Bank layoffs

Bank layoffs... IEA predicts $200 oil... Cramer and Nygren on Yum Brands... "The McDonald's of China"...

We reported yesterday that the big broker-banks are laying off an additional 15% of their workforce – on top of the 150,000 already departed. Citigroup and Goldman Sachs wasted no time getting started. Yesterday, Goldman began telling 3,200 employees, about 10% of its workforce, they were out of a job. And Citigroup started cuts as part of its plan to axe 9,100 employees over the next 12 months.

With the Treasury and the Fed pouring money into U.S. banks... I wonder what they'll look like in a few years? Better? Worse? It's hard to say, though I find it hard to trust a fiduciary that needs and accepts a government bailout. Perversely, it's likely to work out the opposite in practice. Those unwilling or unable to get bailouts might actually be riskier than institutions that now live at the trough. (If they're holding bad loans, they could go out of business without help.)

The International Energy Agency (IEA) predicted oil will rebound to more than $100 as soon as the economy recovers – though who knows when that will be. (I wonder what $3 and an oil-price prediction would get me at Starbucks?) The IEA also doubled its long-term forecast from $108 a barrel for 2030 to $200 a barrel. The group believes companies will have a harder time pumping new oil to replace aging wells (Peak Oil). "Current global trends in energy supply and consumption are patently unsustainable," the IEA's report states.

The funny thing is, the IEA will look like it knew what it was talking about in a couple of years when the Iranian, Mexican, Venezuelan, and Norwegian state oil companies – representing 25% of the world export supply – essentially go off line. The state-run oil companies are under-investing in future reserves and production because the governments take too much cash out of the oil companies to fund social "progress." This will seriously crimp supply and cause oil prices to soar.

Last night on TV, Jim Cramer touted fast-food operator Yum Brands (YUM) as one of his favorite stocks to buy during a recession. Yum operates 35,000 restaurants under the brands KFC, Pizza Hut, and Taco Bell. The company is currently trading for 14 times earnings, less than its five-year average of 17.5 times earnings, and yielding 2.5% on fears that a weakening China will hurt its growth.

CEO David Novak appeared on Cramer's show saying his company is in excellent shape. (What else would he say?) Novak said Yum has had its seventh straight year of 10% earnings per share growth, and it expects to do at least that next year. The company has faced margin pressure from a slowing China and rising chicken costs, but both pressures should ease next year. Yum is still opening 500 restaurants in China next year, bringing the total to 3,000 by year's end. It has 60 restaurants per million people in the U.S., but only two restaurants per million in China.

Bill Nygren from value investing fund Oakmark Advisors agrees with Cramer. From Oakmark's second-quarter shareholder letter...

Today, a quarter of YUM's profits come from China, where KFC is the leading restaurant company. YUM has added new restaurants in China at a mid-teens annual growth rate, yet their existing units have continued to achieve strong growth... We believe that purchasing power parity suggests that the Chinese Yuan is one of the few currencies that should appreciate versus the dollar. If that happens, then YUM's China earnings will grow even faster when translated into dollars. That's growth we aren't explicitly modeling, so we consider Yuan appreciation to be a free option. Another free option is YUM's new East Dawning chain, fast Chinese food in China. YUM management believes that East Dawning has the opportunity to become "the McDonald's of China." Pizza Hut in India is another free option — with about 100 units it is in a similar position to where KFC China was ten years ago. KFC has also started a venture in Russia and believes that with time, it too could become an important earnings contributor.

"The McDonald's of China." That's an odd-sounding turn of phrase. I'd expect the McDonald's of China to be... McDonald's.

China or not, you should expect Yum's low prices to fare far better than pricier options like Ruth's Chris or McCormick & Schmick's. Restaurants are tough businesses in the best of times. In the worst of times, they're money pits full of expensive people and fixtures and rising costs on everything from silverware and cooking gas to toothpicks and lobster tails. Ruth's stock peaked around $23 in 2006 and is below $2 today. McCormick peaked at $28 in May 2007 and sells for less than $5 today.

Yesterday, on a conference call, Sean Egan of Egan-Jones credit ratings said most restaurants will be hurt by the combination of a bad economy and an Obama presidency. The one exception Egan mentioned: McDonald's. Even after comrade Obama gets his hands on your wallet, you'll still be able to afford a Big Mac.

Now that Yahoo's ad deal with Google is off, Yahoo CEO Jerry Yang says he's open to a new offer from Extreme Value and PSIA pick Microsoft. Late Wednesday, at the Web 2.0 conference in San Francisco, Yang said, "To this day, I believe the best thing for Microsoft to do is to buy Yahoo."

Microsoft offered $33 a share for Yahoo earlier this year, which Yang said was too low. Yahoo shares are trading around $14.

I think the best thing for Microsoft to do is buy back $40 billion worth of stock, or pay out a big special dividend – anything to prevent management from making big, expensive, and highly risky acquisitions.

New highs: none.

In the mailbag... tragic evidence of what happens when you mix beer and Japanese verse... If you had any doubts, we read everything you send to: feedback@stansberryresearch.com.

"Okay, with all this tortuous political writing you have once again awoken me from my peaceful money-making slumber and forced me to pen something ridiculous. I have in the past submitted awful doggerel to cancel your dogma, but your current political diatribes can only be cured by extreme intervention: Annoying Haiku! Yes, you asked for it so you got it:

"Late Fall in Hong Kong,

Investments in the Harvest

Yield, Puts, and your Shorts

"See you in Hong Kong and let's have a few beers – and let's keep the Shorts on please..." – Paid-up subscriber DCWilliams

"Always look forward to my daily dose of the Digest and after your latest info on GM. What would happen if you short a company that then might possible go into a bankruptcy protection plan? If your still short when a plan is filed, what happens to your position?" – Paid-up subscriber Steve

Ferris comment: With a big, liquid stock like GM, it should still be relatively easy to cover a short position for some time after a bankruptcy announcement. Lehman Brothers common, for example, still trades millions of shares per day. Common stocks of large, liquid companies usually continue to trade after filing bankruptcy. They fall precipitously on the announcement, then delist and trade, often quite actively, on the pink sheets.

In recent memory, the only common I've seen come through bankruptcy and do well is Calpine. It was selling for pennies during the bankruptcy and has been as high as the low $20s per share since emerging from bankruptcy. If someone had been short, he would have wanted to cover before it emerged from bankruptcy, and he would have had plenty of liquidity available for that purpose. Can't think of another one like that off the top of my head, but I know they exist.

I bet some people are still short Enron. They made 100% on their short because they never had to cover. I would expect there to be ample opportunity to cover a GM short even after it announces bankruptcy.

Regards,

Dan Ferris

Medford Oregon

November 6, 2008

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