Wednesday, December 15, 2004

Alcatraz: The Remedy for White-Collar Crime?

December 12, 2004 - Street Insight

  • I propose all executives convicted of a white-collar crime serve their time at Alcatraz.
  • Serving six months to a year would make an honest person out of even the most crooked offender.
A couple days ago, I briefly visited San Francisco (I left my heart there). I had several hours of free time to kill, so like any self-respecting tourist, I went on a tour of Alcatraz -- what a place! I don't have a frame of reference, since it was my first prison visit (and hopefully my last), but it must have been the most awful and unpleasant place in U.S. to be sentenced to.
This Alcatraz visit brought me to a realization that the U.S. government is misusing this national treasure. In fact, I strongly believe the National Park Service should turn Alcatraz back over to the Department of Corrections. Alcatraz could single-handedly restore investors' faith in financial statements and markets. My proposal is very simple: First, all executives of publicly-traded companies that commit a white-collar crime (i.e. lie to investors, manipulate a company's financial statements, do insider trading, steal money from their company, etc.) should serve their time at Alcatraz, not in a minimum-security country house.
Time served doesn't have to be very long. After seeing the horridness of Alcatraz, the reader will agree that six months to a year is plenty of time to make an honest person out of even the most crooked executive.
Second, the SEC should require every executive of a publicly-traded company to take a guided tour of the functioning prison at least once a year -- with Eliot Spitzer as a guide. This once-a-year field trip would eliminate even a trace of temptation to commit a white-collar crime. If the aforementioned suggestions are implemented, our children will think that white-collar crime is when your dry cleaner did not remove the stain from the dress shirt. Wouldn't that be nice?
Vitaliy N. Katsenelson, CFA Copyright 2004

Thursday, December 02, 2004

Ukraine Developments Are a Positive Sign

December 2, 2004 - Street Insight
  • As in the 2000 U.S. election, the Supreme Court, not tanks and armies, is deciding the legitimacy of the election.
  • Peaceful demonstrations and protests are actually a sign of a democracy.

I see why Americans (and Europeans) are unhappy about Putin's involvement, but it's a game everyone plays. I would like to politely disagree with Jeff Matthews and politely agree with Geoff Johnson on the political situation in Ukraine. Though I am sometimes mistaken for an expert on Russia, I am not one. I have been out of touch with Russia for too long to stay current on all political and economical developments, and to be honest, the U.S.A. is so much more fun to follow. I proudly declare myself a "Capitalistic Pig." I look at the world from the American prism as an American citizen. That being said, I have to admit that my expertise on Russia lies in an understanding of how Russian (in this case, Ukranian, who are very similar to Russians) people think, since I lived there for a considerable portion of my life. I believe the developments we are observing in Ukraine -- so far -- speak very highly of Ukraine. Ukraine had a very close, highly contested election, the outcome of which is disputed. There is nothing unique or unusual about this. The United States, a highly developed, democratic nation, had its own decidedly contested election where the candidate who lost the popular vote became the president. I am not mocking the American election system -- not at all; however, I am sure the U.S. election in 2000 looked very odd and awkward to foreign observers. I believe the more important issue at hand is how the conflict in Ukraine is resolved. And so far, Ukraine has shown that it follows the rule of law. Similar to the 2000 U.S. election, the Supreme Court, and not tanks and armies in the street, is deciding the legitimacy of the election. And believe me, this in itself is a great development for Russia and Ukraine. Furthermore, peaceful demonstrations and protests are actually a sign of a democracy. But demonstrations are not unique to Ukraine. I remember several years ago not-so-peaceful demonstrations in Seattle protesting the United Nations. Could demonstrations in Ukraine get violent? I would not rule it out, but if they do, it will be because the demonstrators are drunk, not because the government brings out a military presence. Finally, we come to Putin's role in this election. Putin has being accused of trying to influence the election in Ukraine. I believe this is true. However, Putin is trying to do what he thinks is best for Russia the same way George Bush is doing what it thinks is best for the United States when he is trying to influence elections in Afghanistan and Iraq. I understand why Americans (and Europeans) are not crazy about Mr. Putin's involvement in the Ukranian election, but this is the game that everybody plays -- I guess this is our turn to be upset.

Disclosure: Long small traces of Russian DNA, and high American cholesterol

Dollar General Fails to Show Me the Dollar

December 2, 2004 - Street Insight

  • A turnaround seems unlikely, as the numbers are even worse than they appear on the surface.
  • It feels like there is a disconnect between management, the stock market, analysts that were on the call and reality.

I'm getting tired of hearing about the improvements management boasts about qtr. after qtr. and not seeing results. Last quarter I truly hoped that things could not get any worse for Dollar General (DG), but they did. I was a big believer in a Dollar General turnaround, but I think I was wrong.

I think the numbers are even worse than they appear on the surface. Sales grew 11.5% -- not a spectacular number and below my long-term expectations. But it seems this is the least of DG's problems. Cost of goods sold (COGS) went up 1.2% -- a huge increase considering the razor-thin margins in retail. If you think problems could not get any worse -- well, they do. SG&A costs went up 0.54%, operating profits shrunk from 7.8% to 6.1%, inventory turnover was down and operating cash flows were almost wiped out by a huge increase in inventory.

EPS came at $0.22, a decline of 4.3% over last year -- and this is after the company bought back nearly 9 million shares of its stock, lifting EPS by 2.6%. EPS was also helped by a lower tax rate and lower interest expenses.

It feels like there is a disconnect between DG management, the stock market, analysts that were on the call, and reality. Management was talking about the great improvements it is making as if the company did not have one of the worst quarters ever. Analysts are completely ignoring the issue of rising inventory and the collapse of profit margins. The stock market is fixated on the decline in oil and completely ignoring DG -- the stock did not budge at all, even though company missed earnings estimates by close to 15%.

Although management has being talking about improvements that it has made over last 10 months, all I wanted to do was yell: "Show me the money!" They bragged that they have improved apparel merchandise and that sales of jerseys were very good, but then they said that overall apparel sales were disappointing. I am getting tired of hearing about the great improvements that management is boasting about quarter after quarter and not seeing the results.

What am I missing? Dollar General's problems are likely to be similar to Wal-Mart's (WMT). High energy costs are having a very negative impact on low-income consumers, which makes perfect sense. Low-income consumers are not enjoying the fruits of the housing market appreciation. Higher gasoline and heating oil prices are having a significantly larger impact on low-income consumers since they are taking a larger bite out of discretionary income. Also, higher health care costs are impacting low-income consumers disproportionately more than everybody else. I believe the aforementioned factors are responsible for weaker-than-expected sales growth.

The inventory increase is also a big concern. Management indicated that inventory will likely decline next year, but something is wrong about substantially rising inventory levels for a company that just spent millions of dollars on inventory management and automatic replenishment systems. From my past experience, a decrease in inventory turnover is a precursor to larger problems down the road. No Longer Sold on Dollar General December 2, 2004 - Street Insight

  • I was a big believer in the company, but management has lost all credibility in my eyes.
  • As of this morning, I am out of Dollar General.

I mentioned on the second quarter Dollar General (DG) conference call that I will be putting DG on probation.

I was a big believer in Dollar General and I stated my position several times on Street Insight. However, management lost all credibility in my eyes after the last two conference calls. Though valuation is not very high, in my mind it doesn't price in all current developments.

DG stock's indifference to yesterday's developments is puzzling to me, but I'll let future shareholders sort it out. As of this morning, I am out of Dollar General. Vitaliy N. Katsenelson, CFA Copyright