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Bill Rempel on Bon-Ton Stores

(Guest Commentary by Bill Rempel – April 29, 2007)

Dear Subscribers and Readers,

As I am writing this, the Shanghai Composite is up 2% to another all-time high – despite the People's Bank of China increasing the required reserves ratio by another 0.5% to 11.0%.  The speculation in China is now getting red hot – although just like all other bubbles, it can and will go on for longer than anyone things.  Moreover, the Chinese market is only approximately 10% the size (in terms of market cap) of the U.S. market – suggesting that any additional liquidity flowing into the market (whether it is domestic or foreign in nature) could yet mean a significantly higher market over the next few months.

In the meantime, I urge our readers to continue to keep an eye on the Chinese market – as any spillover effects from even a correction could have serious implications, especially since the Yen carry trade is again getting stretched (as measured by the Pound/Yen and the Euro/Yen ratios).

As I mentioned in our mid-week commentary, I am currently away on a business trip – to Quincy, Illinois, of all places.  I also apologize for not responding diligently to my emails recently.  I will definitely back to all you guys sometime this week!  Because of my weekend commitment, I did not have time to write a full-blown commentary this weekend.  Instead, I have ask Bill Rempel (of – one of our regular guest commentators to fill in for me this weekend.  For those who like to keep track of the Dow Industrials vs. the Dow Transports – along with our sentiment indicators – you do not need to worry.  Just like the format of our last weekend's guest commentary, I will comment on those (and you will see our usual charts as well) after Bill's writings in this commentary.

Let us now begin will Bill's commentary.  In this commentary, Bill will be discussing his thoughts on Bon-Ton stores (BONT) – focusing on its valuations (absolute and relative to other stores in the industry) as well as a “red flag” in terms of its corporate governance.  Without further ado, following is a biography of Bill:

Bill Rempel (aka nodoodahs) is an active poster on the MarketThoughts forum as well as a few others around the web. Bill is a regular, monthly guest commentator on our website (see “Seeing the Forest for the Trees” for his last guest commentary). Bill graduated from Caddo Magnet High School (a high school for nerds) back in 1985 and proceeded to learn the hard way when he drank his way out of a scholarship to Tulane later that year. After a few years of sweating for a living, he decided to go back to school, and graduated from LSU-Shreveport in 1995 with a Bachelors in Mathematics - all the while working the overnight shift stocking shelves in a grocery store.

Post-college, Bill has been in the P&C insurance industry as an actuary, product manager, and pricing manager. Bill and his wife Millie are amateur investors with a variety of holdings, but they prefer to buy and hold value investments. In typical "value" style, they live cheap, driving old cars and preferring to save or invest instead of buying fancy "stuff."

Disclaimer: This commentary is solely meant for education purposes and is not intended as investment advice.  Please note that the opinions expressed in this commentary are those of the individual author and do not necessarily represent the opinion of MarketThoughts LLC or its management.

While I usually reserve this column for traditional value stocks, every so often something catches my eye and I feel the need to write about it.  In this case, it's a stock that came to me from my GARP (Growth At a Reasonable Price) screener, Bon-Ton Stores (BONT).

BONT claims to be one of the largest regional department store operators in terms of sales in the United States, selling their assortment of brand-name fashion apparel, cosmetics, home furnishings and other goods through 279 stores in mid-size and metropolitan markets in 23 states.  Women's apparel makes up about a quarter of sales, and has been holding steady.  Home goods are the second-leading category, and men's apparel and cosmetics are the third- and fourth-largest categories, making up a quarter of sales combined.  The brands they sell are what might be called mid-to-upper-level luxury, such as Coach, Liz Claiborne, Calvin Klein, Waterford, etc.  Their private brands shoot for the same benchmark.  The target customer group is women between the ages of 35 and 60 with annual household incomes of $55,000 to $125,000.  The "Services / Department Stores" industry is tough, with a lot of cross-competition.

A year ago, Bon-Ton Stores purchased Carson's and, so far, they seem to be doing a good job of integration. The current Vice Chairman and President of Merchandising is a Carson's acquisition, for example.  The incremental changes in integration expense may be a driver for future earnings growth.  Maybe.  There may also be important gains in purchasing power from suppliers, they kept a good portion of the merchandising staff from Carson's, and this acquisition added to the private brand portfolio.  Acquisition problems or benefits will be the driver of downside or upside surprises in earnings for the next year or more.  BONT expects to spend over $100 million in 2007 for capex, including store remodeling, two new stores, two store closures, and three store expansions.  This is a significant amount of capex for a company with a $900 million market cap.  They own very few of their store locations.  Another item to watch is foreign currency exchange rates, as BONT sells in the U.S. and reckons their earnings in dollars, but many of the goods they sell are imported.

A person to watch is Tim Grumbacher, the executive chair of the Board of Directors.  Basically he controls 63% of the voting shares of the stock, making the company essentially a family affair.  Institutional Shareholder Services gives Bon-Ton Stores a very poor grade, and for good reasons.  This is a company with two-tier stock, always a red flag for governance, and the common gets one vote per share while the Class A gets ten votes per share.  There are only four shareholders of record for the Class A shares, by the way, and they do not trade, but can be converted on a one-for-one to the common.  At least the two classes get the same dividend, but the yield is so small as to be meaningless to most investors.  They have various anti-takeover actions in place and as a Pennsylvania corporation they have additional anti-takeover ammunition. 

As I mentioned, this stock meets GARP criteria as follows:

Criteria BONT Value Ranking
P/E (TTM Intraday):Greater than 5, Less than 30 18.6 N/A
EPS Gwth. (Last Qtr. vs. Same Qtr. Prior Yr):Highest 20% 126.1% 93%
Rev. Growth (Last TTM vs. Prior TTM):Highest 20% 164.3% 97%
Rev. Gwth. (Last Qtr. vs. Same Qtr. Prior Yr):Highest 20% 168.4% 96%
Price Perf. (Last 52 Wk):Highest 40% 86.1% 96%
EPS Growth (Last TTM vs. Prior TTM):Highest 20% 72.9% 80%

Additionally, the insiders are net buyers of the stock, with a 10% owner, Trafelet Capital Management, buying even more shares in the past few months.

The idea of GARP is not that the stock is necessarily cheap, but is cheap for its given amount of growth.  Per Yahoo data, this stock doesn't look unreasonable, and given the amount of share price growth, it could be said to be relatively cheap.

Market Cap (intraday): 903.19M

Enterprise Value (29-Apr-07): 2.08B

Trailing P/E (ttm, intraday): 18.62

Forward P/E (fye 03-Feb-09): 11.12

PEG Ratio (5 yr expected): 0.82

Price/Sales (ttm): 0.27

Price/Book (mrq): 2.59

The above, including the sub 1.0 PEG, is for a company with a 9% ROA and a roughly 15% ROE.  The major fundamental screening flag is the very high Debt/Equity of 3.46, due primarily to the financing taken out for the acquisition in 2006.  A metric that would bear watching is the interest coverage, now at a multi-year low.

On a P/E basis, BONT is in line with the industry (18.3).  On a P/B basis, it is cheap to the industry (4.0).  The LT Debt/Equity is high compared to the industry (0.5).  Dillard's (DDS) and Saks (SKS – from whom they bought Carson's) are both three times as large as Bon-Ton and are after some of the same customers.  However, Saks is projected to get 8% annualized EPS growth over the next five years, with a PEG over 3, and Dillard's is projected at 6% with a PEG of about 2.5, whereas Bon-Ton is looking at 13.5% and a PEG under 1.0. 

As you might expect for a company with this much recent earnings growth, the chart looks stretched.

BONT (Bon-Ton Stores, Inc.)

Here it is on the weekly scale.

BONT (Bon-Ton Stores, Inc.)

I have no current position in Bon-Ton Stores, and I am not sure that it fits into my portfolio at the moment, or that this is the right time to buy.  It does look interesting to me, and just recently appeared on my screeners for potential longs, so I thought it would make a good subject for examination.

Bill, thanks for your guest commentary on Bon-Ton Stores.  Anyway, without further ado, this author would now like to continue on with the rest of our commentary.  Before we do so, however, let us do an update on the two most recent signals in our DJIA Timing System:

1st signal entered: 50% long position on September 7th at 11,385, giving us a gain of 1,735.94 points

2nd signal entered: Additional 50% long position on September 25th at 11,505 giving us a gain of 1,615.94 points

Let us now discuss the most recent action in the U.S. stock market via the Dow Theory.  Following is the most recent action of the Dow Industrials vs. the Dow Transports, as shown by the following chart from October 1, 2003 to the present:

Daily Closes of the Dow Jones Industrials vs. the Dow Jones Transports (October 1, 2003 to April 27, 2007) - Over the last week, the Dow Industrials rose to another all-time high - rising 158.96 points. Meanwhile, the Dow Transports diverged - declining 83.47 points, implying a Dow non-confirmation. Such a non-confirmation is definitely ominous, as it is coming in the midst of an overbought condition in the major market indices around the world, as well as stretched valuations in the Chinese stock market and the severly oversold condition of the Japanese Yen. Don't be surprised if we witness a correction sometime this week. However, the internals of the market and most of the world's stock markets continued to remain healthy, and thus the intermediate term trend remains up. For now, we will remain 100% long in our DJIA Timing System, although we will most likely trim down our position if the Dow continues to power higher this week. Readers please stay tuned.

For the week ending April 27, 2007, the Dow Industrials rose 158.96 points while the Dow Transports actually declined 83.47 points – resulting in an ominous Dow Theory non-confirmation.  Usually, a one-week non-confirmation is of not much concern to us, but the current non-confirmation is slightly different, as I mentioned in the above chart.  For one thing, the seasonally strong month of April is now ending.  The tailwind of quarterly contributions from calendar-year DB pension plans that were due on April 16th (which had been supportive for the stock market) is no longer with us.  Moreover – in a couple of weeks – many of the insiders which had been prevented from dumping shares onto the stock market because of restrictions during earnings season will be able to start selling.  More ominously, this non-confirmation is also coming in the midst of:

  1. An overbought condition not only in the Dow Industrials and the S&P 500, but in most of the world's major market indices as well.

  2. A highly overbought condition in the Chinese stock market, as exemplified by the Shanghai Composite Index.  As a matter of fact, one can most probably state that the Shanghai Composite is now in the blow-off stage.

  3. A Yen carry trade that is very overstretched no matter how you measure it.

For now, however, the combination of this and the continued strength in the internals of the stock market (as the A/D lines of the NYSE Common Stocks only Index continue to make all-time highs last week) suggest that we have not seen the top of the stock market just yet, but should the Dow Industrials rise another 2% to 5% in the coming week, then we will most likely trim down our 100% long position in our DJIA Timing System.  For now, we remain 100% long in our DJIA Timing System.

I will now continue our commentary with a quick discussion of our popular sentiment indicators – those being the bulls-bears percentages of the American Association of Individual Investors (AAII), the Investors Intelligence, and the Market Vane's Bullish Consensus Surveys.  The latest four-week moving average of these sentiment indicators decreased from last week's 24.8% to 24.4% for the week ending April 27, 2007.  Following is a weekly chart showing the four-week moving average of the Market Vane, AAII, and the Investors Intelligence Survey Bulls-Bears% Differentials from January 1997 to the present week:

Average (Four-Week Smoothed) of Market Vane, AAII, and Investors Intelligence Bulls-Bears% Differentials (January 1997 to Present) - For the week ending April 27, 2007, the four-week MA of the combined Bulls-Bears% Differentials decreased from 24.8% to 24.4%, consolidating the somewhat overbought reading of last week. While the four-week MA is not very overbought, we will most probably trim down our 100% long position in our DJIA Timing System should this spike up this week. For now, however, the intermediate term trend remains up.

With the latest non-confirmation of the Dow Industrials on the upside by the Dow Transports, I am now skeptical of any further rallies in the market this week – especially if we “spike higher” by 2% to 5% over the next five trading days.  Sure, we haven't really seen much deterioration in the market internals just yet – but in today's globalized, just looking at U.S. market internals isn't sufficient, especially in the short-run.  While U.S. internals suggest that a significant top is most probably at least three to four months away, this author would not hesitate trimming down our 100% long position in our DJIA Timing System in the short-run – especially if we see a quick upside spike in investor's sentiment over the next week or so.

I will now close out our commentary by discussing the latest readings of the ISE Sentiment Index.  For newer subscribers, I want to again provide an explanation of ISE Sentiment Index and why it has turned out to be (and should continue to be) a useful sentiment indicator going forward.  Quoting the International Securities Exchange website: The ISE Sentiment Index (ISEE) is designed to show how investors view stock prices. The ISEE only measures opening long customer transactions on ISE. Transactions made by market makers and firms are not included in ISEE because they are not considered representative of market sentiment due to the often specialized nature of those transactions. Customer transactions, meanwhile, are often thought to best represent market sentiment because customers, which include individual investors, often buy call and put options to express their sentiment toward a particular stock.

When the daily reading is above 100, it means that more customers have been buying call options than put options, while a reading below 100 means more customers have been buying puts than calls.  As noted in the above paragraph, the ISEE only measures transactions initiated by retail investors – and not transactions initiated by market makers or firms.  This makes the indicator a perfect contrarian indicator for the stock market, and it has had a great track record so far according to the following Wall Street Journal article.  Following is the 20-day and 50-day moving average of the ISE Sentiment Index vs. the daily S&P 500 from October 28, 2002 to the present:

ISE Sentiment vs. S&P 500 (October 28, 2002 to Present) - The 20 DMA of the ISE Sentiment bottomed at a reading of 98.5 on March 21st (representing the lowest reading since the 97.6 reading on October 30, 2002) and has since bounced back to a reading of 124.2 as of last Friday. Meanwhile, the 50 DMA finally turned up in the latest week, rising from 112.2 to 113.9.  A rising 50 DMA has generally been bullish for stock prices - especially after coming off such an oversold reading. Again, this author currently do not see a significant top in the stock market until July/August at the earliest - although we will definitely be open-minded to trimming down our position should the S&P 500 rally 2% to 5% over the next week or so.

While the 20-day moving average of the ISE Sentiment (at a current reading of 124.2) is nowhere near overbought levels, its rally from a reading of 98.5 on March 21st (representing the most oversold reading since a reading of 97.6 at the close on October 30, 2002) is most probably getting “long in the tooth” in the short-run.  Should we see a spike in the ISE Sentiment readings sometime this week (preferably a one-day reading of over 200) – then we will not hesitate trimming down our 100% long position in our DJIA Timing System.  In the longer-run, however, the rising 50 DMA suggests that the bull market is not over yet.

Conclusion: Again, please do not hesitate to email Bill or post a question in our discussion forum should you have any questions about Bill's latest guest commentary on Bon-Ton Stores.  Going forward, we will continue to keep watch on the company – and hopefully get a good entry point over the next few months.  As for the U.S. stock market, we will continue to remain 100% invested in our DJIA Timing System, but as I have mentioned before – the latest non-confirmation in the popular Dow indices is now a significant red flag.  Should the Dow Industrials or the S&P 500 spike higher by 2% to 5% over the next five trading days (preferably accompanied by a spike in our sentiment indicators or the ISE Sentiment Index) – then we will most probably trim down our 100% long position in our DJIA Timing System.  Subscribers please stay tuned.  As always, we will send out a real-time email alert to our subscribers should we decide to trim our long position in our DJIA Timing System.

Signing off,

Henry To, CFA

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