The Greek Crisis And Cheap Retailers

The never-ending Greek crisis provides an absorbing spectacle. No more eloquent comment on their default odds is needed than the 18% yield currently provided by 10 year Greek government bonds. While the EU, ECB and IMF maintain the façade that Greek debt will be money good in spite of the fact that it trades at half its face value, few others are fooled.

Greece’s problem is Germany and France’s problem through the exposure of those countries’ banks. And now it’s come to this: today’s Greek government auction of 90-day t-bills was completed at 4.62% with 30% of the bids non-competitive. As reported on CNBC, this 30% was bought by Greek banks who will turn around and use them as collateral with ECB while borrowing at 1.25%. Either the banks pick up the approximate 3.3% or they get bailed out by the Greek government. This is what passes for riskless arbitrage nowadays.

If the inescapable conclusion is that Greece needs debt relief, what opportunities are created by the continued delay? There seems little doubt that eventually German and French taxpayers will foot the bill, either through absorbing some of the losses their banks take on imprudently high levels of Greek exposure or through direct purchases of the unwanted Greek bonds. Betting on continued austerity as the answer doesn’t provide attractive odds. Recent riots in Athens reflect the frustration that many feel over paying for debts incurred by others.

We generally have long equity market exposure in our hedge fund, and think being short the Euro now is both an attractive investment as well as a good hedge. The likely passage of a vote of confidence in the reshuffled Greek government and commitment to further austerity will release a further €12BN loan tranche as well as pave the way for a new €120BN bail-out. And that is about as good as it will get. Further misses of tax revenue targets will follow; thoughtful Greek citizens will accelerate withdrawals from local banks, and the crisis will roll on. If the crisis somehow passes stocks will likely regain their upward momentum; if not, a modest short in the Euro will provide a helpful offset. Greek savers are starting to hoard gold – it’s not clear why any intelligent Greek citizen would keep his savings in the bank at the moment.

In our Fixed Income Strategy we have been reducing our investments in Emerging Market currencies. Unattractive U.S. interest rates virtually compel an income seeking investor to allocate some capital in emerging markets currencies, and we have been following that strategy for some time. WisdomTree Dreyfus Emerging Currency Fund (CEW) is a well constructed short duration ETF, and we had until recently held this as a core holding. However, the potential for US$ strength driven by Greece has caused us to exit this position for now.

In our Deep Value Equity Strategy, we continue to like natural gas E&P names such as Range Resources (RRC), Southwestern Energy (SWN) and Petrohawk (HK). All are trading at attractive levels compared with the net asset value of their likely reserves. We like natural gas thematically given its smaller carbon footprint than other fossil fuels, cheap price (one third the price of oil on a BTU equivalent basis) and safe, domestic source of supply. The recent law passed in Texas compelling greater disclosure about the chemicals used in hydraulic fracturing should help alleviate some of the environmental concerns as well.

We have been adding to retailers lately. Family Dollar (FDO) is a relatively recent holding of ours. FDO’s operating margins are lower than their peers, including Dollar General (DG) and Dollar Tree (DLTR). 

Dollar Stores Selected Metrics, most recent full year

 

FDO

DG

DLTR

Operating Margin

7.3%

9.8%

10.7%

Net Margin

4.6%

4.8%

6.8%

Rev/Sq Foot

$163

$194

$168

Net Income/Sq Ft

$7.41

$9.36

$11.32

Net Income

$358MM

$628MM

$397MM

Market Cap

$6.8BN

$11.5BN

$8.1BN

Trailing P/E

19.1

18.3

20.4

 

The point of this investment is that better performance is possible if FDO can improve its procurement and operate just a little more efficiently then its operating leverage can lead to sharply higher net income, at which point it will appear cheap versus its peers. Can they do it? Recent signs are promising, and the stock is owned by a long list of activist hedge funds topped by Bill Ackman.  Management recently rejected a buyout offer from Nelson Peltz at higher than the current stock price, and the resultant poison pill defence expires next March.

 

Disclosure: Author is Long RRC, SWN, HK, FDO

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