Saturday, March 14, 2015

Capital Misallocation DuJour

Let's polish your financial and accounting skills. What price would you put on the stock of the following Fort Lauderdale based company? 
Their Investor Relations web site reads as follows (minus a few crossed-out words to keep the suspense going):

Photo of person marking the words Marketing and others on a transparent board."The Xxxxxxx, Inc. is an American entrepreneurial “emerging growth” company with a brand and xxxx that is widely followed throughout the nation. We believe that xxxxxxx is the “new xxxxx”.  The Xxxxxxx is a fast growing, early mover in the xxxxxxx industry. Management believes that we are one of the most followed xxxxxxx on Facebook, and we believe we are the only known xxxxxxx verified by Twitter.
Many quality xxxxxxxxxxx go into every xxxxxxxx we make which is what we believe elevates our xxxxxxxxxx above the rest and why people line up in front of our xxxxxx sometimes for over an hour to get one of our xxxxxxxxx creations. Our goal is to make people happy with our xxxx.
Our xxxxxxx have received numerous accolades, including being listed as one of the best xxxxxxxxxx in the country."

composite image of the Twitter bird and their check mark
Don't let their "Management believes" and "we believe" statements throw you off. Clearly, both were made by the same person (natural or legal). Let's remember that the speed of growth associated with start-ups often results in simple message mistakes like this one. Now that you can call me old fashion, but I am not sure of the bragging value from being "verified" by Twitter.
And in case you doubt it, the company is real. It's even publicly traded. Their latest 10Q shows revenue at just over $995K, That's "K" as in Thousands.
COGS show at over $920K, and Total Operating Expenses at $959K.
Like with any other up-and-coming company, their 18 million shares-outstanding trade with some volatility. The recent market correction pushed this company's stock down by 29%.
composite image of NBA game between Lakers and Suns
Key assets are deployed in LA and Phoenix
Their key assets are deployed in two important metropolitan areas: Los Angeles, CA and Phoenix, AZ.
As for their balance sheet, liabilities equate to 280% of their assets; thus leaving them with a stockholder's deficit rather than the usual equity. Translation, their founders either blew up all their money or have no skin in the game. Both are bad, if you wonder.
But the market is nonetheless quite confident. That much is evidenced by their rich valuation. How rich, you ask? Well, have you guessed how much capitalization do they deserve?
Say you give up.
Wall street has valued their shares-outstanding at a whopping $71,000,000; which is down from their recent valuation in excess of $100,000,000.
What? These guys are insolvent and losing money by the boat load. Why would anyone give them more funds? Their negative Cash Flows from Operations amount to about 250% of their revenues. Are investors off their tree?
But wait, something important must be missing among all these facts. Why else would financial experts dish out such rich valuation for what amounts to garbage, right?
Let's see, their President / interim CFO has an MBA from the University of Miami. Meanwhile, the CEO has an undergraduate from Jarvis Christian College. Could their pedigree be the reason for so much market good faith?
If you haven't taken a look at the company's name by clicking on the 10Q link above, let me share that the special product they tout is a cheese sandwich... Well, a "gourmet" cheese sandwich. So their main assets deployed are food trucks. To be exact, we are talking about four (4) food trucks.
Not an image of a military-spec food truck with anti-ballistic features and vertical jet liftoff capabilities
Is it possible that each of these trucks will deliver value in excess of $17 Million?
I thought long and hard and continue to be convinced that the trucks must be special. Certainly a mission critical project like theirs calls for military-spec vehicles with anti-ballistic features and vertical jet liftoff capabilities...
... and it goes without saying that the cheese used in their splendid sandwiches must carry self-propelled cancer-fighting nano-agents...
... all features that are highly valued by beer guzzling fairground attendees in LA and Phoenix.
At this moment, I feel the need to clarify that I hope no one has been hurt by my sarcasm.
... drum roll please...
The name of the company is The Grilled Cheese Truck, Inc. I think that it vividly illustrates the orgasmic nature of the Wall Street party that is taking place right now; thanks to the keg sponsors at the Federal Reserve. 
Two days ago, I proposed that the presently inflated stock market valuations were not a sign of economic health. 
Even the best marketing guys I know can't come up with this much fluff-ware.
Financial bubbles anyone?

The Melty Buzz illustration from The Grilled Cheese Truck's website.

Friday, March 13, 2015

Artificial or Else - Questionable US Recovery

They claim the recovery is solid. Just look at the stock market, they say.
picture of CNBC's Senior Economics Reporter Steve Liesman
CNBC's Steve Liesman
Economists like CNBC's Steve Liesman and investment peddlers everywhere insist that the seemingly unstoppable stock market climb is a sign that all is rosy within the US economy. After all, they say, isn't the stock market a price-discovery mechanism intended to value all information about the economy instantaneously?
Well, yes and no. The stock market, like any other market, acts as a pricing tool. Where things go bad is that it is now being distorted by the massive gravitational presence of the Federal Reserve's balance sheet. Never before in history did a single entity monetization so much. Never before did markets have to deal with such a large distortion. Let's take a close look at a sector that I feel disproves their allegations.
image of chart from Saint Louis, MO Federal Reserve showing a decline in Retail Sales at Department Stores compared to an increasing US population
Department Store Sales collapse.
Meanwhile, the buying population increases.
Visiting the Federal Reserve's own website, one can easily see that retail sales at department stores across the nation have collapsed. Things are so bad that I will suggest you take pictures of all the anchor stores next time you visit the mall. In no time, your images of formerly well known dinosaurs will appreciate in value.
But not all is bad of course. Noise is never so simple to clean. The fact remains that a continuously growing US population has made the size of the buying market larger; thus helping grow total US retail sales. Yet, all benefits from such market growth seem to have completely missed department stores across the nation. Just look at the Fed's chart above; department store revenue has fallen to scary levels. As a result, there's even talk about how these players are failing to entice new buyers as they continue to lose old ones.
But don't say I didn't warn you. While my forecast for the beginning of 2015 was a little lower than where things are now, I had told you in my article back in July, 2013 that Department Store sales would continue to plummet. Well, they did.
stock price chart comparison of Dillard's, Macy's and Nordstrom.
Stock valuations of Dillard's, Macy's and Nordstrom
continue to push higher despite horrible retail performance
Surprisingly, though, none of these terrible facts is reflected in their stock valuations. As things have turned worse, stock prices of companies like Macy's, Dillard's and Nordstrom continue to increase; just as if revenue performance was stellar.
So, how is this possible? Isn't bad sales data supposed to push stock prices lower?
While we all know that the stock market can behave irrationally in the short term, we still trust that long term price performance correlates with fundamental health. But as it should now be clear, we are witnessing an anomaly.The expected poor stock price is conspicuously missing. Current valuations rather reflect boom times.
Thanks to the disruptive effect of the Federal Reserve's Balance Sheet, department stores are being rewarded for carrying a poor business model that sports an upcoming expiration date.
The Fed's massive money printing has created the ideal environment for capital misallocation. So the story repeats: excess money is put in the wrong hands and... boom, a bubble pops. Let's hope that shrapnel doesn't hurt innocent people this time around.
If you still believe that the market is really serving as proof of a healthy US economy, don't worry; I have a couple of other posts that will destroy your thesis. Until then, enjoy the volatility.