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Home Depot (HD) vs. Lowes (LOW): Go With Oprah

With both home Depot and Lowe’s reporting numbers in the past two weeks after the dust has settled, what should you do? After all, both have disappointed with earnings falling 29% for Home Depot (HD) and 12% for Lowe’s (LOW). Both have lowered expectations for the remainder of 2007 and both stocks have been losers over the past year with investors seeing their investment flat lined. Now, eventually we all know that housing will turn around because nothing stays down forever and let’s be honest, folks do need a place to live and there are more of us every year. There is built in demand here. Neither Home Depot or Lowe’s will need to convince people they need to buy the products they sell, what they do need to do is convince them to get those products from them, not the other guy.

Enter Oprah. Probably the single most important endorsement a company or person can get today is one from Ms. Winfrey. The mention of a book on her show instantly makes it a best seller. A personal trainer or self help personality featured on the show will find their schedule instantly filled at whatever rate they demand. In short, if Oprah gives you the thumbs up, welcome to instant success. Love her or hate her, her impact is undeniable. You are probably asking yourself what this has to do with Home depot and Lowe’s.

Oprah shops at Lowe’s. This spring has featured various home improvement episodes like the most recent one in which Oprah did a favor for her neighbors by sprucing up their Chicago balconies. Who did the work and got essentially an entire show long infomercial and thumbs up from Oprah? Lowe’s.

The effect of this can be seen in the latest earnings report from Lowe’s when they reported that 17 of 19 company segments experienced market share gains during the last quarter and while customers are spending less per trip, more of them (to the tune of 5.9%) are choosing Lowe’s when they shop. While this number may seem small, it is staggering when you consider Home Depot experienced a 20% drop in store traffic during the most recent quarter.

Eventually housing will turn and the big winner will be the one with the most customers, thanks to Oprah, that will be Lowe’s.

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iPhone: Apple (AAPL) Making All the Wrong Moves

After my first post on the iPhone last week in which I opined that the AT&T (T) lockup was a mistake for Apple (AAPL) and that the real winner in all this was AT&T. The #1 response from readers I received (other than I was a moron)was that this “was a short term arrangement that all carriers do, within 6 months the iPhone will be available to all carriers.” Hold the phone (pun intended), it would appear that the iPhone will only be available to the 47 million AT&T subscribers for the next 5 years!

USA Today reports the supposed half-decade deal also precludes Apple from developing a CDMA handset in that time. It would also appear that the arrogance and dismissive attitude Apple took with carriers during negotiations may come back to bite them. Word is that the #2 carrier in the US, Verizon will introduce it’s own version and is claiming it will be an iPhone-killer. According to Denny Strigl, Verizon CEO, “We do have a very good response in the mill. You’ll see that from us in the late summer.”

Rather than have a market all too itself for some time buy playing nice with all carriers, the attitude Apple took has caused a rush to introduce like versions to co-inside with it’s launch. Now not only will the iPhone not be available to the other 140 million plus US cell phone users, but those folks will be able to get their own version from other carriers this summer. Anyone want to bet it will be available for far less than the $500 -$600 the iPhone will be?

Now, any Verizon offering will not have the iPod application that the iPhone will have but if my many critics are to be believed, that was not going to be a major selling point anyway so the elimination of it will really be an insignificant factor to those purchasing these phones from Verizon. What will matter? Price. If consumers are able to avoid cancellation fees, can get a similar phone at a cheaper price and already have an iPod, there is zero incentive to rush out and get the iPhone.

This also means that the 10 million units Apple plans to have sold by the end of 2008 will be done to 47 million AT&T subscribers meaning 1 in 5 will have one? Doubt it.

How long does anyone think it will be before RIMM’s (RIMM)Blackberry has a version out there that will be available through all carriers?

When entering a new business, it is not really a good idea to strut in and tell folks who have been doing it for many years how much better you are than them and why you are going to dictate what they can or cannot do. All reports out there indicate this is what Jobs did and in the process seems to have focused the efforts of the other carriers into competing against him rather than working with him. Bottom line, he needs their networks for his product, he seems to have forgotten or chose not too recognize it.

I said before that the iPhone, as things are currently configured will be nothing more than a niche product and that it will be Apple’s first stumble after a string of hits in recent years, if the USA today article is correct, the AT&T deal all but assures it.

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Eddie Lampert Speaks at Investor Conference

The following are remarks from Eddie Lampert, Chairman of Sears Holdings (SHLD) to a conference held at the Third Avenue Mangement Investors Conference in 2003. It should be noted that this is prior to the Sears aquisition that created the Sears Holdings we today know. It should also be noted that Third Avenue was also a large investor in Sears along with Lampert. His insights into the Kmart deal almost creates the bluprint for the reasoning of the Sears one. These items are so informative when delivered by people the likes of Lampert of Buffett. The educational value of them alone is invaluable.

Overview and Summary of
Remarks by Edward S. Lampert
Founder and Manager of ESL Investments
Delivered at
The Third Avenue Management Investor Conference and Luncheon
November 18, 2003
Summarized/Edited
by
Kaushal B. Majmudar
Managing Partner
The Ridgewood Group
(www.ridgewoodgrp.com)
[Ed. Note: Edward S. Lampert of ESL Investments is an intelligent investor that we admire. As he has traditionally maintained a low profile, we were pleased to have the opportunity to hear from him at a recent event. We hope that others seeking to learn about intelligent investing can benefit from his thoughts as much as we did. This is a selective and personal record of what he said and so should not be taken literally.] Edward Lampert: [Comes to the podium after being introduced by Marty Whitman]. I will make some brief comments and then take questions.
About ESL
I started my firm in 1988 and began investing. I was inspired by Warren Buffett’s letters while still working on the Arbitrage desk at Goldman Sachs. We consider ourselves “Aggressive Conservative” investors [Note: A lot like Marty Whitman’s “Safe and Cheap” motto]. In investing, we seek to do a few things well, namely
1.) Understand the Business
2.) Understand the People Running the Business and
3.) Get safety from the price that we pay
Generally speaking, we focus on absolute returns in making investments. By the way, past performance as a measure of quality is wildly overrated. It would make a lot more sense to place more emphasis on and think about the people that put the track record together and the quality and value of the portfolio that they are managing.
About KMART
We invested in Kmart. Kmart was one of the worst managed companies in its industry. It was clearly distressed. Marty is one of the more sophisticated distressed securities investors and he was buying.
The standard Retail Bankruptcy process model is well established. People wait until Christmas and see what happens and then close the worst performing stores. Then the company hobbles along until the following Christmas and does the same thing again closing even more stores. It can be a slow process. Surprisingly, most of the Boards of Directors that put the company into bankruptcy stay in place until the company finally emerges under new ownership [pursuant to a plan of reorganization].
In the Kmart deal, neither I nor Marty were on the board or the creditors committee initially. Meanwhile, the professionals were making $10 to $20 million PER MONTH while the company was in bankruptcy. With that kind of money coming in, there would be low incentive to push to come our immediately. ESL and 3rd Ave. spent a lot of time trying to understand the existing process. They wanted to know the Company’s plan to emerge and the goals of the creditors committees.
Finally, Brandon (??) who works with Marty at 3rd Ave got onto the creditors committee. Their agenda (ESL and 3rd Avenue’s) was to have KMART emerge out of bankruptcy as soon as possible but with little debt.
The “Experts” said that KMART would never emerge from bankruptcy. The press was also extremely critical. As much as possible, everyone let Marty deal with the press because he is so frank and his comments on the matter were dead on. Most of the players involved in the process lacked urgency. This included many banks
and landlords (except those who actually wanted their space back). Lots of the players involved also probably had conflicts to deal with.
I have learned that it often comes down to who makes the decisions and also where the benefits and consequences fall – who benefits if the decisions work and who pays the price if it does not work. The large annuity aspect for advisors making $10 to $20 million per month made it less urgent for them to make it come out of bankruptcy. It was a difficult situation and a difficult process. However, ESL and 3rd Ave were able to influence the situation. Their power and leverage came from their willingness to put more money into the reorganized company as part of the plan (this was their source of power). In the process, they were able to force the shutdown of about 300 stores.
The plan they worked out was to take out the banks with cash (using money they invested). Trade creditors actually wanted the new equity. The Company ended up coming out of bankruptcy with $1 billion in cash and no debt. Because of Kmart’s consumer nature, perception was important. Now when it emerged from bankruptcy, the experts who said that it would never happen were wrong. However, they changed their tune and now started talking about how the Company would go right back into bankruptcy, a so called “Chapter 22” filling [i.e. Chapter 11 times 2]
More recently, they have been focused on trying to improve the operations and execution by KMART. There were already policies and procedures in place that people had not been following. People made a lot of improper decisions, but actually a big part of the problem was that they had been operating with the wrong “frame” for decision making. For any company, you need to have an overarching PHILOSOPHY to guide operations for profitability.
At KMART, they are trying to instill a teaching and learning culture by going back to first principles. This is challenging because in their case, they need to communicate to 170,000 people. They are simultaneously trying to improve the look of the stores and change the employee mix. They are thinking like owners in their approach to KMART. A lot of the successful companies in retail actually had owners (i.e. owner operators).
However, it is definitely an uphill battle. The Press does not understand what is going on at KMART. However, the Customers do and they have started getting compliments (from customers) again. Still they do have a lot of challenges.
ESL was established to invest like owners. The last 20 years has been about CEO as politician (e.g. Rumsfeld/Cheney) versus CEOs as owners. There is a whole system today that supports the rights of agents instead of the rights of shareholders. The Shareholder representation system is broken. Many of the recent SEC proposals are trying to introduce reforms to better align company, management and
shareholder interests. Good managements should be paid lots and lots of money because it is a hard job, but
only if they perform. You cannot pay people irrespective of performance. KMART was helped by the owner mentality that was possible because of presence and involvement of the large interested shareholders. Activist owners like ESL and 3rd Avenue help foster the proper balance between management and shareholders. This balance benefits all shareholders and not just the agents as is so often the case [in the
status quo today].
Q&A (selective)
Q#1 Someone asked about the Capital Structure of KMART at the time of the ESL investment.
A: There was approximately $1 billion in Bank debt, $2.3 Billion in Bonds, $800M in preferred stock, and some amount of common which was essentially worthless. Also about $4 billion of trade creditors were outstanding. In contrast, in the quarter ended July 2003 (post reorganization), the company had $1.2
billion in cash. $50 million of mortgage debt and a $2.0 billion 3 year line of credit (not drawn) Also, post reorganization there were 90 million shares initially issued at around $10 per share but now trading at $27 or 28 per share for a nice gain.
Q#2 Is future profitability for KMART based on repositioning the entire strategy or just better operations?
A: A lot of KMART’s problems were self imposed. They had a lot of possible assets and a good sized customer base. However, they needed to get back to basics and EXECUTE better and deliver a better in store experience to their customers. People like winners and they give winners the benefit of the doubt. The same people
who will wait in line at WALMART because WALMART is perceived as successful would get really pissed off if they go to a KMART and have to wait. However, expectations were so low that improvement was possible.
Q #3) There seems to be a pattern of ESL making investments in retail given positions in companies like KMART, AUTOZONE, and SEARS. This seems surprising since Buffett would consider retail to be one of the not so great businesses. What do you see that Buffett does not and why do you like retail so much?
A: Actually, investing in retail for ESL has been an opportunistic thing and a relatively recent phenomenon. I would agree with you about the general characteristics of retail not being that attractive. ESL was started in 1988, but their first retail investment (probably AUTOZONE) was made in 1997 and a few other opportunities
since then.
For more on Intelligent Investing, please visit us at The Ridgewood Group(www.ridgewoodgrp.com) or give us a call at 973-544-6970. Also visit our Blog at www.ridgewoodgrp.com/blog. For more on value investing please visit www.valueinvesting.info and www.indexvalue.com.
Copyright © 2003 by Kaushal B. Majmudar

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Coffee, Cows & Corn All Hurting Starbucks

Starbucks recently met its expected earnings number of 19 cents per share, representing 18% earnings growth. Great, right? But does that make it worth paying 36 times earnings? I’d say no.

Let’s look closer. In the first quarter of 2007, Starbucks (SBUX) bought back $50 million worth of stock. In the second quarter, that number exploded to $513 million, or 17.1 million shares. This represented 2.1% of diluted outstanding shares and was the reason Starbucks met expectations. After all the negative publicity recently, a miss would have led to a share sell-off and more stories about the “end of the line” for Starbucks.

While I applaud share buybacks as a way to enhance shareholder value, Starbucks cannot continue to spend $500 million a quarter to reach earnings estimates. One also has to consider that Starbucks’ margins will be under pressure from higher costs, and that store traffic growth is anemic.

Domestic same-store sales transaction growth was a paltry 1%, leading me to wonder when CEO James Donald will finally admit McDonald’s (MCD) coffee offerings are affecting sales. He never had to address the issue, as not a single analyst’s question on the earnings call broached the subject.

After the earnings announcement, in an interview on CNBC, Donald said “we do not really consider or discuss our competition.” He’d better start. They are stealing his business. Attracting only 1% more people per quarter will not fuel the long-term growth rate of 21.9% that analysts expect.

Another problem for Starbucks is ethanol–hardly what investors might expect to trip up the coffee company.

This year, the U.S. ethanol industry will produce over 5 billion gallons and use more than 1.5 billion bushels of corn, pushing prices near $4 a bushel. Dairy farmers are seeing the cost of feed jump and are finally able to pass that on to consumers. After years of flooding international markets with surplus milk products, the European Union, under heavy pressure from within, has curtailed its $59 billion annual subsidy system, at least where dairy is concerned. Combine that with drought conditions in New Zealand and Australia, two big milk-exporting countries, and it makes for tight supplies worldwide–and higher demand for U.S. product. Milk farmers, who collected 12.3% less for their milk in 2006, are fully intent on making that up this year.

“The price this year is not just going to beat the record by a few cents. It’s going to knock it out of the park,” Michael Suever, senior vice president for milk procurement at Chelsea, Mass.-based HP Hood, told the Boston Globe in April. Prices for raw milk are expected to rise at least 25% this year.

Starbucks, which uses an estimated 93 million gallons of milk a year, is looking at a $279 million milk bill in 2007. While it may not seem a lot to a billion-dollar company, it does equate to 36 cents a share, an increase of about 9 cents, or about 10.3% of profits, over 2006. This does not include the price increase to be incurred from changing the percentage of hormone-free milk from 27% to 37%. Starbucks does charge 50 cents more at some locations for this milk, so it must cost considerably more, no? When you are guiding 83 to 87 cents a share and 18% growth, the 10% of that in milk costs is huge.

We need to now look at biodiesel. Currently, Brazil is famous for two things: coffee and ethanol. Its national ethanol program has allowed it to become independent of imported oil, and now it’s turning its sights on biodiesel. Researchers have found an economically viable way to turn coffee beans into biodiesel. The oil-extraction from coffee bean rate, now at 92% to 94%, means the project will begin next year, and this year’s harvest will be affected, as coffee bean supplies are built up in anticipation. The project will enable coffee producers to produce enough biodiesel to power all their farm and agricultural equipment.

Why does this matter to Starbucks? Brazil is the world’s largest coffee producer and exporter, and this study contends that up to a fifth of coffee production will be used to produce biodiesel.

Let’s go back to Econ 101: When you constrict the supply of an item and have constant or increasing demand, price must increase. Starbucks, which already gets $5 for a cup of coffee, will feel the pinch. How much are people going to be willing to pay for a cup of coffee? Like all products, raising prices depresses demand. In the case of Starbucks, I think the effect of price on demand is more dramatic than commonly thought, as quality coffee can now be had at McDonald’s for a fraction of Starbucks’ prices. All coffee producers and sellers will be affected by the price increase, but when you are at the top of the price ladder and have painfully slow growth that is already a result of those lower McDonald’s (MCD) prices, that pain may be more immediate and severe.

When you add the Brazil situation to the recently announce Ethiopia settlement that now has Starbucks paying additional royalties for coffee from that country, Starbucks is now facing an onslaught of input price increases with not much wiggle room on the revenue side. When consumers are looking at $4 a gallon for gas, will they cut back on the $5 latte and go for the $3 one at McDonald’s? I bet they will.

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iPhone To Boost Blackberry Sales

Here is a post I found from another blogger. His argument is almost identical about the iPhone. At is current pricing level, it will just not sell to the masses. He agrees the big winner will be AT&T and then takes the discussion one step farther and states it will actually increase Blackberry sales. The Blackberry sales increase angle is a concept I did not go into but do agree with.

From Big Ben’s Investing Blog:

There is no question that the late June debut of the Apple (AAPL) iPhone will create a lot of stir. Much of the hype is already priced into the stock. Or at least most of the hype will be priced into the stock before the iPhone debuts in about a month. I still think you a can stay long Apple until the release. Apple will have a tough time selling the iPhone. An initial $500 price tag for a 4 GB music phone and a $600 price tag for a 8 GB phone will be too steep for most consumers. Still many iPhones will be sold and I remain bullish on AAPL.

Who Else Will Benefit?

1. Research in Motion (RIMM): Many of the same features of the iPhone can be had for a lower monthly fee and lower upfront cost with a Blackberry. The Blackberry Pearl runs between $59 and $149 depending on the carrier. Plus the data fees are $10 less per month than the iPhone. I believe consumers will upgrade their cell phones this summer and choose RIMM over the iPhone.

2. AT&T (T) will be a winner no matter what happens. AT&T is the exclusive carrier of the iPhone and will gain wireless subscribers. More importantly more consumers will add media bundles to their wireless plans when they upgrade to a “smartphone” in order to use all of its features. This is a homerun for AT&T, as the average revenue per user should increase with more “smartphone” subscribers.

3. Motorola (MOT) is my sleeper pick. Hovering near its 52 week low, I see lots of value MOT. Motorola has the RAZR 2 set to debut in July and the Q9 smartphone also set to debut shortly. The Q9 will put added pricing pressure on the iPhone and Blackberry Curve & Pearl.

One important thing to remember is that these cell phone upgrades come in cycles. I would never “invest” for the long haul in any of the above names. These are simply 6-8 month “trades.”

The “apple-holics” can scream at the blogger here:

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Corn Processors Easily Passing Along Cost Increases

Corn Products (CPO) CEO Samuel Scott said in a conference call with analysts. “We were able to get prices through in the areas where we did not have fixed prices sooner than we anticipated.”

The company’s sweetener products, such as high fructose corn syrup, or HFCS, account for 55% of sales in all three of its segments. The #1 US producer in the US and worldwide is Archer Daniels Midland (ADM). Starches and co-products, such as corn oils and feed, make up the rest of the company’s products. Corn Products, the number 4 HFCS producer in the in the U.S. said it’s ability to pass along corn price increases to its customers faster than expected helped profits. .

Another major factor was the elimination of a 20% tax on US HFCS being imported to Mexico. The tax shut down a big chunk of the market overnight for U.S. exports of HFCS as well as bulk corn for HFCS production by U.S.-owned firms, said Corn Refiners Association spokeswoman Audrae Erickson.

The tax was ruled illegal and was repealed. Last summer, NAFTA reached an agreement to send up to 500,000 metric tons of HFCS into Mexico from October 2006 to December 2007. NAFTA’s full, free-trade agreement opens up a huge soft drink market to many corn refiners.

Assuring the use of HFCS in the US, Coca-Cola came out and said they were disappointed with their North American results and wanted to drive Coke Classic again. HFCS is the sweetner used in these non-diet drinks. With the South American ethanol boom increasing sugar prices, soft drink makers have no alternative but to swallow any price increase corn processors decide to pass onto them.

More good new for ValuePlays Portfolio member ADM, up 16% since my January recommendation. With gas prices surging, ethanol is very profitable desipite corn’s price increase. We now know that corn food processors are able to pass along this additional cost to buyers also. When you consider the additional demand from Mexico coming online soon, it looks like more demand induced upward pricing pressure will benefit corn processors. After all, what alternative product do HFCS users have? The answer? Nothing…

ADM will be ringing the registers

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Selling Citi (C) Shares To Eddie Lampert

In September last year I bought shares of then Citigroup, now just Citi (C). I bought them because at the time they were trading at about 10 times earnings and had a dividend yield of over 4%. I paid $48 and change a share and then turned around it would appear and sold to them to greatest value investor of my generation, Eddie Lampert in December for $54 a share and a 12.5% gain in roughly 3 months. So why am I upset?

I am upset because I seem to have had this almost pathological inability to listen to myself prior to this blog. Had I not sold, my gain on the stock currently would have been 14.5%, plus the 2% in dividend checks I would have received for a total return of 16.5%. The pain here is felt even more when you consider after taxes my original gain is reduced to 8.25%!!

So, why did I sell them? I like businesses I can easily understand whether it be selling paint, cigarettes, insulation, clothes etc. Citi is massive and about as complex an international operation as there is out there. While it was (and apparently still is) “cheap”, “cheap and “value” are not the same thing. There are plenty of “cheap” stocks out there that are so because the underlying business just sucks, period. Here is where I went wrong. Citi has a great underlying business, it is just poorly run. That makes it’s cheap price a value once CEO Prince either gets his act together or is shown the door. Citi also would have paid me over 4% a year in a dividend to wait for either of these eventualities. Not a bad deal in retrospect. Fundamentally I saw this which is why I bought shares to begin with, I just was not convinced so I took the quick money.

Don’t get me wrong, 8% after taxes in 3 months is nice, but, making small mistakes can eventually lead to larger ones. In an interview I gave with Geoff Gannon, I said my biggest mistake as an investor has not been picking losers, but not being confident enough in my reasoning and leaving too much money on the table. Read it here. In other words, making very good instead of great returns.

Blogging seems to have cured that as my format and interaction with readers does force me to constantly evaluate and explain my reasoning and methodology. It has lead to a more intimate understanding of my picks and pans and has to date cured the “doubting Todd” side of me.

I know what you are saying, “Citi only trades at $55 a share now, the difference is only $1 from your sales price” True, but my total return is 1/2 of what it could have been. Funny how things like that work, huh?

So, what to do now? Lick my wounds and go back at it. What else is there? Life is about living and learning and if you stop doing either you can’t do the other. There was a great quote I heard once and if anyone knows who said it let me know so I can credit them, “there is no shame in making mistakes, just not learning from them”

Lesson Learned

PS. Eddie, can I have my shares back?

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ADM Buyout Rumor: Nothing There

Recently word has been circulating that there may be a buyout offer for Archer Daniels Midland (ADM) in the not too distant future. Let look at the possibility and price.

Currently ADM has a market cap of $25 billion and annual sales of $40 billion. It is the one of the world’s largest processor of HFCS, ethanol, bio-diesel, cocoa and oil seeds. It does business in 35 countries and has over 26,000 employees. Shares currently trade at 15 times this years earnings and 14 times forward earnings. ADM has grown earning 21% in 2005, 40% in 2006 and should hit 21% in 2007 (year end June). After years of leaving analysts and Wall St. in the dark about earnings, former CEO G. Allen Andreas commented before he retired last fall that the current unprecedented expansion will “substantially add to earnings in 2008”. This is the first comments I have every heard an Andreas publicly mutter on earnings. Current CEO Patricia Woertz commented on the latest earnings call that she was “more enthusiastic about the future” of ADM than ever before.

That being said, if insiders are this optimistic at a company that has a storied history of playing it’s cards closer to it’s chest than la cosa nostra, one must imply from this that 2008 is shaping up to be a very good year. Current estimates have ADM increasing earning next year only 9% in part due to the rise in corn costs. Yet the empirical data coming out suggests that this, far from being an issue may actually lead to more profits. In the most recent call ADM said despite corn costs rising, corn processing earnings increased 15% . Other ethanol producers also experience similar results. Recently, Corn Products (CPO), who produces no ethanol, only HFCS and other corn products commented that they have easily been able to past cost increases along to end users. The reason? The economics of corn are such that end users of its byproducts have no substitute for them. When you consider that 500,000 extra tones of HFCS will be sold into Mexico annually beginning in the fall of 2007, you have this increased demand further pressuring prices upward. Corn processors are also in the unique position to be able to easily hedge against price spikes, further insulating them from their effects.

Production increases mean ADM will increase it’s ethanol production 50% by 2008, it biodiesel production will double and it will add substantial cocoa production in the US. HFCS production can be increased without the building of new facilities so the option to maximize anticipated demand increases is easily attainable.

Currently June options have speculators positioning themselves to pay $40 to acquire shares before June 16th with call options out numbering puts almost 4 to 1 clearly leading to an upward bias in shares. Currently ADM has an enterprise value of $30 billion or roughly $46 a share. With managements enthusiastic expectations for 2008, any offer to buy the company would have to be well in excess of that. More realistic earning estimates for next year that put eps growth in line with the 20% increases each of the past 3 years put 2008 share price at $44 at the low end of the PE scale. All this means shareholders should expect shares to trade in the lower 40’s for FY 2008 that begins in July 2007 and any buyout offer should be at a minimum a premium to that putting shares easily into the $50 range.

Will it happen? There would be immense pressure on new CEO Woertz not to do a deal and she will likely not want to go down as the one who “closed shop” so to speak on a 115 year history by selling out to private equity, or worse, an oil company. Insiders and shareholder have visions of ADM becoming the “Exxon of Biofuels” and a buyout would quell those dreams. The only offer that may receive support would be a management buyout that allowed current holders to retain ownership in a now private ADM with current management a vision. The Andreas family had led the company for generations and as large shareholders would lead a revolt against a buyout by another firm. This anticipated hostility to an offer means it will either be avoided, or, be one that it very hard for shareholders to resist.

Either way, through results or a buyout offer, shareholders stand to prosper.

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Thank You Ben

Fed Chairman Ben Bernanke said last Thursday subprime mortgage woes do not present a serious problem to the U.S. economy. Not only do they not pose a serious problemn its effects on the overall housing market would likely be limited: “Curbs [on subprime lending] are expected to be a source of some restraint on home purchases and residential investment in coming quarters.” Can we stop panicking over this now?

In March in a post I wrote “Where do we go from here? A slow decent to normalcy. That is all. Not a crash, not a recession, not a depression, just normal housing conditions with realistic lending guidelines.”

It would seem Mr. Bernanke is now echoing that sentiment. Conditions now are not dire, they are getting back to normal. A little perspective is needed. Things have been insane for quite a few years in housing and the current slow down, while it may hit some of the more careless folks out there, is very good for everyone as a whole. The more froth and speculation in any economic activity, the harder the eventual fall then becomes. Bernanke should be given credit from resisting the shrill shrieks from the Barney Franks of the world on Capitol Hill to drop rates and increase regulation in the lending market. These actions would have lead to increased volatility in all markets and the uncertainty and guessing games that would have been created could have developed into something far more serious. In doing so he has all but assured a “perfect storm” of good things for the economy. The runaway housing prices will moderate, inflation is doing the same, economic growth has not suffered, job creation remains strong, unemployment is almost non existent, the S&P and DOW are at all time highs and historically speaking, interest rates are a non factor. All this in the face of Alan Greenspan running around the Asian continent telling everyone the sky is falling

While his predecessor, Greenspan, gets far too much credit for the “soft landings” he engineered from the problems he created, Bernanke should be credited for not needing a “landing” at all, just a nice smooth ride

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Starbucks’ (SBUX) Ethiopia Fiasco: Firings Ahead?

After the work I have done on Starbucks (SBUX), I ended up in correspondence with people intimate with the recent Ethiopian negotiations (on the Ethiopian side). In response to a question I asked I got the following response….

“At this moment, SBUX and Ethiopia are working out the terms of a licensing agreement acknowledging Ethiopia’s ownership of three coffee marks. An Ethiopian official told me today that he hopes an agreement will be concluded in the coming week or two. SBUX was offered exactly this deal 18 months ago or so, but it rejected the offer dismissively and without seeking to discuss it. This led to the Oxfam campaign that has tarnished the SBUX image. SBUX’s arrogant rigidity is a mystery. Prices were not mentioned in that agreement, and are not mentioned in the present — probably very similar — version, as far as I know.”

In any matter, it is now clear that Starbucks will be paying more for it coffee from Ethiopia. Do not be surprised to see other coffee producing nations look to do the same thing in an effort to enhance profits.

“Coffee prices are rising as demand for premium coffees has been rising (in part because of SBUX’s own growth) faster than supply, though supply of ordinary coffee is plentiful. The two executives within SBUX who are held most responsible internally for their mishandling of this are Dub Hay and Sandra Taylor. Both could be gone some months from now, but it is likely that Schultz will wait long enough to weaken the cause-effect link to the Ethiopia embarrassment since SBUX hasn’t openly acknowledged how badly they handled it. It has been a PR disaster for SBUX but has given Ethiopia invaluable publicity for its coffees. Millions who were ignorant of the facts now know that Ethiopia is a coffee producer, that it is the original home of coffee, and that its coffees are among the world’s finest.”

The Ethiopian fiasco has badly tarnished the “Good Citizen” image Starbucks once had. In a Wal-Mart (WMT)inspired move Starbucks seems to have put profits ahead of the lives of Ethiopian coffee farmers in order to protect the bottom line. This uncharacteristic move to me is extremely telling. It is a sign that management recognizes costs are rising at a rate faster than they can offset them with revenue increases either by passing them off to customers or selling those customers more non coffee products. Their 1% transaction traffic growth the last quarter illustrates they will not be able to do it selling more people more items. This realization is causing them to do almost anything to control any cost they feel they may be able to, hence the initial hard line in Ethiopia. It smacks of a bit of desperation from a company who is seemingly in denial about it’s future.

After all the negative publicity from this and doubt about future profits recently due to competition from the likes of McDonalds (MCD) and Dunkin Donuts, a profit warning would put shares into a free fall.

Perhaps Schultz and company are hoping for cost relief to bail them out or have a “Hail Mary” planned. Either way, the rest of 2007 could very unkind to shareholders.

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Congress Votes To Raise Taxes

In a stunningly underreported event, Congress approved the blueprint for the 2008 budget and in it is the single largest personal tax increase in US history. Where is the media on this?

Passed essentially online party lines 52-40 in the Senate and 214-209 in the house, the budget blueprint plans to allow the personal income tax, capital gains and dividend tax rates to increase in 2008. Quoting House Budget Committee Chairman John Spratt (D. SC), “It’s not the perfect solution, but it is a long step in the right direction.”

How? Raising taxes has never been the answer to our “budget” problems. Cutting spending has. More money in the hands of Congress will only lead to more spending. If history has shown us anything, this is an undeniable fact. In the outline, it proposes $20 billion dollars MORE of discretionary spending than the President had proposed. How about we back out that “discretionary waste” and not pick my pocket?

Corporations have spent the last 4 years raising dividends at a 20 year record rate as a way to reward shareholders. The effect of these increases will now be negligible when the tax rate on them is allowed to almost double. Look at the chart below.

The S&P has enjoyed a smooth ride as investor have parked their money and enjoyed the steady stream of reduced tax rate dividend checks. An increase in these rates would cut the value of these dividends by almost 50% and surely lead to a huge increase in volatility. While professional traders love volatile markets, they are the enemy of the average investor who gets sideswiped by the big market swings and end up losing money.

I cannot figure out why no one is talking about this now. One thing for sure, if it passes, it will be all we talk about..

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High Gas Prices: Blame The Person In The Mirror

Everyday gas prices hit a new high record level the folks people love to blame are the oil companies (Exxon (XOM) is the main whipping boy), the Iraq war, a Bush / Cheney conspiracy or the local gas station. As a matter of fact they blame everyone except the real culprit, themselves. Year to date gasoline demand is at a record 9.2 million barrels a day. Much had been said in the news about refinery outages and there have been a few but they have been able to keep up increasing production 3.1% which is ahead of the 2% increased in demand. Note that it is ahead of the increase in demand, not usage. In fact, refiners have been able to meet 96% of our highest even demand. This compares to 93% of demand last year and is above the 5 year average of 95%.

This means that despite you and I demanding more gasoline than ever, refiners are doing their part keeping up production. This demand and inventory depletion has lead to prices at the pump surging 43% this year past post Katrina levels to $3.13 a gallon nationally on Friday and seem to be heading past the inflation adjusted all time high of $3.22 set in March of 1981. For me, I cannot get too worked up about gas when I pay $3.40 a gallon for milk, $7 a gallon for coffee at Dunkin Donuts, almost 6 times that at Starbucks (SBUX) and $6 a gallon for water at a ball game.

Savvy investor will be buying refiner stocks like Chevron (CVX), Exxon, BP (BP) and Valero (VLO)as prices and demand will not slow for at least the next 4 months, leading to plenty of profits.

So if refiners are doing their part, why have gasoline inventories dropped 15% between February and April to the lowest levels since 1956? The main culprit? A strike at a French port that has decreased gas exports to the US 9.6% or 109,000 barrels a day and is responsible for almost the entire shortfall.

This works out fine, it is much more fun to blame the French that ourselves anyway.

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New Forbes Online Article

I have another article at Forbes Online today. Actually, I think it was posted on Friday. You can read it here…If you want to wait..

I will post it here some time next week.

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Top Stories This Month to Date From VIN

I am doing it a little different that on the site. The reason is that two of the posts are from the NT Times and require a subscrition. If you do not have one, the links are useless to you. I have simply ommitted them and included the next post in in order to provide links you can actually read. If you have a NY Times subscription, you can find the links at VIN. Here they are:

1- Sears Holdings: A “Technical” Look : ValuePlays
2- Financial Blog Watch: Episode 2, Controlled Greed Radio.WallSt.net
3- Short Term Thinking In Altria: A Profit Killer– ValuePlays
4- Using Stops: Are You Stopping Gains? – ValuePlays
5- Author Says Work Has Been Wonderful- Omaha.com

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Soros Buys ADM Shares

George Soros initiated holdings in Food Products company Archer-daniels-midland Co. (ADM). His purchase prices were between $30.76 and $36.72, with an estimated average price of $33.6. The impact to his portfolio due to this purchase was 1.27%. His holdings were 858,500 shares as of 03/31/2007. Shares of Archer-daniels-midland Co. were traded at around $36.69.

Soros, while I could not disagree with his politics more, I cannot argue with his track record in his investments. He is truly one of the all time greats in that department and anything he does is worth noting and following.

I have stumped for the value of ADM shares (and have held them for years) on this blog many times, the latest being here. It is always a confidence booster to know that one of the world greatest investors seems to be thinking along the same lines as you.

ADM shares, up 15% since I recommended them in Jan., are only in the infancy of recognizing their eventual value…