Random Idea's  Instablog

The retailers have been on a run.  The Retail HOLDERs (RTH) has bounced roughly 40% off of the bottom in early March.  While signs of “green shoots” have become evident, one wonders whether the cause is underlying business strength or the sugar high of a huge stimulus package working its way through the system.  What is more obvious is that the consumer will not lead us out of this recession.  In fact, the consumer will face headwinds for a time due to an increased savings rate needed to work off an over-leveraged balance sheet.

Given the headwinds to the consumer and diminished disposable income available for discretionary purposes, I would expect the retailers to continue to be under pressure.  However, this has not been the case.  As an example, J. Crew has more than quadrupled off of a year low of $8/share.  While J. Crew is a great brand in the retail space, I believe shares more than value this.

At a current price of $35.23, JCG has a market cap of $2.2 billion.  Against this, I forecast net income of $54 million ($0.88/share) for 2009 (Note: JCG’s fiscal year ends in January) and $1.19/share in 2010.  Historically, earnings peaked at $97 million in 2008.

So even at peak earnings, shares trade for over 22x earnings.  How about cash flow?  If we take free cash flow (defined as operating cash flow-maintenance capex) of $54 million in 2009 and $84 million in 2010, JCG still looks quite expensive.  Apparently CEO Millard Drexler agrees as he has sold $33 million of stock in September. 

In my estimation, 15x normalized FCF of $100mm makes sense to me, or a price of $24/share, given headwinds in retail and capital intensive nature of growing the business.

Disclosure: My fund is short JCG and short JCG calls.  No position in RTH.

Below is a letter I wrote to my Congresswoman, Senators and the President.  As a Republican, I’m embarrassed that it has been our party that has over the past thirty years been largely responsible for the expansion of the federal deficit.  What happened to limited government?  I don’t write to argue politically…only to admit my party’s failure and admit that we need to do something about it.  The debt is everybody’s problem and if some serious changes do not occur we will be in big trouble. 

As you may have read in my previous post, a potential issue with GMXR this year is their covenants.  In particular, I mentioned that the covenant of keeping Debt/EBITDA below 4.0x would likely be triggered this year.  Surprise surprise, at offering of 5.75mm shares (5mm +15% over-allotment) puts them below this range, moving my modeled debt to EBITA at year-end from 5.4x to 3.9x.

I don't like this offering.  I think GMXR stock is undervalued and that offering over 30% of existing shares is dilutive.  My model suggests this is $5/share dilutive, bringing fair value down from $40 to $35.  The offering (assuming it goes through at roughly current levels) does partially alleviate GMXR's liquidity and leverage issues and sets up the Company to up forcasted CapEx in 2010 from the current $75mm.  So I suppose its like taking the cough syrup as a kid.  You never liked taking it but knew it was for your own good. 

As mentioned above, I believe GMXR stock to still be undervalued, though not as much as when I wrote my previous post.  I would therefore recommend a small position, adding every couple of dollars down with an expectation of hitting $35 in the next two years.

Investment Summary

NGP Capital Resources (hereafter NGPC) is a financial services company investing dedicated to investing in the Energy sector.  The Company is regulated as a Business Development Company (BDC).  This means that they receive certain tax benefits and in exchange they must pay out a substantial portion of their earnings in the form of dividends to shareholders.