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It has been quite a while but I had to flag this article.  Im not a huge fan of Walmart’s but I do think that with proper management they can rehabilitate their profile and do good by doing well, in the classic sense. 


Looking through some interesting data released recently (mainly bls, bea and census) and I managed to put together a couple charts are that are pretty interesting. The first looks at historic corporate profits and fixed capital information (these are from the NIPA accounts). As is obvious, fixe capital formation tracks profitability very closely. The notable departure from this trend occurred in the 1999 to 2002 era. I surmise three dynamics drove this. The first is the fact that there were many unprofitable companies (dotcoms and other service oriented no-hopers) that depressed profitability relative to gross investment. The second is the over investment in many tech oriented platforms, like software. Finally, let’s not forget the huge telco over investment at this point in time.
So the relationship reasserted itself and we had investment tracking the profit cycle very closely. Recently, however, this looks to be coming unglued. I think it may stay unglued for a while. Here is why:
First, companies need to be sure that a recovery is real before they start reinvesting. Many companies may be overlevered, so pouring cashflow into new projects may not be favorable compared to debt reduction if sales growth is not reliable. Second, and in my opinion, this is the reason, capacity utilization is so low. The capacity overhang is huge, having dipped as low as the high 60%s in durable goods. That needs to get absorbed, otherwise, there is no real need to re-invest, unless some new curve jumping technology comes along.

I recently read a piece in one of the CFA Institute publications about the dangers of “conviction” levels.  Warren Buffet talked abut the need to constantly challenge one’s own convictions and outlooks as an excellent measure to keep thinking fresh, timely and accurate.  It was with this in mind that I recently stumbled across an amusing pair of headlines in the May 11th issue of Automotive News.

Let me first say that the auto sector fascinates me for three reasons.  First, it is extremely important to the US economy.  One statistic everyone has heard is that roughly 1 million people (read as consumers) depend on GM’s post retirement health benefits.  Second, it is a huge consumer of resources.  Approximately 30% of steel consumption goes to the auto sector.  The plastics sector depends quite heavily on automotive as well.  Finally, it is a microcosm of many problems facing the US – healthcare, retirement benefits, environment, reliance on  fossil fuels, new fuel technology and demographics.

So I opened up the May 11th issue of Automotive News and found this curious headline: “Chrysler shoppers shrug of Chapter 11”. The article goes on to say that Kelley Blue Book’s survey of consumers showed that people care little if at all about the bankruptcy.  Sure, cars were junk before, they’re junk now.  But another survey by ntoed that the percentage of respondents who said they would consider a Chrysler for their next purchase increased 30% in the 7 days after bankruptcy was declared. 

Now, I was convinced, along with many others, that once an OEM filed, buyers would flee out of concerns that the warranties would become worthless.  We were in good company, in conclusion, if not in reasoning.  In a sidebar to that same Automotive News article was the following headline “Residuals tumble after Chapter 11 filing.” Apparentlythe Automotive Lease Guide slashed residuals on Chrysler products after the Chapter 11 filing.  Now that makes sense.  And this fits my previous conviction. 

The bit about consumer acceptance really shook my conviction, however, so I paid close attention to the Chrysler Financial lenders call.  One bit of info that came out was that auction sales in May decreased (i.e. more fleet and lessor purchasers) and prices at auction actually rose.  Apparently, Chrysler cars and minvans became more valuable and desirable after bankruptcy.  These result more reflect the Kelley Blue Book and findings in the main article than the sidebar leasing information.

One big take away for me was that conviction levels must always be tested and tempered.  Even an obvious outcome may not be so obvious, so we as analysts must be careful and humble in taking a view on anything.  This sounds obvious, but I know I often claim a high level of confidence in an outcome.  Quite possible that confidence could be greatly shaken.

But that’s just one credit analyst’s opinion.

Brad DeLong posted on his blog this piece from the FT.  I normally try to come up with original stuff, but this really scared and fascinated me.

Reading in the Philadelphia Inquirer today a quote by a hiring manager from Wal-Mart caught my eye.  What struck me about this was that the brief piece noted that he worked at a “hiring center”.  That sounds interesting, because one might normally expect hiring to occur at the store level, not at a separate, specially designated center.  A quick google search unearthed an article noting that WMT had recently opened a hiring center, in Woodbury, NJ to help find 550 workers for a new facility in Deptford, NJ.  According to the New Jersey CAFR,  back in 2006 (as former state budget analyst, trust me, the wheels of government grind slowly and its hard to get very up to date information) WMT was the 6th largest employer in NJ after Shop Rite, Verizon, UPS, Harrah’s and J&J.  So here we have one of NJ’s largest employers actually expanding operations to hire new workers in the ninth most populous state next door to the nation’s sixth largest city.

Naturally, the people mentioned in the article appear to be looking for sympathy, but again, we see who WMT helps to employ.  One of the interviewees is a former real estate salesman.  Even money would bet that this gentlemen came to the real estate game during the recent bubble lured by the promise of quick riches with low barriers to entry (rumour has it that a typical real estate exam requires a pulse and little else).  None of this is made explicit in the article, but one can’t help but wonder. It seems as though WMT tends to catch individuals who have made mistakes in the past, whether that may be banking on a ethereal industry like real estate or having several children out of wed-lock that makes it difficult to find permanent work.  The members of one family of three interviewed have been unable to find work since October 2007. These individuals are normally supported by the social safety net.  However, in some instance, this breaks down.  In the case of the real estate agent, health benefits for him and his wife run to $1,300.  In other G7 nations, that is provided by the state.  Here, it will be provided by WMT, either directly or through a salary that helps to fund that cost.

So, while we don’t have a government safety net that provides employment or benefits to the family of three or health benefits for the Mr. and Mrs. Real Estate Agent, we have WMT.  More interestingly, WMT’s revenue stream this day appears more robust than that of the US or local municipalities!

I have always believed that WMT has taken too much stick in the press about its human resources practices and its impact on “mom and pop” businesses.   Let us dispose of the latter first.  The bottom line is that WMT customers need not shop at WMT and are free to patronize small businesses.  In my opinion, WMT does away with a subsidy to small businesses.  Consumers have a choice: they can retain more of their disposable income by shopping at WMT or they can give some of it to smaller businesses.  As a former banker to post soviet enterprises, I personally saw many inefficient enterprises receive subsidies from the government.  If we agree that smaller businesses are less efficient than WMT in purchasing, pricing, inventory management etc., then we might also agree that patrons of small business effectively subsidize these less efficient operators in a way similar to the government subsidies I observed in the former Soviet Union.  So WMT effectively ended this enforced subsidy, tax even, off inefficient businesses.

But at the same time, WMT provides its own subsidy to workers in the form of employment.  I watched Wal -Mart: The High Cost of Low Prices and was struck by two common themes.  The first theme was one of complaint: that WMT does not provide benefits, pays too little, has questionable hiring and retention practices.  The second theme was one of desperation exhibited by those workers.  Interviewees had exhausted elements of the public social safety net and lacked skills to find better work.  I was struck by the consistency of these themes.  I don’t remember the exact plights, but generally the worker interviewed was female, poorly educated and the single mother of at least two children. Furthermore, these workers had exhausted the various exhaustable state and federal social programs and were forced to seek employment, landing on WMT as the only viable alternative.  These two themes converged to trace a profile of WMT as an extra-governmental social safety net.  These people were rather desperate and there opportunity set appeared to be limited to WMT and homelessness.   When we consider that WMT is often the largest private employer in many states, the extent of the social safety net it provides becomes clearer.

Casting WMT as a public good can be tricky, but as described above, not entirely ludicrous.  The argument strengthens when we think about how WMT’s aggressive supply chain practices emphasize consistently low prices.  We may conclude that the retailer may have helped play a role in containing core CPI.  Scholars have studied this topic and I believe concluded that inflation has benefitted from a WMT effect.

But the case for WMT as a public good grows as we consider its green initiatives.  In fact, these initiatives may even help to rehabilitate WMT.  First, WMT has aggressively pursued sustainability in packaging through its supply chain.  It even hired a person dedicated solely to this effort (Amy Zettlemoyer, although she hyphenated her name when she got married), which includes scoring suppliers based on the sustainability of their product packaging and delivery.  Now, WMT is populating the rooftops of its huge footprint stores and DCs with solar panels to help generate its own electricity. 

So as WMT once was hailed as an exemplary retailer, before being questionably pilloried for its HR practices, it stands to once again regain stature as a leading green retailer.

But that’s just one credit analyst’s opinion.

Martin Wolf wrote in yesterday’s FT about the difference between the US and emerging markets, specifically Russia.  He notes the importance of corruption, which is another key differentiator between the US and emerging markets and one which goes far to rebutting Johnson’s argument.  This is not to say that the US is free of corruption, but that the overall control of the the legislative process is not controlled by any one economic group. (Naturally, there are powerfullobby groups such as the NRA and AIPAC which very greatly influence certain elements of the domestic and foreign policy agendas.)  Wall Street appears to have enthralled public officials and has most certainly spent bundles on lobbying.  But this is a very far cry from Russia’s loan for shares program in the early 90s.  Paradoxically, Wolf makes a point now when it seems (I havent been involved in Russia in years) that the old powerful economic and industrial interests are waning.  Waxing in their stead are the KGB nomenklatura within Putin’s orbit, or so the story goes.

On to Roubini.  Let me just say that he is smarter and richer than I.  Nothing against the man, I don’t know him.  And I haven’t read his book.  But going into this post, from everything else I have read by him and about him suggests that his big contribution can be summed up as follows:  volatility (incarnated and worshipped as VaR) is the dispersion of observations around a trend line, which completely ignores the angle of the trend line and the horizontal axis (on a graph where the x axis = time and the y = value).  In other words, we spend too much time tying to see how wide the cloud of observations is around a trend line and ignore the fact that a rapidly rising trend line has further to fall.

But he and some friends did produce an interesting idea in today’s FT.  They (Roubini, Viryal Acharya and Matthew Robinson) propose, as part of a larger regulatory system, a systemic risk tax that would tax large, complex financial institutions through increased deposit insurance, fees and capital requirements.  The authors also call for an increase a market risk regulator to, naturally, levy the tax.  I hadn’t heard this one and though it was interesting.

But that’s just one credit analyst’s opinion.

Much has been said about the bottoming of the economy and the glimmers of hope for the recession’s end.  But these terms are likely to have been misconstrued by the layman because, they refelct the academic economists’ focus on the first derivative, or rate of change, of time series data.  It would be hard to fault the average reader/listener of the broadside press to misapprehend the recent positive ebullience as referring to economic growth and improvement in unemployment.  Examples of the recent uptick in positive outlooks are too numerous for me too mention and many of the pundits are truly forgetable. 

Undoubtedly there is improvement in the sense that things are getting bad at a slower rate (not getting less bad).   But academics and economists (and especially academic economists) tend to look at time series in order to take a view on  economic trends.  That is they look at GDP figures, durable goods orders, unemployment etc.  But more importantly, they look to the first deriviative of these data series: the rate of change.  When they see economic indicators that have been declining at high negative rates begin to continue declining at smaller negative rates, they see reason for optimism.   

They are in a way justified in their optimism, but they run the risk of generating expectations among the average working person.  Naturally, this is not a completely bad thing, as economics has much to do with expectations and actions based on those expectations.  So creating a positive expectations may have a collateral beneficial effect.

However, I recently come across some potential informations that may be more concretely positive. As a credit analyst, I always look to the downside, so to get me to be positive about anything is truly difficult indeed.  But I discovered some interesting data I’d like to share. 

My firm has exposure to the machine building and forging industries.  These are highly cyclical and I track them to keep an eye on trends. Looking at the February durable goods orders, I saw something encouraging: a genuine uptick in new orders. The same can be said about Industrial Machinery.  I have some clear graphs that show this, but I cant seem to figure out how to paste them into my blog.

The important message is that these indicators, and a couple others give me reason to be optimistic.  Now, these trends never describe a nice curve, the jump up a bit, then come down by more, so its impossible to conclude that one uptick is a sign of recovery.  However, these upticks are the first signs of resistance.

But that’s just one credit analyst’s opinion.

Simon Johnson notes in a recent post that which caused me concern in a recent posting about the threat of inflation.  I agree that this could be a big threat and I also agree that the Fed’s actions are very appropriate under the circusmtances.   I also agree that inaction is probably far worse than the current actions undertaken by the Fed and the Obama adminsitration.

Where I differ with Simon Johnson (and lets face it, he’s much smarter and more experienced than I) is in his casting of the US as an emerging market.  I accept his drawn similarities between the US and emerging markets in terms of typical macroeconomic indicators and I even acknowledge his qualitative parallel that focuses on the role of elites in emerging markets and the role of the US financial sector as one of those elites.  However, I think that those similarities are superficial and much more easily addressed in the US than in Indonesia, Russia or any other emerging market that Mr. Johnson parallels with the US.

I base this disagreement on my belief that the US has stronger institutions that inhibit prolonged dominance by elites.  We have strong interest groups across all areas of the American political process, so to say that one dominates is misguided.  Even in terms of economic power, Im not sure that Wall Street carries the same weight as the oil and gas complex in Russia, for example.  Perhaps policymakers have recently become awestruck by Wall Street, but the US budget does not rely heavily on tax revenues from Citi the way the Russians rely on Gazprom. As result, that control by the elites is more easily severed.

Moreover, we have a vibrant middle class (which in my opinion should stifle most comparisons to emerging markets which are generally poorer and lack a middle class) that can return to a robust policial process to set things straight.  naturally, the middle class has to conciously awaken and pressure its representatives, but I find it hard to believe that a dentist in Singapore is as empowered to influence the role of elites as a dentist in Nebraska.

But that’s just one credit analyst’s opinion.

I was reading the Comments on Credit blog ( discussing the need for cashflow in lending and de-emphasizing collateral.  They are right, collateral is very chancy.  But they dont go far enough.  So ill pick up the baton.

Relying on collateral is risky for several reasons. First, established manufacturing companies, those more likely than not to provied assets for ABL structures, are very exposed to a synchronized downturn resulting from a cycle trough or exogenous shock.  This means that earnings will become strained as the industry is declining (cyclically or secularly). As a result, the demand for the hard assets (we will deal with current assets in a moment) will be at a low point, as the industry for which the M&E is designed or the real estate is best suited is generating lower cashflows.  Simulataneously, the synchronized downturn will flood the market with similar use equipment.  The combined increase in sully and decline in demand will yield lower liquidation values.

Moody’s recently published a report demonstrating that revolvers tend to rise as companies approach distress.  For revolving lenders, this means that excess availibility declines and the collateral cushion thins.  This also means that other secured lenders who might have a second lien on other assets (think about a lender with a lien on M&E who is starting to realize that the supply/demand imbalance in distress is depressing collateral value) will see collateral cushions disapear.

In the end, what matters is the ability of the assets to generate cashflow and that is driven by the microeconomics of the industry. 

At least, that’s just one credit analyst’s opinion.