretty much said the same thing and blamed the higher costs on one-time charges which either became two-time charges or were filled in by new costs.

And finally, they said their denim is now a single digit grower (though Money McBags wasn't sure if they just meant in department stores, or overall) so they are going to increasingly need to rely on new products to spur growth and to date, the new products have killed their margins.  In a trendy business, continuing to hit on new products is more difficult than solving the Poincare Conjecture or listening to a Ray Romano stand-up routine and not wanting to cut out your ear drums, so this is getting to be a tricky proposition.

In terms of their balance sheet, cash is now down from $13MM at the beginning of the year to $8.5MM, driven by a $3.5MM burn from operations due to rising inventories and helped out by growing accounts payable (which sounds about as healthy as a cock sandwich with extra VD).  While they aren't in imminent danger (though at the rate of their cash burn from operations they only have 12 months of leeway), Money McBags would not be shocked by some kind of secondary offering because unless they can get their operations in order and start GENERATING cash, their growth plans are going to have to be put on hold.

So how the fuck does one forecast a company whose growth rate over the past 4 years was 30%, 35%, 10%, and 16%, who sells an expensive discretionary good in the midst of GLOBAL RECESSION, whose management team has grown revenue 46% this year and yet had earnings decline because they understand costs like Donald Rumsfeld understands war strategy or Sheyla Hershey understands when enough is enough, who burned cash in both quarters this year and is getting to the point where the may need to reload faster than Peter North on a day he is filming a double feature, who is in a market that is all about fads and their biggest product is starting to have its growth slow, and who has been so shareholder unfriendly that they stuck shareholders with a 48% tax rate so the management could get a better earnout and thus order a second helping of caviar when they were done screwing equity owners?

One could annualize the $.02 they have made in the first half of the year and call their earnings run rate $.04 and slap some growth on that, but that would be the easy way out.    Money McBags is in a good mood today (mostly because he recently discovered Sofia Vergara) so he'll assume JOEZ can kind of keep this up and grow revenue 35% for the rest of the year and 30% next year (assuming they don't run out of cash or can raise cash to continue to expand).  He'll call gross margin 51%, operating margin 38%, and the tax rate 45% (though they say it will wind up closer to 40% sometime around the year infinity).  Doing that, Money McBags gets to $.16 eps for next year at the high end because every single one of those estimates is giving them a fuckload more credit than they have earned.  So next year the company should earn somewhere between their current $.04 run rate and $.16 assuming they don't have to issue more shares to help quell their cash burn.  JOEZ is now trading at between 13x and a bazillion x those numbers.

So in short, Money McBags is glad not to be involved in this company as they have been able to deliver profits about as well as George Will delivers a punchline but if one believes what management says and not what they have actually done (like you know, lose money, mismanage costs, fuck over shareholders, and burn in cash), one could make an argument that 13x for a 40% grower is cheap, of course one could also make an argument that Tori Spelling is hot, so be careful to whom you listen.  Money McBags remains fascinated by this little stock though as it's not often you find 40%+ topline growers who manage to consistetly shrink their profits.

Have a good weekend, and remember WGP is on facebook and twitter.


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