Trade Alert: Short the dollars (not the dollar)

“The lady doth protest too much, methinks.” – William Shakespeare (Hamlet), Act 3, scene 2

One of the Bill Shakespeare’s most frequently misquoted lines is the one that best captures Frau Merkel.  Here’s Angela on Greek bailouts in 2009:

“I will not allow Germany to participate in any speculation.”

And 2010:

“There’s no looming insolvency,” Merkel told Deutschlandfunk. “I don’t believe that Greece has any acute financial needs from the European community and that’s what the Greek prime minister keeps telling me.”

And in 2011:

“We don’t do Greece any favors by speculating about more aid.”

And in February of this year:

“This is not just about saving but, in addition, structural reforms that will help the creation of better institutions, such as for privatisations and tax collection,”

So is it any wonder that Spain and Cyprus are the fourth and fifth countries to ask for a bailout? There are 17 Eurozone nations, three more and it’s practically 50% bailed out (I’m looking at you, Estonia, Slovakia and Slovenia).

But who really cares? We’re three years in on this manufactured crisis, exacerbated by indecision, and prolonged by a feckless central bank.  What we’re you supposed to do, not buy stocks while chasing that extra .01% yield in a CD? Here’s what the Dow and NASDAQ have done since November 2009, just as Dubai defaulted and Greece said they didn’t need a bailout for their 300 billion euros of debt:

Now I don’t know when the euro is going to finally break up, but my guess is that it limps along for several more years, with German intervention and stealth U.S. bailouts.  The day the euro is abandoned and dozens of well run European companies are re-denominated in currencies no one has used for two decades, it will be the shopping event of a generation. But you can’t sit in all-cash waiting for that moment as it’s likely to take longer than any bear out there is currently suggesting, it’s going to be a couple-month trade at best (and please don’t buy the crazy fee-laden Nassim Taleb Black Swan ETF in the meantime).

You’re best off investing in long-term secular trends and shorting long-term collapsing business models.  Trying to game when empires will fall is fool’s game.  In December of 2008, after Lehman had failed, if an oracle  had told you that four years later national unemployment would hover around 9% and household wealth would be at 1990s levels, would you have gotten long stocks? Scary thought but if you stayed in cash you would have missed a 50% rally in the broad indexes.

We’ve been adding new longs to the portfolio (Lindsay LNN, Juniper JNPR, Broadcom BRCM and Facebook FB) and I want to get rid of one that has done nothing for us, Cisco CSCO.  We bought CSCO in November of 2010 and even factoring in the company paying dividends for the first time ever, we’re down about 12%. I should have sold the name when it was bouncing around the low 20s, mea culpa for that.  There are better opportunities for our portfolio and we are plenty levered to the app/cloud infrastructure buildout.  Plus with Fusion-IO getting their products into the Cisco ecosystem, we have a stealth play on the networking giant’s revenue footprint anyway. And we recently adding Juniper, which can be a high-beta play on the Cisco move anyway, meaning it will likely move up more than Cisco if and when they move up again.

At any rate, as we continue to bet against trends that are past their time I’m adding short positions in Dollar General DG and Dollar Tree DLTR to our Revolution portfolio.  First off,  here’s why I’m not shorting Family Dollar FDO too: Nelson Peltz has put an soft floor on the stock with a $7 billion buyout offer (though Bill Ackman dumping his entire 8.9% stake after putting out an enormous presentation is not nothing). But just look at what DLTR and DG have done since Bear Stearns failed in 2008:

Buying the dollar stores in 2008 means you nailed a spectacular trade, consumers traded down, shopped less, and what they did spend went to small-scale value retailers and that made you between double and five times your money.  Kudos.  In 2012 it’s time to bet against the dollar stores.

This isn’t an anecdotal trade but some of that stuff makes me giddy.  Like Dollar Tree’s board giving the CEO a $10 million retention bonus. Or the Wall Street Journal running articles like “A Discount Retailers Even Wal-Mart Envies”. Or that no fund manager I talked to liked the idea of shorting these guys (and that many of them tried to talk me out of it).

Fundamentally we are getting short because the low-hanging fruit for dollar stores has been taken out, and now they’re in a death race to fill up vacant strip malls in less and less desirable areas. Ruidoso and its surrounding towns have a population of about 21,000 and five dollar stores with more on the way.  And it’s not like we are in a retail desert, there’s a Wal-Mart in Ruidoso Downs plus a couple grocery stores.  What the dollar stores are facing in Ruidoso is the kind of saturation that’s playing out all over the U.S..  Check out these graphs from Forbes:

And you have to love these quotes from the bullish article of  what Dollar Generals needs to do to stay on track:

The Tennessee-based chain added 63 units in the space of roughly two months, which sounds like a lot, bit is actually a little off the pace the company needs to achieve the 625 new stores slated to open this year.Going forward, DG needs to average 1.8 new stores per day to hit its new-store expansion target of 625 units and seven percent square footage growth by the end of its fiscal 2013. And then DG needs to maintain or possibly accelerate that pace over the coming fifteen years, as Dollar General claims the U.S. market is capable of supporting upwards of 20,000 stores.

Wanna bet that Dollar General’s real estate team is building stores and taking leases in markets they don’t know and cities they wouldn’t have considered till now, just to keep up with expectations?

Dollar General and Dollar Tree have basically doubled their retail footprint since 2001.  And their stocks are priced like they could do in the next ten years what they did in the last ten.  DLTR is a $12.7 billion company that trades about 26x earnings, while DG is worth $17.68 billion at 22x earnings.  For non-linear comparison, Ralph Lauren RL is a $13 billion company and trades at 20x earnings, while Target is $38 billion company that can be had for 13x earnings.  So the dollar stores are neither small nor cheap.

But what should really terrify DG and DLTR shareholders is that the business model doesn’t leave any room for error or pivoting.  This quote from Dollar General CEO Rick Dreiling sums it up:

Dreiling told analysts in a conference call that his company would be very careful about raising prices, even though its costs for fuel and such were rising. “This sounds almost silly,” he said, “but a $1 item going to $1.15 in our channel is a major change for our customer.”

DG and DLTR are already scraping the bottom of the barrel in price-point, inventory selection and customer base.  Long-term this is a strategy for disaster, you want to own companies that can pass on costs and increase pricing power over time, not ones that have to eat commodity spikes because their customers just cannot. Here’s what Dollar General did in 2011:

It [Dollar General] also refrained from passing along its higher commodity costs on such products as coffee, whose wholesale price has risen four times since December. “We have 228 items that are priced at $1 that we think are incredibly important to our customers that we elected not to take price increases on,”

How charitable of them.  I hate a business that can’t capture the upside when the macro picture improves and is forced to take losses just to keep people coming in the door.  That’s how Syms and Filene’s went bankrupt. Retail is hard, margins are crappy(even when you trick poor people into buying at higher unit prices) and the dollar stores are delving into new markets to boost sales.  Here’s what Dollar General said on the most recent conference callabout their apparel offerings:

Apparel sales overall continue to struggle but there were several positives in the quarter including infants and toddlers, ladies sleep wear and under garments and accessories. Hanging apparel in particular continues to be an area where we believe we can improve our results. We are executing our fresh approach to apparel pricing as we are adding in season promotional events and we are flowing new apparel to the stores more frequently, so that our customer sees fresh merchandised more often.

And here’s Dollar Store CEO Bob Sasser on his exciting new product categories:

You’ve got water blasters for a buck, 26-inch water blasters. We have a new item—we’ve done well with our solar stakes – for only a dollar, can you believe that? You buy solar stakes, and for the Memorial Day through the Fourth of July time period, we’ve got some that have the red, white and blue on them, so you can be patriotic and light up your sidewalk all at the same time.

I can appreciate some homespun corniness but this is too much to bear.  Tiny retail margins are one thing but when you consider they are on small amounts it becomes hard to justify DG and DLTR’s prices on the back of squirt guns and glows sticks.  Plus delivering those water guns for a dollar means huge capex for distribution centers and stores like the $330M DLTR and the $650M DG are spending. Soon the days of double-digit growth will give way to numbers that look more like the prices on DG and DLTR’s inventory.

I’ll be starting by shorting some common stock in each of these two names for now and I’ll be looking to add some longer-dated puts in coming days and weeks.