Limited Brands Reports Q3 results

I will begin this post by saying I don’t understand the shopping mall experience. Perhaps because of my gender, I just don’t understand why people, usually women, like to “go shopping”.

However, I can understand what goes before my eyes, and that is people shop. I might not understand fashion retail, but I understand the economics of it – something about the marketing works. It gets people to pay more for a product that inherently has very low marginal cost to purchase. The embedded marketing costs, however, are huge.

Earlier this year, I invested in some corporate debt of Limited Brands (NYSE: LTD) – the 2033 series of debentures, which has a coupon of 6.95%. Investors back then assumed that retail was going to get thrown out the window along with the rest of the economy and especially for a discretionary retail shop like Limited Brands (their primary brand name is Victoria’s Secret), droves of people would be not shopping for lingerie. Or will they? According to their last quarterly report, they are on track to bringing in about $500-600M in free cash flow, depending on how the Christmas season works out.

For 35 cents on the dollar, I figured that the debt would be a good buy. It was tough to rationalize how being rewarded 20% interest a year (plus another 4% capital appreciation) under the assumption that Limited Brands would not blow up could lose money. And indeed, it has not lost capital – the same debt is trading for around 71 cents if you shop around carefully. This will still net you 10% a year in coupon payments, and about 1.5% a year capital appreciation compounded over the next 23.8 years.

If you look at their balance sheet, they have about $2.9 billion in debt, covered by $968M in cash, and positive earnings. Although I have no idea whether the retail chain over the next 23.8 years will survive, at least right now it is looking quite good.  The following is the debt maturity schedule from the Q2-2009 SEC filing, which shows they have staggered out their debt financing fairly well:

15. Long-term Debt

The following table provides the Company’s long-term debt balance as of May 2, 2009, January 31, 2009 and May 3, 2008:

May 2,
2009		 January 31,
2009		 May 3,
2008
(in millions)
Term Loan due August 2012. Variable Interest Rate of 5.18% as of May 2, 2009 $ 750 $ 750 $ 750
$700 million, 6.90% Fixed Interest Rate Notes due July 2017, Less Unamortized Discount 698 698 698
$500 million, 5.25% Fixed Interest Rate Notes due November 2014, Less Unamortized Discount 499 499 499
$350 million, 6.95% Fixed Interest Rate Debentures due March 2033, Less Unamortized Discount 350 350 350
$300 million, 7.60% Fixed Interest Rate Notes due July 2037, Less Unamortized Discount 299 299 299
$300 million, 6.125% Fixed Interest Rate Notes due December 2012, Less Unamortized Discount 299 299 299
Credit Facility due January 2010 — — 15
5.30% Mortgage due August 2010 2 2 2
Total 2,897 2,897 2,912
Current Portion of Long-term Debt — — (7 )
Total Long-term Debt, Net of Current Portion $ 2,897 $ 2,897 $ 2,905

Another similar corporation that is debt-free is Abercrombie and Fitch (NYSE: ANF), which seems to defy everybody’s expectations during recessions by coming back from the financial netherworld to make insane amounts of money. I can see the appeal of Victoria’s Secret – sex sells – but Abercrombie? When walking into the two stores to do some ‘consumer research’, I just don’t understand what keeps these names afloat in the retail fashion world.

However, I can at least invest and make some cash off of it while the going is good. Will I know when it is time to liquidate? Who knows.

August 2009 Fiscal Monitor Released

The Ministry of Finance released the August 2009 Fiscal Monitor today, which is the best at-a-glance fiscal picture of Canada. I covered the July month in a previous post.

The extra month of data continues to print a grim picture – while personal income taxes in the five months between April and August have dropped about 5% (and this does not account for the fact that the government has been reducing income taxes by increasing the basic rate and also increasing the lower two income thresholds in the previous federal budget), corporate taxes continue to fall off a cliff, down 37% in the equivalent period. Only 2% of that is explained by the small decrease in the corporate tax rate between periods.

On the consumer spending side, GST collections actually increased 6% on a month-to-month basis (which is relatively surprising), but the net collections over the five month period has been down about 20%.

Unemployment insurance benefit payments, another barometer of job loss, is up 54% over the equivalent 5 month period last year.

The total fiscal deficit for the 5 month period is $23.7 billion dollars, which if extrapolated, will suggest a total deficit for the fiscal year of approximately $57 billion.

The two take-home messages of this report is that corporate profits in Canada have dropped dramatically; paradoxically, the phased in reductions in income tax that will occur over the next few years (19% to 18% effective 2010; 18% to 16.5% effective 2011; and 16.5% to 15% effective 2012) will have less of an impact and will likely cause more investment to come into the country. The other message is that personal income tax collection seems to be down slightly, but unemployment is rising, but people continue to spend. It makes one wonder how much of a pool of savings there is for people to draw on when they are not working.

Inevitably, Canada’s fiscal situation is stronger than in the USA. If Canada were running deficits equivalent to the level of the USA’s economic output, we would be on track to run a $180 billion deficit for fiscal 2010.