Looking at entry points for ANF.

Did a quick comparison on various retail stocks.  ANF and AEO are very similar stocks.  I still like ANF because of its strong Balance Sheet and its robust inventory levels (32% higher than last year going into holiday sales).

	Market  Cap  (Billions)	Income  (Billions)	Employees (Thousands)	P/E	EPS	Profit Margin (percentage)
RL	12.53	0.659	24000	19.94	6.82	10.29
DDS	2.17	0.432	24564	5.59	7.71	6.74
KSS	12.2	1.21	29000	11.38	4.23	6.42
TJX	23.2	1.35	166000	17.73	3.47	5.92
M	12.83	1.18	166000	11.28	2.71	4.54
ANF	3.88	0.199	9000	20.33	2.22	5.02
AEO	2.76	0.187	6900	14.97	0.95	6.18
JCP	6.89	0.195	156000	42.47	0.76	1.11

Two positions for 19 December 2011

Taking on new IPO Zynga Inc.

Looking at exit point -Accenture.

Ecopetrol S.A.: The Colombian potential

By Daniel U. Alvarez

PEREIRA, Colombia (MercadAnalytic) – Ecopetrol S.A. (NYSE:EC) is the biggest corporation in Colombia and one of the top 40 oil companies in the world.  It is also one of the four major oil companies of Latin America and currently has a market capitalization of $85.74 billion.   

Not unlike most Latin American companies, Ecopetrol is structured as a Sociedad Anomina (S.A.) which is the equivalent to a U.S. corporation.  The Ecopetrol S.A. website indicates that it went public in 2007.  Ecopetrol S.A. owns the largest refinery in Colombia and most of the countries' oil pipe-line infrastructure.  Ecopetrol’s footprint is mainly in Colombia, but it also has operations in Peru, Brazil and the Gulf of Mexico.  

Ecopetrol’s financial and operational performance has been steadily improving since it became a public company.  Its third quarter production results for the nine-month period ending September 30, 2011 shows an 18.5% increase compared to the same period in 2010, and its third quarter production results for the three-month period shows a production growth rate of 15.7% compared to the third quarter 2010. 

Ecopetrol also posted the following nine-month period ending September 20, 2011 results:

Ÿ          --  revenues increased by 52.3%;

Ÿ           --  operating income increased by 94.6%;

Ÿ            -- EBITDA increased by 74.6%; and

Ÿ            -- net income increased by 96.6%.

Ecopetrol’s export sales increased from 363,000 to 513,000 barrels of crude and gas per day or 40%.  At the end of the third quarter, the company also indicates that the United States led the way as its biggest export recipient with 58.8% of its total exports.

Transportation capacity grew by 15% from 936,000 to 1,076,000 barrels per day.   

On November 21, 2011, Ecopetrol approved its 2012 – 2020 strategic investment plan “which includes a total of $8,477 million of which $7,452 is expected to be invested directly in Ecopetrol and $1.025 to be invested in other companies of the corporate group”.  The following shows the allocations by component:

Exploration -- $1,419 million.  The company plans to drill 42 exploratory wells of which 36 will be located in Colombia. 

Production -- $4,113 million.  Ecopetrol has established a 2012 production target of 750 thousand barrels of oil equivalent per day which is 10.6% higher than the 2011 goal.

Refining, Petrochemicals and Biofuels -- $601 million.  This investment will primarily be used to improve operational requirements in its two refineries; Barrancabermeja and Cartagena.

Transportation -- $2,025 million.  The company aims to increase crude evacuation capacity by 600 thousand barrels a day in 2012.

Other investments -- $318 million.  This allocation will primarily be used for research and development and information technology and social responsible programs.

In the 2012 – 2020 strategic investment plan, the C.E.O. and President of Ecopetrol, Javier Gutierrez Pemberthy, states “our efforts are focused on fulfilling the goals we set forth for the years 2015 and 2020.  2012 is essential to make our vision as a corporate group a reality, which explains the importance of the approved investment plan [sic]”.      

Earlier this year two rating agencies raised the credit-worthiness of Ecopetrol.  On March 22, 2011, Standard & Poor raised Ecopetrol’s risk-rating from ‘BB+’ to ‘BBB-‘  and on June 23, 2011, Fitch raised its risk-rating from ‘BBB-‘ to ‘BBB’.  Both risk-rating agencies assigned Ecopetrol with a rating outlook as “stable”.

One of the concerns in investing in Colombia is security and government stability.  Under the previous Presidency of Alvaro Uribe Velez, the Colombian government made significant strides in establishing a safety and security for its citizens.  The Uribe government is also credited for strengthening democracy in Colombia.  The current government of Manuel Santos is following in Uribe’s footsteps and continues to make progress in transforming Colombia into a strong democratic government.  Within the last year key leaders of the Fuerzas Armadas Revolucionarias de Colombia (FARC) were eliminated.  A national program to re-integrate many of the FARC members in to society continues to show progress.     

Ecopetrol financials are solid.  Its current price/earnings ratio is $20.37 and its earnings per share is $2.08.  Its stock price has a 52 week range of $37.48 - $46.35 and closed at $42.35 on December 6, 2011. 

Disclosure:  We do not own Ecopetrol S.A. stock but are considering long-positions and are looking at entry points at around the $39 per share level.  

S&P threatens eurozone with widespread downgrades

By Daniel U. Alvarez

PEREIRA (MercadAnalytic)– Standard & Poor’s (S&P) ratings services last night threatened to downgrade the status of 15 of the 17 European Economic and Monetary Union (EMU or eurozone) members, adding pressure to get their sovereign debt problems fixed.

The risk-rating agency believes that “systematic stresses in the eurozone have risen in recent weeks to the extent that they now put downward pressure on the credit standing of the eurozone as a whole”.  The following “five interrelated” concerns are cited by the agency as contributing factors to the potential downgrade:

1)      Tightening credit conditions across the eurozone;

2)     Markedly higher risk premiums on a growing number of eurozone sovereigns, including some that are currently rated as ‘AAA’;

3)     Continuing disagreement among European policy makers on how to tackle the immediate market confidence crises and, long term, how to ensure greater economic, financial, fiscal convergence among eurozone members’

4)     High levels of government and household indebtedness across a large area of the eurozone; and

5)     The rising risk of economic recession in the eurozone as a whole in 2012.  Currently, we expect output to decline next year in countries such as Spain, Portugal and Greece, but we now assign a 40% probability of a fall in output for the eurozone as a whole.

Interestingly, the potential downgrade announcement came hard on the heels of: 1) Franco-German initiative announced early Monday by President Nicholas Sarkozy and Chancellor Angela Merkel to enforce budget discipline and 2) Italian Prime Minister, Mario Monti’s, government austerity plan to cut $30 euros from its budget.  

Market reaction on Monday before the S&P announcement was well-received.  Late Monday, however, the markets began to give-up some the gains. 

Sarkozy, Merkel and Monti have a very difficult challenge ahead of them.  One of the measures proposed by the Franco-German initiative is to agree on “mandatory limits on budget deficits that eurozone members would have to adhere to, or risk possible sanctions”.  Monti’s austerity plan was approved by his cabinet on Sunday but still needs senate approval. Trade unions oppose the austerity measures and planned for protests later in the month.

Amazingly, the markets initially responded positively to the proposals, but nothing has been approved yet. 

Assessment

We believe ratification of the Franco-German proposal and the Italian austerity plan is going to be a major challenge to ratify.  In the end, pressure from the S&P and the United States may still not be enough for passage.  

Accordingly, we expect a higher U.S. dollar opening and equities to pull-back.  We still hold the following positions: $DOG, $RWM, $SDOW, and $FAZ.  On Tuesday and Wednesday we will be looking for exit points.  

Two head-lines don't make it a trend

By Daniel U. Alvarez

PEREIRA – Stock index futures added gains Friday morning after a positive U.S. jobs monthly report and the European Central Bank’s announcement that it is planning to lend the International Monetary Fund euros in an attempt to ease the euro zone debt crisis.  The European Union’s plan allows the European Community Bank to lend up to $270 billion euros and essentially use the IMF as a clearinghouse.  November U.S. payroll jobs climbed to 120,000 and the jobless rate falls to 8.6%.     

Assessment

Both of these head-line news stories are favorable for continued Friday morning stock market increases.  However, the European sovereign debt crisis is far from being fixed. Until European budget deficits are addressed, this fundamental macro-economic problem will continue to drag the markets in the long-term. 

Our strategy is to wait for the markets to culminate and look for sell-off points.  We don’t believe the head-line is sufficient to create a trend and are setting up our trades accordingly.  We are looking at entry points for the following ETFs: $DOG, $RWM, $SDOW, and $FAZ.  

The Basic Financial-sector short play

By Daniel U. Alvarez

PEREIRA -- Stocks and commodities rallied world-wide yesterday as a result of the Federal Reserve-led “coordinated action” to provide low-cost emergency U.S. dollar loans to European banks.  The benchmark U.S. Treasury 10-year note yield rose two basis points to 2.09% early Thursday morning while most European bond yields continued to drop for a second day.  Not too surprisingly, U.S. stock index futures are dropping this morning snapping the 400 point Dow Jones surge yesterday.

Focus of the Day

The most impressive sector gains yesterday were in the U.S. financials’.  JP Morgan increased the most by 8.44% followed by Goldman Sachs by 7.84%, Wells Fargo 7.39% and Bank of America by 7.09%.  The second head-line news report of the day is tomorrow’s job report.

Short Financials

Accordingly, the cliché “Opportunity doesn’t knock twice” may apply to today’s strategy in shorting the U.S. financial markets.  This is especially going to be true if the “shock therapy” provided by the seven central banks yesterday does not stick.  The gains made yesterday by the banks are tenuous at best.  Any negative headline news and the frothy gains made yesterday in the financial sector will be blown away. 

My biggest concern with shorting the financial market prematurely is tomorrow’s employment report.  A positive jobs report will continue to bolster the financial sector.  I am looking at a favorable jobs report tomorrow thus setting the conditions to pull the trigger after the jobs report.

I will be monitoring $FAZ very closely throughout the day and may place purchase a block if it tanks…say to around $39.  Yesterday $FAZ closed at $41.33.  I also like the steep drop $FAZ took from $55 a few days ago to its current price.  I like playing $FAZ but I still think it is too high to get in at this point.  I remember getting in at around $39 early November and riding the wave up.  It’s a good play and its worth dusting-off the playbook.           

Diamond Inc.: Getting to the nut of the problem

By Daniel U. Alvarez
PEREIRA -- On November 1, 2011, Diamond Foods Inc.’s (NASDAQ: DMND) unexpectedly disclosed serious discrepancies (possible understatement of accounts payable) regarding its 2011 financial statement reports and as a result announced its decision to delay its acquisition of the Pringles snack business from Procter & Gamble Company (P&G) (NYSE: PG).  Naturally, the November 1, 2011 confession caused an immediate plunge of Diamond Food’s stock price, but worse, it triggered several lawsuits from furious investors and created rumors about the future viability of the company.  The purpose of this study is to determine the facts and critically analyze the cause and effect of Diamonds Food’s allegedly financial statement fraud and attempt to make a prediction about the future of this company.    

 Introduction

          Diamond Foods’ core competency is in its innovative food packaging methods and marketing abilities.  The company which brands includes; Kettle Brand Potato Chips, Emerald Premium Snacks, Pop Secret Popcorn, and Diamond Culinary Nuts, was clearly in an expansionary mode prior to its November 1, 2011 financial statement revelations.  For example, in his 2010 letter to Diamond stakeholders, the Chairman, President and Chief Executive Officer, Michael J. Mendes, announced that “Diamond Foods had a transformational year in 2010…with strong growth and profitability in the core business…the company acquired and successfully integrated the global operations of Kettle Foods…once again generated record earnings while continuing to invest in brands, innovation, operational infrastructure and people” (p. 1). 

     Undoubtedly, in the last couple of years, Diamond was on a clear trajectory to significantly expand its market share by acquiring other snack food companies.  According to a recent comment published in Barron’s Magazine (2011, November 5), “on April, 2011 Diamond Foods took on an even bigger bite by announcing its plans to acquire the Pringles chips business from P&G in exchange for Diamond stock” (p. 1).  Diamond’s growth in the past couple of years is truly impressive.  Table 1 shows Diamonds net sales growth by product from 2008 through 2010.

Table 2 shows the remarkable increase of Diamond stock especially from October 2010 to October 2011.  At its peak, Diamonds stock traded at $95, more than double what it is trading today.  Prior to Diamonds’ November 1, 2011 announcement its key financial performance measures were impressive; for example, its Price/Earnings ratio was $23.3, and its Earnings per Share was at 2.23.      

     Unfortunately, in its aggressive pursuit to increase its market share by acquiring companies of similar product,  Diamond may have also created the conditions conducive to fraud, as illustrated in the Fraud Triangle.   According to the Public Company Accounting Oversight Board (PCAOB), the “three key components that make up the Fraud Triangle are; perceived pressure, perceived opportunity and rationalization”. 

Diamonds’ Leadership

     The cliché that “leaders are responsible for everything that happens or fails to happen in an organization” certainly applies to the Diamond Food story.  The two most influential individuals within the Diamond Foods’ leadership structure are Michael J. Mendes, Chairman, President and Chief Executive Officer; and Steven M. Neil, Executive Vice President, Chief Financial and Administrative Officer. 

Michael J. Mendes, President and CEO

     Mendez joined Diamond in 1991.  He holds an M.B.A. degree from the Anderson School of Management at the University of California, Los Angeles.  Mendez assumed the duties and responsibilities of President and CEO for Diamond in 1997.  The immediate impression is that Mendez has an incredible amount of knowledge and experience with the Diamonds’ financial and operational requirements.       

Steven M. Neil, Executive Vice President, CFAO

     Neil joined Diamond in 2008.  Prior to joining Diamond, he served in various companies in financial and information systems capacities.  Neil holds an M.B.A. degree from UCLA, a bachelor’s degree in mathematics from UCSB and is a Certified Public Accountant in the state of California.   Neil appears to have a lot less knowledge and experience regarding the intricacies of Diamonds operations, but has significant knowledge and experience with financial statement operations and reporting.     

The Nut of the Problem

     Before Diamonds’ initial public offering in 2005, it core business product for years was packaging and marketing various type of nuts, particularly walnuts.  The relationship between Diamond and its walnut farmer suppliers is apparently long and tenuous.  For example, according to Alpert (2011, November 5) “the Wall Street Journal talked to some walnut growers and found serious issues with Diamond’s accounting”.   Interestingly, prior to Diamonds’ announcement to acquire the Pringles chips division from P&G on April 2011, numerous financial institutions such as Bank of America Merrill Lynch, Morgan Stanley and the Blackstone Group scrutinized the Pringle chips deal and didn’t find any irregularities with the financial proposal.  However, the conditions were about to change for Diamond.   

    Apparently it was the Internal Audit Department at Diamond that first identified the accounting issue after it was pressured by the press regarding the accounting concerns addressed by the walnut farmers.  According to Alpert (2011, November 5), Diamonds’ payments to walnut farmers for their fall 2010 crop “came short of market prices”.  The controversy lies with a payment made to farmers on September 2011, well after the end of Diamond’s fiscal year closing, July 31, 2011.  Diamond classified this particular payment to walnut farmers as “a momentum payment” of 30 to 40 cents per pound for the coming 2011 crop.  However, the walnut farmers contend that the payment was  really a way to compensate them for their 2010 crop payment deficiency.    

     The walnut farmer’s contention is very interesting.  Essentially you can draw two scenarios from the information that has been provided so far:

     Scenario 1.  The walnut farmers’ were indeed paid in full for their 2010 crop and the “momentum payment” was truly a pre-payment for the farmer’s 2011 crop.

     Scenario 2.  Diamond insidiously understated 2011 accounts payable to walnut farmers as a way to bolster their 2011 net income.

Potentially Fraudulent 2011 Financial Statements

     The remainder of this report will focus on scenario 2.  So what’s the big deal?  Why would Diamond want to make their income statement look better?  Recall the acquisition of Pringle chips from P&G   When Diamond announced on April 2011 that it was going to acquire Pringle chips form P&G, its stock surged.  Unfortunately, according to Andrejczak of MarketWatch magazine (2011, November 2), Diamonds’ decline in stock value from its high of $94 to a low of $38.30, erased over $1 billion in shareholder value.  This means that Diamond will now need to take on substantially more debt than prior to the fall of its stock price. The acquisition of Pringle chips was valued at $2.35 billion in stock when it was announced in April 2011.    

The Effects of Potential Fraud.

          Immediately after Diamonds’ November 1, 2011 statement, numerous law firms published press releases regarding legal action against Diamond Foods, Inc.  For example, according to Business Wire (2011, November 8), Bernstein Liebhard LLP “announced a lawsuit had been filed in the United States District Court for the Northern District of California on behalf of a class of investors who purchased Diamond Foods, Inc. securities between the period of April 5, 2011 and November 1, 2011”.  These dates coincide with the Diamonds announcement of the Pringles chip acquisition and Diamonds November 1, 2011 disclosure.  The complaint alleges the following:

1)      The company was underestimating the ultimate price to be paid to walnut growers;

2)      The company was improperly accounting for its cost of sales;

3)      As a result, the company’s financial results were overstated;

4)      The company lacked adequate internal and financial controls

5)      As a result of the foregoing, the company’s financial statements were materially false and misleading at all relevant time; and

6)      As a result of the foregoing, the company’s positive statements about Diamonds Foods’ business, operations, and prospects, as well as those regarding the timetable for the Acquisition [sic], lacked a reasonable basis. 

     P&G stock was affected a slightly with Diamonds’ disclosure and on Monday, November 7, 2011 it issued a statement reiterating its intention to sell Pringles chips to Diamond Foods.  What is interesting about this case is that if Pringles original acquisition price is $2.35 billion, and Diamond stock value fell by $1 billion within the month of October, then Diamond will now have to shore up $1 billion in other debt to make up the difference.  This, of course, if Diamond stock does not continue to fall. 

Conclusion

     It is amazing the amount of risk Diamonds’ leadership was willing to take with its purchase of Pringles chips and its quest to expand its market share.  Table 3 shows how much Diamonds’ stock price has plunged since its disclosure with its November 10, 2011, closing price at $37.52 Also, its Price/Earnings ratio dropped from a high of $23.35 to $16.90.  Furthermore, it is clear that the three elements of the Fraud Triangle were present in Diamond’s leadership during the past year.  The perceived pressure was to expand its market share by aggressively acquiring bigger business of similar product.  The perceived opportunity was the perceived financial gain was going to make, especially with the purchase of Pringles chips.  The rationalization lies within the leadership of the company.  With the deluge of lawsuits that Diamond Inc. is facing coupled with its market value loss of over $1 billion, I do not think they will recover from this blow.  Not only does Diamond now have to raise over $1 billion is debt that was loss with its stock price plunge, I now faces numerous costly lawsuits that will drain the financial resources of the company.  Unfortunately, I do not see a happy ending to this story.   It is important to note the Diamond Inc., has not been indicted of a crime; however, there are numerous lawsuits that have been initiated.

Table -1.  Diamonds’ net sales were as follows (in millions):

Year Ended July 31,

            2010                2009                2008

Snack                                                              $ 321.4            $ 188.9            $ 88.6

Culinary                                                             217.5               241.9             239.9

In-shell                                                                 31.5                 34.3               41.9

Total Retail                                                        570.4               465.1              370.4

International Non-Retail                                      69.2                 68.9              101.6

North American Ingredient/Food Service           38.0                 34.5                56.9

Other                                                                      2.6                   2.4                  2.6

Total Non-Retail                                                109.8               105.8               161.1

Total Net Sales                                                $ 680.2            $ 570.9            $ 531.5

Source:  Diamond Foods Inc. 2010 Annual Report.

Table - 2.  Diamonds’ stock price from December 2008 through November 2011.

Source: Created with Stockcharts.com.  Retrieved from http://stockcharts.com/h-sc/ui?s=DMND&p=

D&yr=3&mn=0&dy=0&id=p87054293865

References

Alpert, B. (2011, November 5).  Getting to the nut of the problem.  Barron.com.  1-3.  Retrieved from http://online.barrons.com/article/SB500014240527487042

70204577013933878950486.html

Andrejczak, M. (2011, November 2).  Diamond Foods cracks under audit probe.  MarketWatch. 1-1.  Retrieved from http://www.marketwatch.com/story/diamond-foods-cracks-under-audit-probe-2011-11-02

Business Wire (2011, November 8).  Bernstein Liebhard LLP announces filing of class action against Diamond Foods, Inc.  Retrieved from http://www.marketwatch.com/ story/bernstein-liebhard-llp-announces-filing-of-a-class-action-against-diamond-foods-inc-2011-11-08

FED's Coordinated Shock Therapy

By Daniel U. Alvarez

PEREIRA -- In an effort to further stimulate the global economy, the Federal Reserve announced this morning along with six central banks; the European Central Bank, the Bank of Japan, the Bank of England, the Bank of Canada, the Swiss National Bank and the Federal Reserve “joint coordinated action to enhance their capacity to provide liquidity support to the global financial system”.  According to the Federal Reserve the purpose of this action is to “ease strains” in financial markets. The central banks agreed to lower the price of the U.S. dollar liquidity swap by 50 basis points. Essentially, the cost of purchasing U.S. dollars by other countries was lowered in an attempt to stabilize global markets.  This pricing agreement with be applied to all operations conducted from December 5, 2011 through February 1, 2013.

Assessment.    

The immediate market response to this announcement is positive.  The pre-open futures equity market rallied with the S&P 500 leading at 9:00 am with a 2.84% increase trending up. Gold is also up $28.60.  This move also helped lower the U.S. dollar index (USD) by 1.05% to $78.32. 

Calibrating a trade strategy is going to be difficult but I will use long-term cash for purchasing value stocks and short term for market swings.  The following are some of the ideas I am assessing:

1)      Long-term buy the $ANF, $DDS, $BRCM, $TIF dips. 

2)      Short-term buy the $FAZ, $TZA, $TVIX dips.