Strolling up Fifth Avenue in Manhattan last week, all of a sudden our 15-year-old daughter says, "I can smell it!"
"It" was Abercrombie & Fitch, the clothing retailer that markets its products with photos of teenagers with perfect bodies and no undershirts. You don't see A&F when you first approach it. You smell it. It pumps its perfume out of the store on to the street.
The second thing you experience is the shirtless young man just inside the door, being photographed with tourists. Funny thing is, he's got this cute young girl with him, too, but nobody wants a picture of her. She spends all her time taking pictures of the shirtless young man and his fans.
Maybe I should sell short Abercrombie shares, kidnap the shirtless model, and take his place. As soon as I took my shirt off, the stock would go to $1.
Or maybe I'll skip the kidnapping, and just short it and wait. Two years ago, Abercrombie's operating margin was 20%. Last year, it dropped to 12%. It has historically sported thick 67% gross margins, reflecting the high price it charges for the ordinary clothes it sells, which are all splattered with its logo, as if a chimpanzee had launched its own feces at some teenager's wardrobe.
But the gross margin is deteriorating as Abercrombie's hyperexpensive, mediocre clothing moves slower – now that it's affordable for fewer and fewer customers and management continues to reject value pricing in the name of preserving the brand. Good luck to them.
I'd say PIMCO's Bill Gross is thinking in the right direction... The "new normal" in America will mean fewer sales of paper-thin T-shirts that cost $50 because they say "Abercrombie" across the front.
While in Manhattan, I preferred H&M over A&F. H&M is the quieter, well lit, discount clothing retailer where I spent less than $100 for two bags filled with stuff for both my wife and daughter.
If these two stores were all you looked at in the U.S. economy, you'd conclude we were closer to a blow-off bubble top than a busted out bottom. Both stores were huge, with multiple floors of merchandise. Both stores were mobbed, with lines at multiple cash registers. I asked an H&M employee if it was always so crowded. He said, "This is nothing. You should see it on weekends." Goldsmith says every time he's in NYC, Abercrombie has a line out the front door.
The deflationists are going to have to work much harder to convert me, now that I've witnessed the festive, almost manic, fin-de-siècle mood in Manhattan. If Abercrombie is mobbed, somebody has money to burn, the country's 9.5% unemployment rate notwithstanding.
The price of flimsy T-shirts is just one indicator of inflation. Another is the price of catastrophe reinsurance, the insurance bought by insurance companies to help mitigate the risks posed by earthquakes, hurricanes, and other disasters. January policy renewal prices were up 15%-30%. The June/July renewal season is upon us, and prices are expected to rise again.
There's less reinsurance capital since last year, when world security markets crashed and Hurricanes Ike and Gustave triggered losses of $13 billion. Even Warren Buffett is pulling away from the so-called "cat" market...
Warren Buffett's Berkshire Hathaway hasn't issued a public statement, but word around the reinsurance industry is Berkshire withdrew a large amount of capacity from the market recently. It's possible Berkshire doesn't want wind-related catastrophe losses to hurt its credit rating, a consideration having nothing whatsoever to do with the prospects for cat reinsurers in 2009 and beyond. In April, Moody's reduced Berkshire's triple-A rating to Aa2.
Berkshire's withdrawal would be huge. Imagine if the price of copper were rising, and all of a sudden the world's biggest copper mine shut down. I know of at least two reinsurance companies trading at discounts to book value, and most of what they own is safe, just cash and bonds.
I'm researching these two stocks for the next issue of Extreme Value. They could easily rise 50%-100% in the next few months as cat rates go up. These are volatile times. You've got to buy what's down and sell what's up. To make sure you get my research on these companies, click here.
Speaking of catastrophe reinsurance, my favorite smallcap company in this space, IPC Holdings, has now seen a third bidder attempting to buy the company. Yesterday, Flagstone Reinsurance offered shares and cash worth a little less than $31 per share for IPC. IPC is trading around $28 as I write this.
The arbitrageurs have gone short Flagstone and long IPC Holdings, so Flagstone is down 10% and IPC is up about 2%. The current offer is priced at about $30.79. Flagstone trades around $9.57, down 10% today.
Bidding wars are ideal for merger arbitrage. And this is a war. Max Re tried to buy IPC, but was rebuffed. Validus Holdings got in the game. Now, Flagstone is getting into the act. Somebody is going to wind up buying IPC. Buying it for less than $29 could make you 5% or 10% quickly. A rebound in Flagstone could get you a 20% or 30% profit.
Since the annual Stansberry Alliance meeting last December, I've been warning investors about blowups in municipal bonds due to shortfalls in state, city, and county budgets nationwide.
Now, with many municipal bonds trading at high yields, our thoughts turn the opposite way... We fancy ourselves contrarians and what's more contrarian now than buying California municipal bonds? Today, The Governator declared a fiscal emergency to bring lawmakers into a special session to close the state's $26.3 billion budget gap – up from $24.3 billion since Tuesday after they failed to close it.
Now, state officials can suspend payments to vendors and local agencies and will instead issue IOU notes. The state's economy is a complete disaster. It's dead broke, and barring the state of California declaring bankruptcy, things could not get any worse. But bankruptcy is incredibly unlikely... If the U.S. government is going to bail General Motors out, do you really think it would let the third-largest state in the country, the world's seventh-largest economy, go bust?
You can now buy California municipal bond funds for double-digit discounts to net asset value with tax-free yields of more than 7%... That's more than twice the yield on Treasuries, not including the tax benefit, which would bring the comparable yield to around 10%.
And speaking of GM going bankrupt... The company asks that you stop speculating in its common stock. Proving just how ignorant the general investing public is, Gene
ral Motors actually had to issue a press release saying its stock is worth ZERO, and there is no reason people should be buying it. (Keep in mind, we told you the same thing more than two years ago.) The release stated:
GM management has noticed the continuing high trading volume in GM's common stock at prices in excess of $1. GM management continues to remind investors of its strong belief that there will be no value for the common stockholders in the bankruptcy liquidation process, even under the most optimistic of scenarios. Stockholders of a company in Chapter 11 generally receive value only if all claims of the company's secured and unsecured creditors are fully satisfied. In this case, GM management strongly believes all such claims will not be fully satisfied, leading to its conclusion that GM common stock will have no value.
The scary thing is, GM issued a similar warning on June 10 after shares – which trade on the pink sheets – rose to $1.59. It can't be hard to successfully compete against such people in the stock market. If they keep buying GM, you'd be competitive by simply not losing every penny you have.
After years of being bearish on Big Pharma, S&A FDA Report editor George Huang published an essay in Growth Stock Wire today titled Why It's Finally Time to Buy Big Pharma. George argues Obama's plan to extend health care coverage will produce windfall profits for Big Pharma...
If Obama ultimately succeeds in expanding health insurance to every American, health care providers will get an additional 50 million new clients overnight. Sales of drugs, tests, and medical devices will likely soar. One thing is certain: When people have insurance, they use more health services and buy more medications... I believe a new bull market for drugmakers is only months away.
Big Pharma is also starting to buy fantastic biotech assets cheap... Today, Johnson & Johnson announced it was buying an 18.4% stake in the Irish biotech company Elan for $1 billion, thereby acquiring the rights to its promising Alzheimer's drugs. It's a great deal for J&J.
It also recently bought out a biotech company called Cougar Biotech (CGRB) to gain access to its promising prostate cancer drug.
In addition to the Obama factor, these acquisitions will start adding huge dollars to Big Pharma's bottom line, only making the situation more enticing for investors. To make sure you receive George's Big Pharma recommendations, click here...
New highs: All biotech stocks... Crucell (CRXL), Quest Diagnostics (DGX), CuraGen (CRGN).
Lots of Alliance feedback in today's mailbag. Are you happy with your lifetime membership? Let us know here: feedback@stansberryresearch.com.
"Thanks guys for opening up the alliance membership the same month I had to renew my short report subscription. You membership would now cost me $9,500 this month which is way more than I can afford. I am not one of your people who have a portfolio of $500k – more like $8k so paying $7500 is a big hit to me to get this service. I hope to make enough off of you other letters that I subscribe to that, one day, I could become an alliance member but I am not made of money." – Paid-up subscriber Sean Pahut
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Regards,
Dan Ferris
Medford, Oregon
July 2, 2009