Archive: January, 2008

HANS: Growth Comes Cheap at Hansen Natural

The following is a reprint of my January 25, 2007 RealMoney column.

Hansen Natural (HANS) develops “alternative” soft drinks such as natural sodas, fruit juice drinks and energy drinks. It is best known for its “Monster” brand energy drink, which is the second-most popular brand of energy drink and has helped the company’s shares become one of the best investments of the last decade.

Hansen now has to prove whether, unlike the namesake one-hit-wonder boy band, it can sustain its momentum to new products and markets. We know what John Edwards thinks of leading energy drink Red Bull, and it’s probably not a stretch to think that many others feel similarly about the new concoctions.

Still, that hasn’t stopped the market from growing exponentially for the last several years. The question keeps getting asked whether the growth can continue, and the answer has always been affirmative so far. What’s more, the past improvement seems sufficient to justify holding the name even if growth slows substantially.

For example, over the last 12 months Hansen generated free cash flow (cash from operations less capital expenditures) of $98 million. Based on its $3.4 billion enterprise value, this equates to a 2.9% free cash flow yield. With the market turmoil having pushed 5-year Treasury yields below 2.5%, Hansen is now yielding a premium to Treasuries despite offering substantial growth opportunity – more than 40% sales growth in 2007 and another 30% or more expected in 2008.

By contrast, Pepsi (PEP - Annual Report) is offering a more generous 4.3% free cash flow yield, but is expected to grow just 7.5%. Meanwhile, Jones Soda (JSDA) is expected to grow a similar 30% in 2008 (though off less-impressive 2007 growth) but its cash flow from operating activity over the last year has been negative.

If Hansen grows as expected this year, its free cash flow yield (relative to the current enterprise value) would approach Pepsi’s. Any additional future growth would be a bonus from that point. And there seem to be many opportunities for the growth to continue.

For example, last February Hansen entered a distribution agreement with Pepsi-QTG Canada. This gives Hansen its first real crack at international sales, which increased from 2.6% of the total in the first nine months of 2006 to 4.0% in the same period last year. Its domestic distribution has also been enhanced by deals with Anheuser-Busch (BUD).

To incorporate earnings quality, I calculated an accrual ratio for Hansen, which describes how much of a company’s earnings (in this case, over the preceding 12 months) are explained by cash flows rather than accounting choices. The closer to 100%, the better, and Hansen’s accrual ratio has been much less volatile than I would have thought for a company growing so fast (rapid growth typically requires cash outflows that aren’t reflected in current earnings.)

hans-accruals.jpg

Source: Zacks Research Wizard, compiled by William A. Trent

Operating profit margins were lower in the first nine months of 2007, but this was primarily due to the legal and accounting expenses surrounding an investigation of stock-option granting practices and the costs associated with terminating existing distribution agreements as the company enhanced its relationship with Anheuser-Busch.

The biggest risk for shareholders is probably Hansen’s choppy record with regard to earnings expectations. The company reported earnings below consensus expectations in two of the last four quarters, and since a miss in November the shares have shed more than 40% of their value. A two-year chart reveals a similar situation in mid-2006.

That 2006 sell-off proved in hindsight to be a terrific buying opportunity. Based on Hansen’s current valuation, I think the current one may prove to be the same.

Disclosure: No positions held at time of writing.

Zacks Investment Research has provided Stock Market Beat with a complimentary trial subscription to Research Wizard.

Topics: Anheuser Busch (BUD), Beverages (Alcoholic), Beverages (Non-Alcoholic), Hansen Natural (HANS), Jones Soda (JSDA), Pepsico (PEP) | 1 Comment

INTC: Intel is Still a Great Value, But Momentum Has Left the Building

The following is a reprint of my January 23, 2008 RealMoney column.

In October, I wrote a bullish article suggesting that Intel (INTC - Annual Report) had all its ducks in a row. Up until the earnings report this week, the stock was performing more or less in line with the S&P 500. Now, however, it is looking like a bad call.

In hopes of figuring out what went wrong with my thesis, I took a fresh look. I still think Intel is worth buying at these prices, but I would probably wait for a signal that momentum was returning to the name before starting a new position.

One mistake was in accepting what I realized were somewhat aggressive estimates. “According to the Semiconductor Industry Association, the year-over-year sales growth for the industry has ranged from 1.7% to 4.8% over the last six months. For the largest manufacturer to be growing at more than twice the overall industry rate seems somewhat aggressive at first glance,” I noted.

I thought that “since Intel and rival Advanced Micro Devices (AMD - Annual Report) were the first companies to over-order, the first to see the damage it did to their margins, and the first to announce cuts to planned expenditures, it should surprise nobody if they are the first to recover as well.” Compared to most semiconductor makers that was true, but not enough to justify a double-the-industry growth rate.

I also thought the worst would soon be over in semiconductor pricing trends, but things have managed to get worse in the meantime. That said, the industry’s capital spending discipline remains intact – data released yesterday showed that orders for semiconductor equipment were down more than originally reported in November and down 18% year/year in December. As demand gradually catches up to supply, pricing power will improve.

To my credit, I was correct about Intel and AMD seeing a recovery sooner than the overall industry. I noted that “margins for both AMD and Intel are lower than they have been at any time since the depths of the technology bust. A modest improvement from current levels would still leave them well below the normal range, if there is such a thing.” Intel’s margins improved from 52% in September to 58% in the December quarter.

I was also correct to point out improving inventory trends at Intel. Inventory levels declined $132 million sequentially and nearly $1 billion from the December 2006 quarter. Inventory reductions tend to put a damper on margins, so once the excesses are depleted margins should improve further. The inventory reductions also provide a significant (though temporary) boost to cash flow.

You didn’t think I’d write a whole article without coming around to cash flow, did you? But why not? Cash flow is probably the single best reason to consider owning Intel right now. Over the last 12 months, Intel’s free cash flow (cash from operations less capital expenditures) was $7.2 billion, for an effective free cash flow yield of more than 7% on the current enterprise value.

Intel has been letting this cash pile up on its balance sheet in cash and marketable securities that are probably yielding just three or four percent. To me it would be a no-brainer to buy the company’s stock and increase that yield to 7%. I suspect a $7 billion buyback announcement, to be executed promptly, would put some mojo back into the shares.

In the meantime, no matter how much of a value Intel seems to be, the momentum is clearly gone. I would probably want to wait for investors to start recognizing some of the value before jumping in here. Though I am not a technical analyst, measures such as the MACD signal or a close above the 50-day moving average would probably qualify. Alternatively, fundamental momentum in the form of positive earnings revisions could also count.

Another option would be to get paid for waiting by selling out-of-the-money put options. The July 17.50’s were selling for $1.25 at the time of writing. That would provide a 7% six-month return on the money at risk and an effective entry point of $16.25 if the option is exercised.

Disclosure: William Trent has a long position in SMH.

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

Officially a Crisis

I follow the spread between BBB (the highest investment grade) corporate debt and Treasuries as a gauge of overall investor willingness or unwillingness to accept risk. Lately, investors have been less and less willing to accept risk, plowing money into Treasury bonds and lowering their yield.

interestrates.jpg

The spread is now 296 basis points, which is close enough to my 3% trigger to call this an “official” crisis. Such events tend to happen only once or twice per decade. As a general rule, they have typically signaled good times to be in risky assets such as stocks.

Topics: Economy, Risk Premia | No Comments

YHOO: Nothing to Shout Yahoo! Over

Last September, I said I was skeptical about Yahoo (YHOO) in a post titled YHOO: Not Shouting Yahoo! Over Yahoo!

So, will Yahoo! reward a patient approach? It doesn’t look that way to me. Its free cash flow in 2006 was $700 million, half the level achieved in 2005. It is only good for a 2.3% free cash flow yield on the current enterprise value. That means essentially all of the return potential has to come from growth – which doesn’t seem like a safe bet given last year’s decline. Sure, the growth rate over the last five years is nearly 45% – but that is coming off of the lowest lows of the Internut Bust. The consensus five-year growth estimate is 24%, including a 20% decline in the current year. By implication, that means the subsequent four years would have to post average growth of nearly 40% annually. Color me skeptical. With an ROE of just 8.27%, assuming growth will be faster than that implies adding debt or issuing new shares unless they can somehow boost the ROE itself – a feat far easier said than done. Coincidentally (or not) that is about in line with the actual year/year growth rate in the latest quarter.

The latest earnings and guidance show that the skepticism was justified. The stock fell another 11% after hours, and is now down nearly 22% since my bearish call, compared with a 7.4% decline in the S&P 500.

Revenues were up – whaddya know – 8.3% and the new guidance midpoint calls for another 10% in 2008. Five year growth estimates have not budged but will now be far more difficult to meet.

Topics: Advertising, Services, Yahoo! (YHOO) | No Comments

LXK: Timing is Everything on Lexmark Call

In December I thought Lexmark (LXK) might be worth a look for value investors. That call is looking much better since Lexmark reported earnings this morning:

Fourth-quarter revenue was $1.31 billion, down 4 percent compared to revenue of $1.37 billion last year. Fourth-quarter GAAP earnings per share were $1.04. Earnings per share for the fourth quarter of 2007 would have been $1.29 excluding $0.25 per share for restructuring-related activities.

The $0.58 consensus estimate was blown away, and guidance of $0.80-$0.90 for the coming quarter (ex. restructuring charges) was also ahead of the $0.80 consensus. Since I originally recommended the stock, it is down 1.5%, but that compares favorably to the 8.7% decline in the S&P 500.

Topics: Computer Peripherals, Lexmark (LXK) | 1 Comment

YRCW: YRC Worldwide Proves Skeptical Investors Right

In December I wrote:

Nobody believes trucking company YRC Worldwide (YRCW) will earn the consensus estimate of $2.52 per share in 2008. If they did, the stock would be trading significantly higher than $17.50 per share.

After all, the company earned $5.00 per share in 2006 and is expected to pull in $2.40 this year.

Well, the $2.40 in 2007 turned out to be $1.88 – and that is only if you ignore $12.77 per share of impairment charges. Although the charges did not affect cash flows in 2007, they indicate that earnings in years gone by were higher than should have been reported in retrospect.

Since the article, the shares are down nearly 16%, compared with an 11% decline in the S&P 500. At one point the shares traded below $12 per share. Meanwhile, my favored trucking play, Landstar (LSTR - Annual Report) is up more than 5%. I still think Landstar offers a more compelling valuation and lower risk over the full economic cycle.

Disclosure: William A. Trent owns shares of Landstar (LSTR - Annual Report) at the time of publication.

Topics: Landstar Systems (LSTR), Trucking, YRC Worldwide (YRCW) | No Comments

MOT: Oracle’s Buyout of BEA Systems is Positive for… Motorola?

The following is a reprint of my January 18, 2007 RealMoney column.

Oracle’s (ORCL - Annual Report) agreement to meet BEA Systems (BEAS) half-way on price was hailed by InfoWeek as making Oracle a middleware powerhouse. “Among other things, BEA will add to Oracle its WebLogic and AquaLogic SOA and BPM tools, as well as its Tuxedo transaction processing monitoring software. BEA’s Java Virtual Machine technology also could push Oracle deeper into the hot market for virtualization software,” said the article.

Oracle has been leading the way in software industry consolidation, and this deal is another step in the process. When SAP (SAP - Annual Report) announced in October that they would be buying Business Objects (BOBJ), I hoped they were following Oracle’s lead. It is better business for SAP to integrate its software with that of Business Objects than to force its customers to do the integration.

In the past, there were just too many different application software vendors. The excess made competition stiffer than it needed to be and made it difficult for customers to integrate the different products. Oracle figured out that customers would be willing to accept the reduced competition in favor of reduced complexity.

Furthermore, software companies generate so much cash that these deals quickly pay for themselves. For example, Oracle’s free cash flow (the difference between the cash generated from operations and cash paid for new equipment) before acquisitions was $6.6 billion over the last 12 months. BEA has averaged another $200 million in free cash flow in each of the last three years. The combined companies will generate enough cash in the next 15 months to completely pay for the acquisition, leaving Oracle’s balance sheet as strong as it is today.

In my October article, I said a higher yield and growing free cash flow (at Oracle) compared with a lower, flat one (at SAP) is not much of a choice in my book. Since then, Oracle stock has continued to outperform, being down just 3.4% compared with a 12.6% decline in the S&P 500. SAP is down 9.8%.

An investor who likes the latest deal even more than I, of course, is Carl Icahn. I agree with James Altucher that piggybacking the best activist investors can pay off. Carl Icahn’s portfolio at Stockpickr lists a few other ideas.

Which brings me to the very first article I wrote for RealMoney, in which I said a cash flow upturn could carry Motorola (MOT - Annual Report) upstream. Motorola represents 25% of Icahn’s holdings.

In September I said “If Motorola can get to 2004 free cash flow levels and grow the cash flow a measly 2% per year from there, I estimate the stock would be worth nearly $23, more than 25% above the current price. Management could do that pretty much just by trimming R&D expenses to the 2004 level (which was all they needed to produce the previous hit product anyway).”

The obvious risk, of course, was that cash flow could move in the wrong direction. And it did. Free cash flow over the trailing 12 months ending in September was just $325 million, compared to the 2004 level of $2.5 billion. With the cash flow, the stock has also headed down – 19.1% since I wrote that article, compared with a 6.5% drop in the S%P over the same period.

At the new (lower) enterprise value, the free cash flow yield is just 1.2%. But turnarounds don’t happen in a day, and the CEO change only happened in late November. I don’t expect next week’s earnings report to be anything special, but I also think a return to pre-RAZR cash flow levels

And if it doesn’t, I expect Icahn will have lots to say about it.

Topics: BEA Systems (BEAS), Business Objects (BOBJ), Motorola (MOT), Oracle (ORCL), SAP (SAP) | No Comments

GLD: One Reason I Still Like Gold

Typically, commodity cycles are driven by supply, not demand.

Gold | Economist.com

World gold production fell by 1% in 2007, according to the latest Gold Survey from GFMS. Gold prices have risen to new highs this year, but fresh supply has been held back by a global shortage of mining professionals and equipment. China, where gold output rose by 12% last year, supplanted South Africa as the world’s number-one producer—a position it had held for more than a century.

Although a recession in the US could take a bite out of demand for gold, it won’t help the supply any. Inflation is still higher than the Fed has historically been comfortable with, and that too seems unlikely to change much in a recession. There seems to me to be more inflation risk than is being priced into most assets, so I’m keeping 10% of my own assets in yellow metal.

Disclosure: Long GLD

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

Topics: Commodities, ETFs, StreetTracks Gold Trust ETF (GLD) | No Comments

PTEN: Patterson-UTI Looks Poised to Profit from Oil’s Ultimate Rise

The following is a reprint of my January 17, 2008 RealMoney column.

For the last several months, as most of us were complaining about the price of oil at the pump, oil drillers like Patterson-UTI (PTEN), Helmerich & Payne (HP), Grey Wolf (GW - Annual Report) and Unit Corp. (UNT) have been seeing customers push back on the rates they charge for operating rigs. Morgan Keegan analyst J. Michael Drickamer described the fourth quarter as “choppy.”

The latest PPI report backs up that assessment. Despite the rising oil price, price increases for drilling equipment have been quite constrained – in the mid single digits compared to a year ago.

Year/Year Price Change for Oil and Gas Equipment

oil-and-gas-equipment-ppi.gif

Source: Bureau of Labor Statistics

Helmerich & Payne has survived the choppiness relatively unscathed, as its FlexRig design is more efficient than traditional rigs and is allowing for higher dayrates. Patterson has been the dog of the group, shedding nearly half its value over the last two years.

From a perfunctory look at valuation using traditional measures such as P/E or Price/Book, Helmerich & Payne and Unit look like the cheapest stocks, while Grey Wolf has the best growth potential. The momentum is clearly with HP, and I wouldn’t blame anyone for wanting to let that winner ride.

 

Price/2008 Earnings

5-year Growth Est.

Price/Book

Free cash flow yield

HP

9.4

10%

2.2

NMF

GW

11.1

18%

1.6

3.5%

PTEN

10.9

7%

1.7

7.5%

UNT

7.5

9%

1.6

NMF

Source: Yahoo! Finance, William A. Trent

But Helmerich’s success has come at a significant cost, with capital expenditures exceeding the cash flow provided by operating activities over at least the last four years (free cash flow has been negative). It has made up this gap by piling on half a billion in new debt. Unit has been in similar straits. Thus, my preferred valuation metric of free cash flow yield (free cash flow divided by enterprise value) is rendered meaningless for these companies.  Suddenly, the lower P/E multiples start to make sense.

There are several reasons I like looking at the free cash flow yield. For one thing, doing so avoids some of the most common earnings management ploys. For another, cash represents the real money the company has available for growth, acquisitions, dividends and share repurchases.

And Patterson has been doing plenty of share repurchases. During the three months ended September 30, 2007, the company purchased 2,275,000 shares of its common stock and the Board has authorized approximately $200 million more for repurchases. These buybacks have reduced the share count from 170 million in the first nine months of 2006 to 156 million in the same period of 2007. That is a 10% gain in earnings per share for any given level of net income.

Unfortunately, the net income has been declining due to the lower rig utilization. This is not expected to reverse soon, as analysts are currently expecting revenue to decline a further 5% in 2008. That’s an improvement from the 17.6% decline in 2007, though, so value investors may want to start looking for the bottom around here. The big fear, of course, is the economy. If demand for oil slows, will prices collapse?

I don’t think so. For one thing, most commodity cycles are driven by supply rather than demand. While a reduction in economic activity may have a short term impact and keep a lid on prices, the longer-term outlook is still driven by long-term economic growth and the growth in supply. If $100 oil doesn’t bring new rigs on line, eventually the demand will catch back up to supply and the price of oil will go higher.

The latest inventory data notwithstanding, oil inventories are at a historically low level relative to sales. A downturn would allow inventories to be rebuilt to something in line with the historical average, but in the long term supply – not demand – will dictate price.

Oil Stocks: Days Sales in Inventory (Including SPR)

oilinventory.jpg

Source: Energy Information Administration, compiled by William A. Trent

A recent Howard Simons article on what really moves energy stocks showed that Patterson is one of the most sensitive names to crude oil prices, natural gas prices, and even the crack spread. Little of that has applied in the last two years, of course. But it might be well worth speculating that in the long term, Patterson again benefits from the higher energy prices.

Topics: Energy, Grey Wolf (GW), Helmerich & Payne (HP), Oil Well Services and Equipment, Patterson-UTI (PTEN), Unit (UNT) | 1 Comment

TSM: Taiwan Semi Provides Stable Cash Flow in an Uncertain Environment

The following is a reprint of my January 16, 2007 RealMoney column

In a volatile market, investors tend to gravitate toward companies and investments that provide stability. As crazy as this may sound, I think that stability can be found in a semiconductor company – namely, Taiwan Semiconductor (TSM). I think the table below shows just how stable.

Taiwan Semiconductor Cash Flow Generation ($U.S. Billions)

2004

2005

2006

2007E

Cash flow from operations

$4.79

$4.77

$6.29

$4.85

Capital expenditures

2.54

2.43

2.41

2.60

Free cash flow

2.25

2.34

3.88

2.25

Sources: Taiwan Semiconductor, Yahoo! Finance, William A. Trent estimates

Taiwan Semi operates in an unsexy part of the semiconductor industry known as “foundries.” It sounds as exciting as a blacksmith shop, and that isn’t far from the truth. Foundries don’t design any of the products they manufacture. Instead, they make the chips that other companies design. Their expertise isn’t in technology so much as process and efficiency.

Because they don’t design the chips themselves, Taiwan Semiconductor and other foundries such as United Microelectronics (UMC) typically get lower gross margins. The design profits fall to their customers. TSM’s expertise in manufacturing and economies, however, are much needed by customers who are often too small to absorb the enormous costs of building a chip fabrication plant.

Such customers include many fabless semiconductor companies and systems companies such as Altera (ALTR), Broadcom (BRCM - Annual Report), Marvell (MRVL - Annual Report), nVidia (NVDA), Qualcomm (QCOM) and VIA Technology, as well as integrated device manufacturing companies such as Advanced Micro Devices (AMD - Annual Report), Analog Devices (ADI), Freescale, and Philips (PHG).

Many small customers have given the company a balanced sales base. By end market, 40-45% of sales are communications-related, about 30% are to the computer market, 15-20% go to consumer electronics and the rest serve the memory and industrial markets. In 2006, the largest customer represented 10% of company sales, and the top ten amounted to just over half of sales. The lack of concentrated exposure to any customer or end market is one of the reasons TSM can generate stable cash flows.

The largest customer related risk factor may be that three quarters of sales are to customers in North America, and thus may impact the company if there is a U.S. recession. However, the global end markets for technology suggest that the true end customer is more widely dispersed geographically.

As the cash flow table shows, it seems fairly safe to say TSM will generate about $2.5 billion in cash flow. In some years, such as 2006, the cash flow may be unusually high. But even the industry downturns in 2004 and 2007 did relatively little harm. Given that the current enterprise value for Taiwan Semi is about $42 billion, it is offering a free cash flow yield of just under 6%.

If I had $42 billion that I wanted to invest safely, I might choose between buying TSM outright or investing it all in 5-year U.S. Treasuries. The Treasuries are currently yielding about 3.0%, so I would get $1.25 billion in interest each year from my investment. If that were my choice, I think I would go with the $2.5 billion in cash flow offered by Taiwan Semi.

It’s true that as a small investor owning a portion of TSM I would not be able to access all of the free cash flow. There is some risk to the comparison, since I am hoping the company invests any cash they hold onto wisely. But the company does pay two thirds of the cash flow as a dividend. Unless things change, that is still a 4.0% yield taxed at 15% compared to a 3.0% yield taxed at my marginal income tax rate.

How Bad Can it Get?

As stable as it may appear, I also have to acknowledge that TSM’s cash flow is not guaranteed. However, I think 2007 probably marked a fundamental bottom for the semiconductor industry – or at any rate that things won’t get much worse.

Consider, for example, the pricing environment. The Bureau of Labor Statistics reported that semiconductor prices declined 16.9% in December compared to the year earlier. That number was a modest improvement over November’s decline, which was the worst on record. Even the depths of the Internet bust were better times for semiconductor pricing. The fact that the pricing environment is so extraordinarily bad suggests to me that it probably won’t get too much worse.

Year/Year Change in Semiconductor Prices (PPI Data)

semiconductor-ppi.gif

Source: Bureau of Labor Statistics

Furthermore, as I have written in other columns, I think the turnaround in semiconductor fundamentals is within sight. Pricing is a function of supply and demand, and since March of 2007 demand (semiconductor revenues as reported by the Semiconductor Industry Association) has been growing at a faster rate than supply (bookings for new semiconductor equipment as reported by Semiconductor Equipment and Materials International).

I think the industry’s recent restraint in adding new capacity will soon become evident in stronger pricing even if there is an economic slowdown. If I am right, what already looks like a solid and stable cash flow level could soon look even better.

Disclosure: William Trent has a long position in SMH.

Topics: Advanced Micro Devices (AMD), Altera (ALTR), Analog Devices (ADI), Broadcom (BRCM), Koninklijke Philips Electronics (PHG), Marvell Technology (MRVL), NVIDIA (NVDA), Qualcomm (QCOM), Semiconductors, Stock Market, Taiwan Semiconductor (TSM), United Microelectronics (UMC) | No Comments