Mark Krieger's  Instablog

 The regional grocery chain has  had a spectacular run-up lately, surging over 100% from $5.97 in early Sept to nearly $13 last week. The stock’s stunning rally is by no means a result of operational improvement or other change in fundamentals, but rather a rumor of a impending takeover. The fact is, Billionaire investor Ron Burkle’s Yucaipa Investment company has taken a large, friendly position  and has consequently  gained board representation.

Further proof of a potential change of ownership was a German newspaper article reporting that GAP’s largest shareholder, the Tengelmann group is investigating the feasibility of the sale of their  entire ownership stake. Interestingly enough, GAP’s corporate bonds have stayed relatively flat in the same timeframe and offer the investor a chance to exploit the inefficiencies of an efficient market by enabling them to buy into a much stronger scenario without having to pay a higher price.

 

Second Quarter earnings: The regional Grocer ( who runs both Pathmark and A&P) sales fell by more than 4% from $2.2 billion to $2.1 billion. While the company’s loss expanded from -$1.97 to -$3.97, its gross profit margin surprisingly improved 30 basis points from 29.8% to 30.1%. 

Although the supermarket chain attributed its poor results to a soft economy and its inability to get its Pathmark acquisition up to full potential, it is still cash flow positive.The company announced that it would be seeking a new CEO immediately with the resignation of its current CEO, Eric Claus.  Board Chairman , Christian Haub ,will assume interim CEO responsibilities until a successor is named.

 

The Bonds: Gap corporate bonds (GAJ) are very unique. These 9 3/8 %, 30 year bonds (aka quibs) were issued ten years ago when the prime rate was 8.25%.  They were sold in $25 units (par value) and are traded on the NYSE( 8 million shares were issued raising $200 million).Most bonds are sold in $1000 increments and are not traded on the NYSE, that is why  these bonds so unique. Their annual payout of $2.34 equates to a current yield of 10.7% and obviously with a yield so high, they are non investment grade.

 

The upside: If GAP is eventually acquired, Bond holders would have to be paid Par value before the acquisition could take place. That would give the holder an immediate 14% gain from the bond’s current price. Another scenario would be GAP calling the bonds at par value so they could reissue new bonds at a lower interest rate ( today’s prime rate of 3.25% is more than 60% lower than what the prime rate was( 8.5%) when the bonds were originally issued).

 

Shrewd Investors are buying the bonds: Both Gamco Asset Management (managed by Mario Gabelli) and Barclays Global Investors have been aggressively acquiring shares bond shares. GAMCO who owns 5.4  million shares,  recently acquired  another 256,000 shares while Barlcay’s added  another 66,000 shares, bringing their total to 2.1 million shares. Further accumulation by these two major  bond holders should bode well for GAJ’s price , especially considering its low liquidity status ( average trading volume of only 17,000 shares, creates substantial volatility).

 

Bottom line: Buying these bonds is appropriate for those with both short term and long term horizons. Those with a buy and hold approach will be getting a very juicy return, thanks to the dividend. Those wishing to make a fast buck could see a nice 10% pop in the very near term as the bonds are now at about the midpoint of their $20-24 trading range and have been trending higher.

 

Disclosure: long GAP and GAJ

 Since my last update, nearly three months ago, the Basic Food Fund or “BFF” has risen 6.4% from $182.93 to $194.66 versus an 8.4% increase in the Dow. Its poor relative strength could be attributable to its lower beta status (lower beta stocks drop less in down markets but rise less in up markets) since its components are defensive in nature. Meltdowns in three securities didn’t help matters either, as both  LUB and WINN received  20% haircuts while CKR took a 12% hit. Big winners in the index were  GAP, soaring  66%, SFD rising 33%, SLE up 30% and TSN adding 12%.

KR replaces LUB: LUB is being replaced by Kroger as a BFF component. The strongest of the three major traditional national grocery chains, KR’s clean balance sheet, low PE multiple and hefty dividend make it a perfect addition to the fund .LUB’s drop into the abyss ( shares must trade above $5 to meet the minimum inclusion requirements ) was the catalyst for its elimination.

The revised index price begins at $214.13.The Index was originally devised during last year’s meltdown as a form of therapy to cope with my severe (paper) losses. By putting my thoughts to paper, the pain and anxiety seemed to diminish somewhat. Now, the fund has become more of a “platform” to promote my positions, as I am putting my money where my mouth is!

 

Component update:

 

SLE: Everybody seems to love Sara Lee these days, as the shares have made another 52 week high. The pie and cake maker has seen a abundance of good news lately:  (1) it beat 1^st quarter earnings estimates and raised guidance (2) Unilever bought part of its global body care and household products business for a better than expected $1.9 billion  price tag (3) Both Procter & Gamble and  SC Johnson  have expressed interest in purchasing its air freshener business for as much as $700 million.

IPSU: The sugar producer announced a joint partnership to build a new refinery at its Gramercy, Louisiana location. IPSU, Cargill and Sugar Growers and Refiners Inc. will each invest $30 million in assets to build a new state of the art refinery on a 207 acre parcel that IPSU is contributing to the new three way partnership. IPSU’s lone analyst also released bullish research notes and reiterated his $20 target price.

BRID; The snack food company made a new 52 week high at $9.99 on news that the company was issuing a ten cent special dividend. Buyers are also banking on further earnings improvement when the company reports its 4^th quarter results next month.

SFD: Duetsche Securites upgraded its opinion on the pork producer from a hold to a buy, citing improving industry fundamentals,  propelling the shares pennies from a new 52 week high.

TSN: The company announced a new CEO, Donnie Smith (a longtime TSN executive) and is expected to report fourth quarter sales of $6.88 billion and earnings of 27 cents when it reports Monday. Two recent downgrades from JP Morgan and BB&T Capital Markets have kept the share price in check, but an earnings blowout could set the stage for an impressive rally.

 

CAG: with a 3.6% dividend yield and a multiple of only 13 times 2010 earnings estimates of $1.69, it is no surprise why UBS recently raised its opinion on the food processor from a neutral to buy rating.

WINN: The Grocer reported poor first quarter results prompting a beating in the share price. As a result, Activist Investor George Schultze, (his Schultze Asset Management firm owns 1.5%) wrote  a letter to the Board requesting them to evaluate other alternatives ( besides store remodels) to enhance shareholder value, such as a stock buyback or entire sale of the company. We will see has this develops.

SWY: the grocer reported solid third quarter earnings, beating the street by a penny. Although sales were down 7%, the company was still able to expand it gross profit margin by 78 basis points to 28.27% and buyback 23 million of its own shares.

GAP: Buyout rumors are fueling this stock’s meteoric rise

SVU: The company slashed its annual cash dividend from 70 cents to 35 cents, to help facilitate its decision to double the size of its Sav-A-lot  division from 1200 stores to 2400 stores. An initial $75 million has been earmarked for the endeavor. About 75% of the stores are run through license agreements. Even though the dividend was cut by 50%, the yield is still a generous 4.6%.

 

CKR:  The burger chain has gotten into a price war with McDonalds and in my unbiased opinion (okay maybe it is just a little biased), is beating them badly. The company’s “Big Carl” is nearly twice the size of MCD’s Big Mac at a lower price, and its famous $6 burger has been slashed to $2.79. The burger chain is also offering a loyalty “rewards” card, giving customers even more incentive to come back. I guess if you can’t beat  them, then “undercut them”, by giving the customer twice the product at less the cost. I just hope this strategy does not backfire .The stock is simply oversold and due for at least a “dead cat bounce”.

 

DLM: selling at one half book value, a forward multiple of 12 times 2010 earnings estimates and a 2% dividend yield to boost, the stock still appears cheap even after a substantial rise. Wall Street   is apparently spooked due to its $1.5 billion debt load and so am I!

 

FLO: The bread maker reported third quarter earnings of 34 cents, matching analyst expectations, but was short $14 million on the top line due to increased promotional activity. The company revised its fiscal year guidance from $1.43   to $1.40, creating a nice buying opportunity ,as the stock overreacted in a unjustified selling stampede. This one is headed back up to $26.

 

KR: the newest addition to the index, stacks up to be a stellar performer. We shall see.

 Bottom line: It is the time to put food stocks on your plate. You won’t get rich overnight in these types of companies, but you certainly will be able  sleep better ,holding these conservative, low risk securities. Most of them have fairly low multiples and decent dividend yields. They are not overburdened with debt and are in an industry we cannot live without - “FOOD”. 

 

Disclosure: Long each of the fourteen components making up the index

 

 

 

 I admit I have been short too long on this one, It feels like getting run over by a freight train each and every day the stock runs up and squeezes me that much more. I am ready to throw in the towel and cover, but I am afraid that it will be at the absolute top, and the minute I close out my position, the shares will quickly plummet. It seems that I am more worried about missing an opportunity to get my money back than losing  even more money (sound familiar?) At this point, it appears that I am grasping at straws  to justify remaining short but here are my bearish thoughts; (1)PCLN’s multiple is based on pro forma earnings not GAAP, otherwise its earnings would be 30% less if you deduct the cost of employee stock option compensation (2) there are few barriers to entry in this sector- a new competitor could easily pop up-eroding PCLN’s market share (3) an impending supreme court ruling could invalidate many  technology software patents ,such as the company’s “name your own price” model. (4) In the last week, PCLN insiders have been selling at will, liquidating over 76,000 shares (5) sentiment is extremely bullish-usually the case at just before price implosions (6)Shares are overbought after quadrupling- a price correction due to profit taking is probably in the cards. (7) The stock is selling at nearly eight times shareholder’s equity.

 To be fair, I must admit, PCLN’s forward multiple of about 20 times  2010 earnings estimates seems more than reasonable, but I am skeptical that it will be able to meet is ever increasing expectations. Its price seems to reflect perfect future execution and sooner than later, the company is bound to make a mistake.  Those in the bullish camp would probably characterize these “so called” negative items I have outlined, as a desperate short’s last gasp “spinning” attempt-maybe so, but if you are destined to go down, you might as well go out fighting!

 

Since my last update the shares are up over $60. My take on the matter is: if I thought the stock was expensive at $150, then I think it is even more overvalued at $207,and a better shorting candidate. The market has ratcheted up its earnings expectations substantially since then, expecting 23% growth from 2009 earnings of $8.10 to 2010 earnings of $9.99—the bar is getting higher and higher and making it a stronger possibility the company could get tripped up.

Market Cap is unrealistic. With a market cap of over $9 billion, PCLN's share value is worth more than JBLU, UAUA and DAL combined. The funny thing is, these airlines are expected  to produce over $50 billion in revenues and $900 million in earnings in 2010 or 18 times PCLN’s sales and twice its earnings.

Credit Suisse sours: Credit Suisse downgraded the shares from outperform to neutral on valuation purposes. The shares are very close to the Analyst's  one year  mean target price of $219.This leads me to believe we are at the upper limits of PCLN’s trading range.

 

Short interest is dropping: During the latest period,PCLN’s short interest dropped 7% from 7.2 million shares to 6.7 million shares meaning there will be less short fuel available to propel the shares.

Bottom line: this one is definitely a  Vegas style casino stock  and although the momentum is clearly up, one piece of unfavorable news could crash the shares ,as fear has a more powerful effect  on the downside, than elation has to the upside. Translation: the stock will drop at twice the rate it ascended if the market suddenly sours on it. I think this scenario will occur, but the question is, will I run out of money before it does?

 

Disclosure:   stubbornly short