Archive: July, 2006

Diversity is Tur-key at Semiconductor Companies

Barron’s says the price war between Intel and AMD (our discussion here) should send investors to more broadly diversified (less PC-oriented) semiconductor stocks.
With semiconductor stocks, diversity is key-Barron’s |

A price war between chipmakers Intel Corp. (INTC - Annual Report) and Advanced Micro Devices Inc. (AMD - Annual Report) highlights a slowdown in the PC market and investors intent on the semiconductor industry might do well to consider shares in companies with more diversified revenue streams, Barron’s financial newspaper reported on Sunday.

Diversity is seldom what you should seek in semiconductors. Typically you want pure-play exposure to an end market that is working. If there are no end markets that are clearly working, you may just want to avoid the semis altogether.

Disclosure: William Trent has a long position in SMH.

Topics: Advanced Micro Devices (AMD), Intel (INTC), Semiconductors, Stock Market | No Comments

LCD Market

The good news is that companies are seeing the light and cutting back on planned capacity expansions.

CMO to delay equipment installation at 8G plant, say sourcesFurthermore, the lower prices are starting to spur some demand. On their recent earnings conference call, tech reseller CDW Corporation said:

Continuing the recent trend, average selling prices of large format LCD monitors have declined significantly year over year. The more affordable prices havedriven unit volume.

The bad news is that some manufacturers continue to pour on the capacity. Sharp will invest 500 billion yen (about US4.26 billion) to build a tenth-generation (10G) TFT LCD plant, with construction to begin in the third quarter of 2007 and volume production to begin in mid-2008, according to the Japanese-language Nihon Keizai Shimbun. The plant will process 2,850×3,050mm glass substrates into eight 57-inch panels or six 65-inch panels.

Prices are now expected to fall a further 25% by year-end for some categories:

The ASP (average selling price) for a sixth-generation (6G) substrate is expected to drop to 14,000-15,000 yen (US$119-128) by year-end, according to the Chinese-language Economic Daily News (EDN).

First-tier makers are now offering prices for a 6G substrate at 20,000-19,000 yen while prices from second-tier makers are about 22,000-23,000 yen, the paper indicated citing sources as saying.

Other news:

The currently tight supply of 19-inch monitor panels will ease by September, when supply will have increased at panel makers, according to assistant general manager Gatti Park at LG Taiwan, as quoted by the Chinese-language Apple Daily.

Samsung Electronics sustained profitability for its LCD division in the second quarter despite weak LCD TV sales, inventory pile-ups and an ASP (average selling price) reduction while LG.Philips LCD turned to losses during the period. There are several factors that contributed to Samsung’s success, including an earlier ramp up at its seven-generation (7G) LCD plants and strong support from downstream LCD TV brands.

Taiwan liquid crystal display panel maker AU Optronics Corp. said its second quarter net profit dropped nearly two-thirds because of steep price declines.

Topics: CDW Corp (CDWC), Corning (GLW), Stock Market, Technology | 1 Comment

Digging Into GDP

Contributions.gifThe market rallied on Friday on news that the economy was weaker than expected, with all of the convoluted logic about the fed pausing on rate hikes and blah-de-blah. Far be it from us to take away the punchbowl. Yet, as often is the case, actually reading through the data yielded some interesting insights.

Consider the chart, which breaks the GDP number into its four main constituents: consumer (personal consumption), business (PDI), trade (net exports) and government spending.

The second quarter marked only the second time (though there were some close calls) that all four constituents had a positive impact. However, in one way that tidbit shows just how weak the economy has become. The last time we fired on all four cylinders, GDP grew at an annualized rate of more than 7 percent. This time it got us 2.5 percent.

The second thing we want to touch on is the maxim we keep hearing about how business will take over when the consumer tires out. Let’s face it: all of the other categories have, at least for one quarter, been a drag on GDP within the last four years. It seems reasonable to believe that the consumer may take a turn resting. As has been the case when other components failed to pull their share, isn’t it possible that total GDP could come in at a reasonable number – say 3 percent?
The problem here is one of magnitude.  In the second quarter, total GDP was a little more than $13 trillion. In round numbers, $9 trillion of that was consumer, business and government put in a little more than $2 trillion each, and net exports took that “little over” back by being negative (they had a positive impact on GDP because they were slightly less negative than they were last quarter.)

So now let’s do the math, and assume that consumers spends 1 percent less than they did last year. That creates a $90 billion drag the others need to make up. But if we want the whole pie to grow 3 percent, that is $390 billion that needs to be added to GDP overall, plus the $90 that needs to be made up equals $480 billion. That would mean business and government each growing 10 percent, or one of them growing 20 percent. It just doesn’t seem all that likely.

There is one wild card, and that is net exports. If we made the assumption that consumers only bought less foreign goods, then the personal consumption would be neutral to GDP rather than a drag. But even in that optimistic (unless you are an importer) case business and government would have to grow faster than 8 percent each for the economy to grow 3 percent overall in the face of flat consumer spending.

Topics: Economy, Stock Market | 1 Comment

The Watch List This Week (July 23-29, 2006)

Performance1.gifThe Watch List has consistently performed slightly better than the small and mid-cap benchmarks that are the best comparison for it. Of course, the limited history (the small/midcap benchmarks have generally been falling) may simply indicate that it is a more conservative/defensive portfolio. The true test will be its relative performance in a market rally.
Interestingly, large caps are up month to date. Would never have guessed it with the general gloom and doom we’ve been hearing, but it is what it is.
We will also be tracking the performance of our personal portfolio going forward. Ideally, what we would want to see is the Watch List beating the benchmarks and our portfolio beating the Watch List.  That scenario would mean that our process for narrowing down the  10,000 stock universe to 100 names is adding value, and also that we have skill at picking from among the available names.
Given that the performance of the Watch List seems clearly tied to the performance of small/mid-cap names, we are considering creating a separate large-cap Watch List. If you have any thoughts on this or how we should present this type of information going forward (more stocks, fewer stocks, separate lists or all together) please let us know in the comments.
Topics: Stock Market | No Comments

To Your Health

Summary: Rising costs harpooned the HMOs, but could have been foreseen by looking at the detailed PPI data.
In the latest Value Line Industry Survey on the drug industry they say:

The major pharmaceutical companies that dominate the Drug Industry will report June-quarter results over the next few weeks. Year-over-year comparisons are likely to be generally unexciting, primarily reflecting pressures on the top line from significant patent expirations and the resulting assault from generic competition. The silver lining in the drug sector’s multiyear descent, however, are valuations that have reached extraordinarily low levels, from which the downside risk appears manageably low and the dividend yield temptingly high.

Click here to sign up for Value Line Investment Survey’s 13-week Trial (Affiliate link)

The New York Times says the pharmaceutical industry is beginning to reap a windfall from a surprisingly lucrative niche market: drugs for poor people.

PPI data shows that hospital costs are rising faster:HospitalPPI.gif

As are pharmaceutical costs: More »

Topics: Healthcare, Johnson & Johnson (JNJ), Stock Market | No Comments

Getting Defensive

defenseaircraft.gifIn reviewing yesterday’s Durable Goods report, one segment jumped out at us: Defense aircraft and parts. A look at the table to the right, which presents the year/year change in shipments, orders, inventories and backlog shows that something interesting may be going on.

Shipments have been poking along at barely above last year’s numbers (and actually below last year in June.) The lag from orders to shipments can be extended in aircraft (less so for parts) so the decline in orders from April was a predecessor to June’s decline in shipments. This was also foretold in the stock prices, which peaked in March (ahead of the rest of the market) and in most cases have not fully recovered.
So what has happened to orders since April? They have been rising at an accelerating pace. Our bet is – you guessed it – defense aircraft and aircraft parts should have strong shipments ahead. Meanwhile, the performance of related stocks has been mixed this year. Names worth researching include L-3 Communications, Rockwell Collins, Precision Castparts, Boeing, Lockheed Martin and Teledyne.

Topics: Stock Market | No Comments

Back to Basics

Summary: Higher prices are leading to increased production, but not enough to offset demand.
Value Line says the following in their latest Metals & Mining Industry Survey:

Thanks to good recent price and earnings momentum, the Metals & Mining (Diversified) Industry continues to be ranked near the top of all the industries covered by Value Line in terms of Timeliness. Equities of companies here, however, have not been immune to the considerable volatility that the stock market has experienced thus far in 2006, arising partly from fears that record oil prices will spark a pickup in inflation and ultimately damage the economy. The Metals & Mining Industry, though, has tended to perform better than many other sectors, supported mainly by strong commodity prices. Another contributing factor has been heightened merger activity, as managements are hoping that the current industry up-cycle will last longer than previous ones, given the rise of China, India, and other developing nations. That said, several issues here are good selections for relative price action for the coming six to 12 months.

Click here to sign up for Value Line Investment Survey’s 13-week Trial (Affiliate link)

PPI data showed that pricing remains strong for most of the basic materials.


Inorganic chemicals:


Organic chemicals bucked the trend: OrganicChemicalPPI.gif
But steel looks like it may be rising again (right). SteelPPI.gif

Zinc shortfall was 120,000 t short of demand for the first five months of the year, because of higher consumption of the metal used to galvanize steel, the International Lead and Zinc Study Group said.

Watch List Companies

Freeport-McMoRan Copper & Gold Inc. (FCX - Annual Report) reported second-quarter profit more than doubled, as higher prices helped offset a shortfall in copper production at its vast Grasberg mine in Indonesia. Net earnings jumped to $367.3 million, or $1.74 per share, from $175 million, or 91 cents, in the same quarter of 2005. In June, Freeport said copper production at Grasberg would be below estimates because of an unusual amount of clay in the section being mined. Glamis Gold Ltd. (GLG) finalized an agreement with the Guatemalan Government to begin payment of income tax effective July 1, 2006. The temporary exemption from the payment of income tax would have expired at the end of 2007. The earlier payment of the income tax will accelerate improvements to services and infrastructure in areas near the Marlin Mine and complement the employment and economic benefits currently being provided (2005 activity details can be found on the Glamis website under Properties-Marlin-Reports/Technical Items-2005 AMR). The funds will also be used for increased capacity building within government ministries with mining responsibilites. Assuming $600 gold and $10 silver prices the income tax will be approximately $4.8 million in 2006 and $10 million in 2007 based on current production guidance. Sasol, Solidarity reach deal, three-day strike ends

Other News 

Xstrata of Switzerland said it would increase its all-cash bid for the Canadian mining company Falconbridge a second time, by 7.2 percent, to 19.2 billion Canadian dollars ($16.9 billion).World No. 2 gold miner Newmont’s output will be slightly down in 2006 and 2007 before it begins to rise in 2008, CEO Wayne Murdy said, adding that he expected gold prices to remain strong for years. Palamin reports 8% rise in H1 copper production Falconbridge 2Q Copper Output Up 6% At 107,500 Tons BHP’s carbon-steel materials unit, which produces iron ore, coking coal and manganese, was the largest contributor to earnings in the six months ended December, earning $2.3 billion, or 34 percent of total pretax profit. Iron ore output has fallen for two straight quarters for BHP before this one, partly due to wet weather and as its expansion works limit production. Copper production rose 16 percent to 311,700 tons in the three months ended June 30, it said. Nickel output rose 31 percent to 41,600 tons. Its metals production rose as last year’s A$9.2 billion ($6.9 billion) acquisition of WMC Resources Ltd. made BHP the world’s third-largest nickel producer and one of the biggest copper producers.

Teck Cominco reports record net earnings of $613 million for the second quarter

Inco produced 140 million pounds of nickel during the quarter, which was 26% higher than a year-earlier production. Cash cost of sales for nickel unit, after by-product credits was well below at US$2.08 per pound, 26% lower from costs for prior-year quarter.

Global miner Rio Tinto Ltd has boosted its iron ore production to record levels, after fighting back from a cyclone-affected first quarter to take full advantage of a recent iron ore price hike. The miner produced 33.32 million tonnes of iron ore in the second quarter, up four per cent on the previous corresponding period.

Disclosure: Author is long STREETTRACKS GOLD (GLD) at time of publication.

Topics: Basic Materials, Freeport McMoRan (FCX), GLG, Newmont Mining (NEM), Stock Market | No Comments

Rockwell Automation: Will Investors Ever Learn?

Rockwell Automation (ROK) sells factory automation equipment. If ever there was an industry poised to do well in today’s economic environment, Rockwell is in it. Productivity growth is the only way manufacturing companies can keep up with low-cost providers.

Rockwell just posted an outstanding quarter. According to Reuters:

Net income increased to $149 million, or 83 cents per share, from $127.3 million, or 68 cents per share, a year ago. Wall Street analysts expected net income of 81 cents per share, according to Reuters Estimates.

Sales of its products, which help factories run more smoothly, came in at $1.4284 billion, up 13.5 percent from $1.2647 billion a year ago. Analysts expected third-quarter sales of $1.3989 billion.

Rockwell expects full-year 2006 results to “modestly exceed” its prior forecast of earnings per share from continuing operations of $3.25 on 11 percent revenue growth.

Not the kind of news one expects to send a stock down more than 10 percent for the day. In part, Wall Street was disappointed that after beating estimates the full-year guidance wasn’t really raised. In fact, some analysts consider the company to have reduced guidance:

Deutsche Bank analyst Nigel Coe wrote in a research note that the profit beat Wall Street expectations largely due to a lower-than-expected tax rate. The lower tax rate, he said, means that “the quality of this (full year profit forecast) number has been lowered.”

Whatever. Management reiterated on the call their past comments that the tax rate can jump around from quarter to quarter due to the timing of various items.
This all brings us back to April, 2005. The stock sold off sharply because the company “missed” its earnings target for the quarter. Problem is, Rockwell doesn’t give quarterly guidance. The high ticket prices of their equipment means there is too much volatility in quarterly numbers just because a sale occurs a few days earlier or later than the quarter end. No matter. Wall Street came up with their estimates and punished the stock for failing to meet them.

Of course, the company went on to exceed the annual guidance it had provided, the selloff marked the low of the year and by the following April the share price had nearly doubled.

Can the same thing happen again? Possibly. The stock is now trading at about 16x the consensus estimate for fiscal year ending in September 2007. That is not dirt-cheap in today’s market, but not outrageous either. Now consider some of management’s comments on the conference call:

We are currently in the teeth of a major correction in demand from our Detroit automotive market. Sales from the Detroit region were down almost 50% this quarter, which in turn reduced total company growth by more than a point, Logix growth by about two points, and control systems’ conversion margin by about five points. In the past, a correction of this magnitude would have had significant consequences for Rockwell Automation. Our ability to deliver double-digit growth during such a correction would have been unimaginable 10 years ago. Quarter four will see a similar 50% year-over-year sales decline in Detroit – and we expect to again deliver double-digit revenue growth.

Currently, we still believe we’re in the 11th quarter of the expansion (of industrial capital spending), and if you look at the historical definition of those expansions, it would last anywhere between 25 and 35 quarters, and I think what we’re continuing to see is disciplined spending by our customers.

This is a solid company that backs up its promises. While it had gotten expensive for today’s market, there was no need for the panic selling following its earnings report.

Topics: Rockwell Automation (ROK), Stock Market | 3 Comments

All CSG Systems Go

Analysts are paid to be paranoid, and sometimes the paranoia gets the better of us. One example of this was last week’s observation about Watch List member CSG Systems (CSGS) when we said that two press releases in one week was unusual for the company. We worried that they were trying to flood the market with good news ahead of potentially bad earnings.

We needn’t have worried.  CSG beat analyst estimates and raised guidance, sending the shares up 3 percent. Even after the move the company is trading at an enterprise value of just 12.5x its trailing free cash flow, a capitalization rate that implies approximately 2 percent annual free cash flowgrowth, which ought to be manageable. In fact, the company is projecting it will grow 25 percent this year (though that is somewhat of an anomaly). The company announced another share buyback, having already reduced the average share count by 2 million shares (four percent) in the last year. These are not just buybacks to replace shares issued to employees on stock option exercise. This is honest-to-goodness reduction in the share count.
So we misread this one. To be fair, it isn’t like we were pounding the table to sell. We closed out our argument with:

Now, before you pull out your order book consider a few points. First, really bad news like losing a top five customer would probably have been announced already due to the Sarbanes Oxley rules. Second, the stock is already pretty reasonably valued on an enterprise value to free cash flow basis. Third, the nature of the companies business results in earnings and cash flows that are quite stable. Of course, that overall stability sometimes results in market overreactions to small misses.

In the end, we may be reading too much into two stories that just coincidentally came out this week. But they caught our attention, and we figured we would bring them to yours.

But let’s not whitewash it. The jist of the piece was clearly negative and clearly wrong, and we want to own up to those just as we crow about our successful calls.

Topics: CSG Systems (CSGS), Stock Market | No Comments

Plantronics Does it Again

By clompersWe said in June that Plantronics was spending too much on advertising. In May we were harsher, saying Plantronics should fire their marketing director. Now, after yet another disappointing quarter (and guidance for yet another still) they are going to reduce their marketing costs. Sort of.

According to the press release:

Given the weaker environment which has been developing, we reduced the level of marketing expenditures we had planned for the first quarter and re-evaluated elements of the marketing campaign planned for the balance of the year. Based on our review, we re-allocated certain funds to shorter-cycle marketing programs that should yield a better return on investment in the near-term. We are continuing to evaluate the extent and types of marketing programs we will undertake for the balance of the year.

In other words, fewer expensive commercials talking about how they were the headset Neil Armstrong used on the moon, more “head on down to Headset HQ and get yourself a headset now buddy!” cross-promotions with retailers. While it certainly marks an improvement, we continue to puzzle over why they need advertise at all. The consumer businesses that should be the beneficiary are doing so poorly we can’t imagine it being any worse without the ads.

The company is blaming the poor consumer revenues, by the way, on Apple:

Based on Altec Lansing’s historical seasonality, we expected a revenue decline in the range of 5-10%. The actual 17% sequential revenue decrease was driven by weaker U.S. retail market conditions for iPod-related accessories.

Didn’t Apple just report better than expected iPod sales? Did customers just suddenly stop accessorizing them?

We think we’ll fall back to the recommendation we made in May. In the meantime, if you are thinking of bottom fishing you should check out the valuation piece we wrote in June. At the time we said a 3.6 percent free cash flow yield just doesn’t cut it when CDs are paying five percent. With the after-hours sell-off today the yield is up to 4.4 percent based on 2005 free cash flow, but rising receivables and inventories suggest cash flow may be lower this year. We’ll let you do the math.

Topics: Plantronics (PLT), Stock Market | No Comments