NY Times Article on Tobacco Taxes

Wow, haven't done Blogger in quite a while.

That said, I stand totally VERKLEMPT (spelling?) on the NY Times article on Tobacco taxes, and how "roll your own" tobacco leaf companies like McClintock are getting around the Obama Administration's taxes on cigarette tobacco.

Why? Not for the reasons you think. Just for what I think, I guess.

Look, Obama smokes. And he is one of the privileged class -- like you, me, anybody who is wise enough to read this -- who can afford to smoke in this era of "tax the smokers".

Apparently, it's perfectly fine and okay to give government workers (in these times) gold-plated pensions, salaries that exceed the private sector's wages, and so on. God forbid these valiant "public servants" endure tough times like the rest of us, have to fret about the viability of their jobs, or worry about their next mortgage payment.

Nay, government employment (federal, state, local and education) will continue apace. Employees in such jobs will continue to garner what to all others amount to gilt-edged benefits -- solid healthcare with negligible co-pay, inviolable defined-benefit pensions, etc.

And the rest of us, those not on the government teat, who try to produce the wealth necessary to support the taxes that provide for these dedicated "public servants' -- apparently must acquiesce. Since, presumably (ironic here), our efforts are not as valuable or noteworthy as those brave "public servants"...

Ya know, "public servants" doesn't mean what it did when my father was alive... but I have to admit, my Dad saw this coming.

When during the late stages of the Vietnam War, he saw half of my cousins get Master's degrees in Education so they could be exempt from the Draft, dear old Dad said, "Just watch. They are taking public education away from the old schoolmarms, and pretty soon, it's going be all about teachers who want to make more money, because they have Master's degrees and think that they are somehow owed it."

Which is exactly what happened. Teaching our kids went from a second-career Mom or spinster -- who knew what little terrors kids really were, because the spinsters/Moms had life lessons -- to a "highly educated professional" who somehow "understood children" because they had "advanced degrees".

Advanced degrees is mostly a myth in this realm, quite honestly. Sure, it's neat and helpful to have an advanced degree in Education from a real "name" college, say UC Berkeley or similar. Your children might benefit from a teacher who has the intellectual capacity to obtain such a degree. But most of these "advanced degree" teachers don't get their Master's from perceived "great-institutions". They get them from the path of least resistance institutions, and they do so because a "Master's" from anywhere is more lucrative than a simple Bachelor's from somewhere.

In other words, most of these teachers are in on the scam.

I had a great argument recently with a former Assistant Principal of a California High School. She was being paid $120K per year before she retired (with full benefits). She said, "You couldn't do my job." I said, "You're right, I couldn't. But I never wanted to. But I would think, that with the benefits and salary that you rose to, somebody else out there could have done your job as well as you did." And I went on with a long list of names, of other people that we mutually knew who had the temperament and ability to have done her job, but who worked in the private sector for less money or benefits.

To which she acquiesced. As in, you're right, other people could have done that job... but I was the lucky one who exploited the opportunity. in other words, FYJIGM... which in Los Angeles city worker parlance, I am made to understood, stands for "Fuck You, Jack, I Got Mine".

This is a long-winded post, so I will bring it back to the leaf tobacco companies, and President Obama.

Our government today stands ready to make certain people a privileged class. If you can afford it, you are privileged. If you cannot afford it, and try to "roll-your-own" (that is, try to make the best out of a bad situation, but continue on with your own pursuit of happiness and liberty), this Government will still try to find you out and make it uneconomic for you to enjoy said liberties.

This state of affairs is WRONG. It smacks of "serve the government BORG", at the expense of one's self.

This new tobacco tax is WRONG from the days of George Washington.

Even George Washington, who suppressed the Whiskey Rebellion of 1794, would understand that -- you know what?, gasp -- Americans like their liberties. They LOVE their liberties.

And the governments' trying one way to tax something is at first "okay, reasonable enough". But then their governments' trying another "something", and later our governments incessantly hammering at something that Americans enjoy, and want to be part of our liberty... at some point, goes against the "life, liberty and pursuit of happiness" doctrine (that Jefferson, an anti-Federalist, as opposed to Washington, wrote in).

Question: what can happen next? The government decides that you can't grow your own tobacco, and smoke it on your own land, without being taxed exorbitantly?

Question: How is this any different than your raising your own Hogs (you know, bacon fat is bad for you), or growing your own Celery (too much salt content, perhaps)?

As Wikipedia states, even George Washington's "internal war" was unsuccessful: "The hated whiskey tax was repealed in 1803, having been largely unenforceable outside of Western Pennsylvania, and even there never having been collected with much success."

In a tremendous lifetime of service to others, the only stain (as Americans) that one could ascribe to the Father of Our Country, George Washinton, is his supression of the Whiskey Rebellion. It is in that one solitary action that George Washington forgot that the United States of America is made by and for the benefit of the People of this Country.

It is not made by the Government, nor those who work for the Government. It is for the People.

The end.

Why China Can’t Lead

By Patrick Garot – 26 March 2009

The market sure picked up since my March 4 (here) and March 9 posts (here). If you've played along, it is time for you to harvest some rocket gains… but that is not the subject of this article.

Instead I will discuss China. I like James Quinn's diarizing on America's fade-out (here) as brain food, but I just don't see it. The question is leadership. What another nation can lead?

Well, Europe has not come to terms with flailing banks (see Harrison's post here). Japan continues on its real, demographically-driven, low demand fade-out. Oil rich Middle Easterners invest, but don't invent. Korea and Taiwan are small, and hurting on export declines.

Some think that this leaves China (see here) to lead the world into the future. But China can't lead, and won't for decades, if ever.

The Bottom 80%

Consider the USA in 1965. Manufacturing hums along. 160 million folks, most productive and decently educated. A growing service sector, expanding institutions, prosperity. Now add an event whereby the US expands its borders to encompass all of poor Latin America and Africa. Then strip out those regions' natural resources, and you have China today.

China has 1.3 billion people. While 562 million (42%) are listed as "urban", in truth there are 180 million in the metro areas that wow westerners – but a third of those are in slums and shantytowns that most westerners don't see. The chart below gives you estimates of life in China for the bottom 80% -- on a purchasing power parity basis, this 80% average $11.58 per day to fulfill all of their needs.

 

The truth is that China is two nations. One is booming, fast-moving and sophisticated. The other copes with a poverty equivalent somewhere between today's Laos, Syria, and The Congo – except without the natural resources of those nations, as much of western China is non-arable desert or mountain.

No Domestic Demand

China's bottom 80% earns $4.48 per day in USD: peasantry amounts. After food, shelter and education are paid, less than $2 is left for "desires" that are often priced in dollars – say, an iPod or a netbook manufactured in China.

China's elegant solution since Deng was to mimic early Asian "tigers" with an export-led tide. Thus the bottom 80%'s per-capita income grew from $1.65 per day in the early 1990s, to $4.48 today. Deng's solution worked.

But China can lead? Nations that can lead must be strong inside and out. And Deng's solution hinged on two things: the assent of Western nations to buy stuff made in China, and cheap labor, from attractive currency rates.

A Manipulated Currency

In January 1990, the Yuan was Y4.73 to the dollar. By January 1994, the Yuan was cheaper at Y8.47 per USD. From 1994 all the way to December 2006, the Yuan stayed above 8 to the USD. Since, the Y/USD rate has been managed down -8% in 2007, and -7% in 2008, to Y6.83 today.

China's economic growth has been a Faustian bargain. The BoC manipulated forex so the Yuan stayed eight to the dollar even as the China-US trade imbalance grew tenfold. Exports sucked out dollars from the US. Now China had to offload dollars, so it bought the "safest" dollar-denominated assets like Treasuries and Fannie and Freddie CMBS, to keep this great game – or Ponzi scheme, you could say if you were average Chinese – going.

As Milton Friedman might say: "You get what you get." In Yuan terms, these assets' value has sunk -15% since 2006 just by forex. If our Fed inflates us out of today's crisis, there could be another -15% or more writedown that China will take on US long bond holdings.

Losses on dollar-assets impact China's wealth position, so its economy. "Truth-time" puts forex back to Y4.7 to USD, if not Y3.5. China's instant losses on dollar-assets in that scenario run to 25% of its GDP, or 40% to 45% if Euro-zone writedowns are included. That is, China would get the same wealth haircut the West just got – but China's agony would be worse, with its less developed, less balanced economy.

China has no solution to its self-inflicted "bubble" of manipulated forex. Keep managing the Yuan, hope Western demand returns, then have to pour good money after bad into the West. Or let the Yuan float, take a massive wealth hit, then watch Western firms unbolt every Milacron from every factory floor, as labor unrest takes hold.

The People's Party

A client of mine wintering in Europe is insufferable. When I ask what the vibe is on the streets of Paris, Berlin or Zurich, he says: "They don't know they're in trouble yet, their government hasn't told them."

It's worse in the PRC. The average under-informed Chinese depends on government to direct, manage and assume the risk for everyday life (except healthcare, for which Chinese families must hoard cash).

There is a great misunderstanding of the People's Party. The Party is Populist. It bows to the bottom 80%'s needs above all. But the Party is not monolithic. Current leaders must do what is "good for the people" (the 80%), or more populist figures gradually assume power, and quietly remove the old guard. Deng was such a figure, a master in orchestrating this dance.

Can the Party let banks and state-run firms fail? Many should be failing now: if they marked down their dollar-assets, Shanghai real estate, and loans to 50%-utilized factories, hundreds would fit any definition of "insolvent". But in the Party's China, this cannot happen. If the banks go under, the jobless grow too many, new, more Populist leaders will emerge. And power within the Party is everything in China.

So current Party leaders are in the hind-end spot of following the west, and hoping for our recovery. There's nothing else for them. BoC Governor Zhou's call this week for a new "world reserve currency" to replace the dollar (here) is only a bleat from the Party's future sacrificial lamb.

Law and Education

Anyone who does business in China will tell you contracts mean little, judges reflect the Party, and it is a land of a hundred excuses, lies and slights veiled as misunderstandings. Rule of Law means nil. As much as we in the West seem to invent laws everyday to cope with this crisis, we still adhere to process. And when even process gives out, there remains the ballot box. Not so in the PRC.

China's education system is producing a wealth of technical professionals like engineers, but to look at abstract numbers lacks context. China does not produce the smartest or most creative of these, nor does it produce a large share relative to its 1.3 billion population. In fact, the bottom 80% are under-educated: only 9 years compulsory education is provided. China spends just 2.5% of GDP on education, ranking it 155 out of 182 nations. Contrast this to Argentina's 3.8% or Brazil's 4.0%.

Historical Precedent

In 1989, Sony Chairman Akio Morita published "The Japan That Can Say No" (here), which asserted that the West depended so much on a "smarter" Japan, that all Japanese should shed views of their country as a "poor island nation with few natural resources", and embrace their own "innate superiority".

We saw how that movie played. Trade runs two ways. In Japan's case, its hoard of dollars led to a giant asset bubble and two lost decades. In China's case, its dollar and Euro hoard may find a different path, but the outcome will be the same. Huge overpayments for in-vogue assets of the day (for the Japanese, Columbia Pictures, Rock Center, Pebble Beach; for the Chinese, natural resources firms).

It's called "trade" for a reason. A manipulated currency, a one-way street, comes back to haunt.

China Can't Lead

For each photo of the glitzy Shanghai Bund, imagine six photos of Mexico, Kenya or Cambodia beside it. Such is the PRC that the Chinese know – 14% glitter, 86% hardship or worse.

China has wealth in sheer numbers, but since most folks subside in poverty, this wealth is opportunity, not reality. China and its Party remain reliant on the ability and assent of other nations to raise the tide for its bottom 80%.

While we can expect a rotation that has China trading more to resource-rich Latin America and Africa, China's biggest markets still will be where the numbers are – the US and Western Europe – for decades to come.

China can't lead because it is mostly poor. It can't lead because its snarky forex plan haunts it. It can't lead because of its Party's dynamics. It can't lead because, like Japan before it, it has yet to learn that "trade" isn't run as a scam, but goes two ways.

Which, in the case of a few Chinese engineers I've used, means actually paying for their copies of Office and Autodesk… too much to ask? When that happens, I'll know the Chinese century may be beginning.

 

 

 

 

 

Questioning the Relevance of Abercrombie - Patrick Garot

New article published on Seeking Alpha is here.

Last Saturday was a sunny one in Carlsbad, CA., ground zero of diminished wealth effects with declines in home values and retirement savings, rising taxes and job insecurity. Here in California, our higher highs tend to lead to lower lows, but we also lead the nation in sea-changes, too.

Still, the mood was good out on the town. But inside the Abercrombie & Fitch (ANF) stores at both the Plaza Camino and University Towne Center malls, the mood was decidedly glum.

No purchases. Few teens. You could smell the sea change.

“The highest quality, casual, All-American lifestyle clothing for aspirational men and women,” boasts Abercrombie’s website. Worried as I was – perhaps our teens no longer aspire? – I decided to ask my nieces, nephews and their friends about A&F, and their relationship with the brand.

One 15 year old girl whose moneyed parents hail from Rancho Santa Fe said, “It (Abercrombie) is not appropriate.” That about summed up the comments that I got from my empathetic nieces. The thought here ran that when your friends’ families are suffering, it’s no longer cool to flaunt a $70 sweater with a $190 pair of jeans.

Meanwhile, teen boys were enthused at Abercrombie’s lower relevancy to girls. “I’ve got better ideas for my money,” groused one. “I wore (A&F) only because I got gift cards,” said my nephew Chris (17). This holiday, Chris received no Abercrombie cards, but did get $250 worth of GameStop gift cards.

Parents around these parts confirmed the new ethic of their kids. Teen girls, if they even stay in the ANF family, are trading down to lower-priced Hollister. Teen boys were glad to be rid of A&F; they wore it because women told them to. Parents, with a new “recession” excuse to control the family spend, couldn’t be happier. One mom related that she stocked up at American Eagle’s pre-Christmas sales, and told her daughter (18) that she wouldn’t get any new clothes until her July birthday. Surprisingly, she said, her daughter was fine with that.

The implications for ANF stock are steady and consistent erosion of margins, profits and cash flows. ANF will experience decreasing brand loyalty – not just in its core group today, but in the future, as new teens (today’s tweens) absorb from older siblings that A&F merchandise is just not as cool.

This persistent erosion has yet to be valued into ANF stock. ANF today trades at $20-$21.

My background, incidentally, is this: my father was in retail, the President (albeit not CEO) of a mid-sized Abercrombie-like concept back in the mid 1970s (good ups) into the early 1980s (it ended in bankruptcy).

My father taught me two things in life. The first, “never get into retail”; this, as all retail concepts die, and the higher the retail flyer, the bigger its crash (Sharper Image, anyone?). The second, “you better ask your mother”.

Well, though my mother was no Wall Street analyst, she was herself a retail exec (women’s wear buyer) who would understand the following.

• Ultra-high margins are not sustainable in a recession. Management’s assertion that it would hold the line on its 67% gross margin is being revealed as false on Abercrombie.com, where this year’s Spring Lines are priced 10% to 15% lower than last year’s.
• “Aspirational” mid-luxury products – particularly clothing, where ready substitutes are available – take a big hit in a recession. Most often, these hits require a complete re-think of a retailer’s business model.
• The momentum of a retailer who “grows up” in good times, like ANF, is cut off at the knees in bad times. The aspirational draw – big stores in pricey malls, in the priciest locations within those malls– acts as the worst form of leverage (the cost of existence) in bad times.
• The ego of a visionary founder works against the company. Michael Jeffries is a great salesman and marketer. But he may need to learn humility… as Ralph Lauren will tell you he got in two different recessions (early 1980s, early 1990s), in order to ride out the third (early 2000s).
• Cash is king in retail. And cash is eroding at ANF, and you would be a fool not to recognize it.

In the fall (Q3) of 2008, ANF’s back-to-school free cash flow (cash from operations less capital expenditures, per its 10-Q) was a negative -$20 million. In 2007, that Q3 number – you have to calculate the change between Q2 and Q3 – was a positive +$219 million. The YoY delta is a whopping -$240 million negative.

Mind you, this 2008 back-to-school disaster was before Christmas, and before the Feds told us we had been in a recession.

ANF’s analyst coverage is miserably trailing such signs. As I write this, Analyst Estimates on Yahoo (27 analyst universe) show an average estimate of $0.97 for the current quarter, with the low estimate at 80 cents per share. This is after management warned on January 9, 2009 that “net income per diluted share for the fourth quarter will be SIGNIFICANTLY BELOW (caps mine) the $1.00 to $1.05 per diluted share guidance previously issued”.

Obviously, most of these analysts can’t be bothered to update, have never worked in retail, or don’t talk to teens and their parents. “Significantly below” in retail (as in tech) means floods, fire and locusts. It means EPS down 40% or 50% against guidance, or more. Whatever the EPS– 97 cents, 80 cents, or my belief, 50 cents – that is against last year’s Q4 EPS of $2.36.

The analysts also are behind the curve on ANF’s vaunted “cash reserves”. Per the10-Q filed for Q3, ANF’s cash plus investments declined from $648 million in 2007, to $559 million. But $100 million of 2008’s cash was borrowed – the first time since January 1998 that ANF had tapped debt or a line of credit. Further, $262 million of those investments were in ARS (auction rate securities), which ANF recently classified as “Level 3” (management decides how to value them).

Add it all up – the $90 million decline from last year’s Q3 to this year’s, the $100 million borrowed to pump up cash on the left side of the balance sheet, and a mark-to-market loss on the ARS of, say, $40 million or so – and what you have is a Q3-to-Q3 decline in cash of negative -$230 million.

And again, this is before the disaster of this year’s Q4, where same store sales were -28% in November, and -24% in December (December’s SSS number was obtained, per DA Davidson analyst Crystal Kallik, only by ANF’s starting clearance sales with heavy discounts on Christmas Eve).

My parents lived the problem with “aspirational” retail. In a lasting recession, you can’t go forward, and you can’t go back. Your pricey rental agreements are locked in, and so long as you have an ounce of cash, your landlords demand it. The virtuous cycle that works in boom times – great spaces, great marketing, soaring margins – kills you in bad times.

If our recession is short, ANF is fairly valued today. If – and it looks like this is the case – the recession is long-lasting, and families continue to deleverage, ANF’s whole model has to be re-thought. All the signs point to such danger ahead. The California teens and their parents are telling us something, and this is that Abercrombie – its wares, and its stock – is not such a good value after all.

article has 5 comments

• Jan 14 10:07 AM

Insight is right on. Having worked as a Wall Street retail analyst for 50 years before retiring I've seen this movie before. All hot brands eventually become tired (although years later they may possibly be rejuvinated) with a prolonged weak consumer backdrop frequently the catalyst. What was once "in" in terms of higher price point brands, becomes "out" during extended periods of economic distress.