• Stress Tests Lead Financials Higher
• Treasury Hesitant to accept TARP Repayment
• Moral Hazard – What is the Government’s Role?
• Solar Companies to Report – Industry Recovering

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Stocks Mentioned:
Yingli Green Energy (YGE)
LDK Solar (LDK)

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Shares of Chipotle Mexican Grill, Inc. (CMG) have risen sharply in the last two quarters.  And why not?  The company continues to roll out new stores and has managed to grow profitability even in one of the worst economic periods in modern history.  Commodity prices that had once hampered margins have backed off significantly, and the casual dining firm recently posted yet another quarter with double digit revenue growth.

Many consumer discretionary stocks have climbed in recent months as the late winter panic led to low prices that were eventually bought on the assumption that things just weren’t as bad as expected.  As the market began picking up momentum, professional money managers and amateur individual investors alike began searching for strong companies worthy of investment capital.  Chipotle was one of the obvious choices due to its strong balance sheet, reliable earnings growth, and the household familiarity with the company.

Where does Gold Go From Here? (video)

But at some point investors need to take a step back and question at what price each investment should be considered attractive.  It appears that at a price near $80, CMG is beginning to push the limits on valuation and could be setting investors up for a disappointing second half.  Part of this concern stems from the company’s most recent quarterly report.

On the surface, the first quarter was a great victory for Chipotle.  The company posted revenue of $354.5 million which was 16% higher than the first quarter last year.  Comparable stores saw sales up 2.2% annually and operating margins were 23.5% (more than 2% higher than last year).  The earnings number came in at 78 cents per share, a healthy 50% increase and management reported that there were 26 new stores opened during the quarter.

Barclays noted particular surprise at the increase in margins as management had issued guidance for a full 2% decline in margins for the full year.  But the details show that much of the margin growth was due to two things:  First there was an increase in menu prices which was initiated in Q4 2008, and secondly the marketing and promotional spending was much lower.  Management explained that the majority of marketing spending would take place in Q2 and Q3 as a new advertising campaign was kicked off.  So we can expect to see these margins contract to some degree for the rest of the year.

The menu price increase baffles me a bit.  While 2008 had management concerned over commodity price increases, that worry has largely gone away as can be seen by the decline in food costs.  But still, the menu prices remain higher than last year which likely has a negative effect on traffic.  While management has been able to make up for this fact through expense control, there is uncertainty as to how long this leverage will be available.  You can only cut costs so far before it begins to effect the way business transpires.

Chipotle is making some very sound financial decisions with its available cash.  The company has spent $50 million since October buying back class B Shares, and still has plenty of cashflow to pour into new restaurant openings.  Guidance is for an additional 120 to 130 restaurants for the full year and still at the end of the first quarter CMG had $204 million in cash on their books.  An excellent approach to debt management has certainly put CMG in an advantageous competitive position.

Despite the strong business, I am hesitant to endorse a purchase of CMG at this price.  The market has largely thrown caution to the wind, but that can only last for so long.  If we get a downdraft in the coming weeks, sellers will likely target consumer discretionary names with relatively high multiples.  This puts a target square on the back of CMG.  In fact, it may be prudent to set up a modest short position in the stock ahead of this potential scenario.  I admire Chipotle’s management, growth prospects, and food but I am uncomfortable with the price of the stock at this point.

FD: Author does not have a position in CMG
CMG Notes
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The Blackstone Group L.P. (BX) reported earnings this morning before the market opened.  While sorting through the private equity firms announcements has never been an easy task, the market quickly stamped its seal of approval and sent the stock significantly higher.  Blackstone traded up as much as 18.75% during the day before settling for an 8.2% gain at the close.  Its interesting to note that this gain is on top of the 242% increase the stock has already seen since the low it posted in late February.

So what got investors so excited today?  The company still posted a loss of $232 million and while that is less of a loss than analysts had been expecting, the difference wasn’t enough to drive such a huge move in the stock.  It wasn’t comments on the future of the company either.  According to Tony James who is the president and COO, the underlying economy continues to decline.  Management also noted that financing was tight and large scale acquisitions funded by debt were still nearly impossible.

Where does Gold Go From Here? (video)

One thing that may have caught investors attention was the fact that the company’s private equity portfolio was only marked down by 3% compared to a full 20% decrease in value last year.  Unfortunately the real estate portfolio faced a more difficult quarter and was marked down by 19% in the first quarter on top of the 30% decline in 2008.  Specifically, Blackstone continued to reel from losses surrounding its purchase of Hilton Hotels.

While the company didn’t overtly state that a turnaround was in process, there were a few subtle signs that things could finally be getting better.  The industry private equity deal flow is down 80% from last year, but management said they are considering an increasing number of potential purchases which they could pursue.  Blackstone has actually been a participant in bidding for some of the nations failed banks who are now looking for options concerning their debt settlement.  While its attempt to purchase IndyMac failed, the firm is actually one of the bidders for BankUnited and will find out soon whether its acquisition attempt was successful.

Looking a bit deeper into the numbers, it appears that the corporate private equity division turned in a profit which is particularly exciting.  I had a hard time understanding how total revenue was $47.1 million, but Blackstone as a whole generated $344.6 million in management and advisory fees.  In actuality, the Real Estate division reported negative revenue which occurred because the company had to reverse gains that were previously tied to an investment.

But the most important piece of information seemed to be largely overlooked by the mainstream media.  The company has decided to reinstate their distribution to common shareholders.  So after cutting the dividend for the fourth quarter, the picture obviously looks bright enough for management to once again pay its investors dividends.  Shareholders will receive $0.30 cents per quarter or $1.20 annually which accounts for a 10% dividend yield when using yesterday’s close.

Now this could be seen as just a way for management to transfer more of the company’s wealth to themselves (the largest shareholders) without triggering the questions that come with selling positions.  But if this argument were true, the company would likely not have cut the dividend in the fourth quarter.  I believe this move is a non-verbal clue that the company is seeing modest improvement and should regain its strength as the economy improves and liquidity begins to loosen.

The ZachStocks Growth Model has booked solid gains in this name so far this year.  Even after cutting back the position size, we still have an unrealized gain of 82% and a nearly 4% position in the stock.  (you can get your Free Trial to the model here).  At the same time, clients of Sound Counsel Investment Advisory also have a position in the name as Blackstone holds a slot on our Focus List. I believe that Blackstone offers an attractive way to benefit from what appears to be a rebounding economy.  The stock will not trade in lock-step with the overall market, but it should trade well as business conditions begin to thaw.

FD: Author has a long position in the ZachStocks Growth Model and in Sound Counsel portfolios
BX Notes
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Investors in IntercontinentalExchange, Inc. (ICE) are celebrating today after the company announced earings for the first quarter.  The data was released before the open on Tuesday and the stock began trading significantly higher prior to the open.  As the trading day continued,  buyers appeared in mass and an hour prior to the close the stock is up more than 13%.

According to the press release, the company actually saw revenue increase 12% to $232 million for the quarter while earnings per share were down a bit at $1.09.  The company’s futures division had record volume for the quarter with 63 million contracts changing hands.  At the same time, the newly acquired Creditex Group, Inc. (a wholly owned credit derivatives subsidiary) is generating quite a bit of volume and appears to have been another sharp acquisition by the management team.  Creditex actually contributed $36 million in revenue for the first quarter and could grow significantly as the credit market begin to thaw.

ZachStocks featured ICE just over a month ago when he price was trading near $85.  Our basic argument was that the advent of Credit Derivative Swap trading, along with attractive pricing power would drive earnings growth.  At the same time we mentioned that the potential for an Emissions Cap and Trade system could provide a great catalyst for additional profits.  The CDS story has begun to play out and while we are still waiting for more information on Cap and Trade, there is no reason to believe this won’t evolve into a profitable business division.

Intercontintental is actually a hometown company for me.  Although the company operates across the US and Internationally, the headquarters has remained in Atlanta Georgia.  I have had the pleasure of meeting the CEO Jeff Sprecher and have been impressed with his candid approach to shareholders, his capable approach to risk management, and his visionary leadership which has grown this small energy trading firm into a worldwide exchange for a diverse assortment of financial products.

At the end of the quarter ICE still had a very healthy balance sheet with $233 million in unrestricted cash and just $370 million in outstanding debt.  At this point, a healthy asset base leaves little need for debt reduction.  This provides management with great flexibility in determining which growth opportunities it will pursue.  The stock is also very strong and could easily be used as currency to purchase competitors.  While ICE continues to work to integrate its recent acquisitions, there should be some great opportunities for additional bolt-on purchases as trading firms struggle to hang on in this market.  ICE has proven to be opportunistic in its growth strategy so don’t be surprised to see future deals announced in the coming weeks and months.

Since hitting a low of roughly $50 earlier in the year, the stock has more than doubled (not bad for just a few months time).  We currently hold a position in the ZachStocks Growth Model which has yielded strong returns for subscribers.  (get your free 30 day trial here)  While it is tempting to take some profits off the table (and we may do so to reduce our risk), the long-term prospects for shareholders still look attractive.  ICE was able to maintain an extremely profitable business even during the most difficult financial crisis of our generation.  I believe that the opportunistic acquisitions should result in earnings that far surpass current analyst expectations.  This means that a current PE of about 24 could prove very conservative farther down the road.

There is certainly some risk that the price will consolidate in the coming few weeks, but over the course of the next few quarters I expect continued gains.  ICE is a great long-term growth position to hold as the market recovers from its current weakness.  Even if the equity markets trade lower, ICE should see trading and clearing volumes remain robust as investment programs revive and new markets are created.

FD: Author has a long options position personally and a long position in the ZachStocks Growth Model

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Being the father of twin baby girls has certainly been an adjustment!  While I have been comfortable with children all my life, and have no problem with bottles, rattles, or even diapers; the double dose has certainly put some bags under my eyes and added a few gray hairs to boot.  Still, I wouldn’t trade the world for this chance to be a Dad to my growing family…

From a financial side, children can bring similar joys and challenges.  There are certainly no shortage of miscellaneous expenses associated with raising a family but my wife tells me it is totally worth the expense to dress the twins up in all manner of matching clothes, hats, shoes, and on and on.  The grandparents think its a lot of fun too.  So do our friends – many of whom brought us great outfits at the hospital six months ago (some of which are already grown out of – hint hint…)

The bottom line is that while not completely recession proof, children’s clothiers can often be somewhat resistant to a decline in the overall economy.  My father-in-law who is a Merrill Lynch representative may roll his eyes when he gets the bill from the latest shopping spree, but the mother-in-law will still pick out her favorite pink sundresses (and will probably throw in something for the big kids too so they don’t feel left out).

Carter’s, Inc. (CRI) is one of the better known children’s apparel companies especially after its merger with OshKosh a few years ago.  The stock has been trading in a relatively healthy pattern compared to many consumer names, and recently hit a 52 week high.  Investors have been impressed with the ability of the company to maintain sales and earnings growth even during what has turned out to be a consumer led recessionary environment.

In a recent conference call, management stated that they are seeing positive trends despite the difficult retail market.  Recent debt relief measures out of Washington will take time to implement.  In the first quarter the company reported sales 8.1% higher than the same quarter last year.  Breaking out the statistics by brand, Carter’s saw 6.1% growth and the OshKosh brand actually grew by 16.6%.  Comparable store sales (an important metric for any traditional retail operation) were up 5.2% for the quarter, and I was fairly impressed to see that the company opened 7 new carters stores in the first quarter.

While growth is still the key goal for this healthy company, management is not unaware of the difficulty in today’s business environment.  A restructuring designed to cut costs has been initiated and is expected to save roughly $10 million annually once it is fully implemented.  As part of this measure, Carter’s is expected to cut 10% of their corporate workforce and consolidate some facilities that have been duplicated with the OshKosh merger.

While the earnings report was certainly encouraging, investors took profits last week and were likely a bit disappointed with the guidance given by management.  The second quarter is actually expected to see sales flat to slightly down.  This is due to a bit of weakness in the wholesale division.  In actuality, the wholesale business line had an excellent first quarter and there is some concern that first quarter orders could cut into some of the sales that would normally come in the second quarter.

Looking to the second half, management is guiding cautiously due to tough comparibles, and an economy that is difficult to predict.  The guidance is likely a bit conservative as most leaders prefer to make low promises and then over-deliver with the results.  The stock is still trading at a relatively attractive multiple due to investor concerns over the retail environment.  I expect this multiple to grow over time.  After all, this particular corner of the retail market (cute clothes for young children) should continue to draw consumer dollars providing the company offers attractive deals.  I would recommend picking up shares of this strong growth company on the weakness after the announcement.  Any economic recovery will likely have a strong effect on the stock price.

FD: Author does not have a position in CRI
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• GDP below expectations but stocks grind higher
• FOMC leaves rates unchanged – see little revocry
• Who is voting your shares – brokers lose rights
• Earnings reports drive ZachStocks names
• Stress test report due out Monday

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Stocks Mentioned:
Bank of America Corporation (BAC)
Buffalo Wild Wings (BWLD)
Verso Paper Corp. (VRS)
Netflix, Inc. (NFLX)
VMware, Inc. (VMW)

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Wall Street is littered with cliche statements aimed at imparting subtle wisdom.

• Markets climb a “wall of worry” and usually slide down a “slope of hope.”
• Bulls make money, Bears make money, but pigs get slaughtered
• Cut your losses and let winners run

And today’s most applicable statement is to Sell in May and Go Away.  The statement basically comes from statistical studies which have proven the “October to May” period to have stronger gains than the Summer doldrums.  There are plenty of explanations for this…  The wall street brokers may spend the summer relaxing in the Hampton’s instead of calling prospects.  Investors may use more capital for leisure than for investments.  Or it may be that businesses grow more quickly in winter months as managers hunker down and get work done.

The main question to us as investors is whether to just take the summer off, or stay involved in the markets?  Now believe me, I would love to spend the summer pushing the twins around in the stroller and watching Braves games with my 9-year old.  But honestly, with a little discipline and foresight, this summer could turn out to be one of the most profitable times for us here at ZachStocks.  The following are some themes which will likely shape the character of our markets in the coming months:

Alternative Energy

We have been a bit early to the party with this sector.  Unfortunately, the global economic crisis put the need for alternative energy solutions on the back burner as governments struggled to prop up financial systems which were in danger of crashing.  But whether the recovery comes quickly, or takes a process of several quarters, the focus will likely return to this important investment category.

Alternative energy has the benefit of being backed from not just an economic standpoint, but also from a political and social perspective.  The Obama administration still expects to create a significant number of “green collar” jobs as initiatives for wind, solar, and other alternative power are put into place.  Across the globe, governments are requiring stricter emissions regulation and generating more electricity from sources other than fossil fuel.

This past week, First Solar, Inc. (FSLR) reported that costs are decreasing to a point where it makes much more economical sense to install solar panels for energy consumption.  The stock ran up sharply, and optimism is beginning to spread to other stocks trading in the same or similar industries.  This summer I expect attention to revert back to alternative energy both politically as well as economically.

Investment names to consider in the alternative energy names include First Solar, Inc. (FSLR); LDK Solar Co., Ltd (LDK); Yingli Green Energy Hold. Co. Ltd. (YGE) and Energy Conversion Device (ENER).  (The ZachStocks Growth Model holds a position in FSLR, LDK and YGE).  We are currently offering a free 30 day trial to the model.

Inflation

It should come as no surprise that with the government printing massive amounts of paper currency to shore up bank’s balance sheets and bail out failed businesses, that this currency will eventually lose some of its value.  Now up to this point, the lack of economic growth has saved us as the dollars have been used simply to pay down loans or take a debt consolidation instead of stoke an economic recovery.

But looking further down the road, inflation is certainly a concern and could become disastrous if the Fed continues to run the presses at breakneck speed.  As investors (and really as consumers, workers and citizens) we want to protect the spending power of our wealth much more than just the dollar amount of our savings.  This will likely become more difficult in the coming months once some economic stability is seen.

In order to combat inflation, the best course of action is to own “stuff” that retains its value regardless of what currencies are doing.  Now it may not be feasible for you to load up your basement with grains, stuff gold under the mattress, and stockpile guns in your attic (I’m not sure I really agree that things will be that bad), but there are some investment decisions that can be made which can protect your spending power, and quite possibly increase your real wealth over the coming months.

Precious metals come to mind first and if you have a plain vanilla brokerage account it is very easy to invest in GLD and SLV (ETF’s which trade in lockstep with Gold and Silver prices).  You can also own an ETF geared toward agricultural commodities such as DBA.  Finally, I think an investment in Intrepid Potash, Inc. (IPI) could lead to out-sized gains as agricultural producers look to Potash fertilizer as a way to increase yields. (The ZachStocks Growth Model also holds a position in IPI)

Growth At a Reasonable Price

Growth At a Reasonable Price (or GARP) is an over-used phrase on Wall Street.  The idea is that growth stocks are only attractive if you don’t have to pay out the nose to own them.  It can be extremely disappointing to find a company that is performing exceptionally well, and then realize that to own them you must pay 45 times earnings.  There are times when buying growth stocks at nearly any price can yield strong trading gains.  But in today’s market, buying at inflated prices is just asking for trouble.

Despite the sour mood carried by many growth stock investors, I have actually found quite a few attractive opportunities with reasonable prices.  The key is understanding exactly what forces are driving long-term growth, and figuring out the variables that could represent risk.  Once you have a clear understanding of how a particular business works, what the long-term plans are, and what challenges could get in the way; you have the necessary pieces to develop a simple reward to risk ratio.  High stock prices by nature beef up the risk side, so it is important to either buy low, or have a very strong outlook for the long-term prospects.

Lately we have been able to pick up several quality growth stocks at attractive prices.  Some names that we have discussed here at ZachStocks include Amedisys, Inc. (AMED), Allegiant Travel Company (ALGT), and First Cash Financial Services, Inc. (FCFS).  (the ZachStocks Growth Model has positions in all three of these names).  More opportunities will undoubtedly arise both as a function of prices being pushed lower as well as companies showing unexpected growth.

Consumer Underperformance

The final theme for this summer carries a more disappointing tone.  Regardless of when the eventual economic recovery occurs, consumers have been shell-shocked and will not be quick to discount the lessons learned in the past 12 months.  Over-leveraged personal balance sheets have left many in an uncomfortable financial position.  Families who lived paycheck to paycheck , found out just how risky this lifestyle is when they lost part or all of their regular income.

So even as the government creates jobs and desperately tries to stimulate economic activity, the average consumer is likely to begin increasing the amount of money put towards saving or paying off debt.  While this activity will likely yield tremendous strength in years to come, it can be very difficult for companies who currently rely on consumer spending to keep them in business.

We have outlined several short opportunities in the past few weeks which have the potential to trade sharply lower due to their high price and questionable growth in this weak environment.  Consumer specific names include Buffalo Wild Wings (BWLD), Rosetta Stone Inc. (RST) and American Public Education, Inc. (APEI).

In conclusion, this summer should offer some exceptional opportunities for traders and investors alike.  The key is to operate a disciplined approach and pay close attention to how trends are progressing.  Buying inflated prices is dangerous, but opportunities exist in sectors that many consider non-traditional or overlooked.

I’m looking forward to serving you throughout the summer!
Zachary Scheidt
Sound Counsel Investment Advisors

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