Archive: February, 2008

HANS: Big HANS is Still the One

Hansen Natural (HANS) is giving back the last month’s gains today after reporting higher than expected sales and lower than expected margins. Both were explained by customers stocking up ahead of a price increase. Count on the same thing happening to Hershey’s (HSY) when they report a March quarter enhanced by customer stock-ups and an early Easter.

While it’s true that the sales were boosted by robbing sales from next quarter, that is a short term issue. I said last month that “Hansen should be able to maintain its current free cash flow yield as long as the company keeps growing, which suggests potential upside in line with the 30% growth rate this year. Unless the growth rate slows substantially, it looks like a keeper.”

That’s my story, and I’m sticking to it.

Disclosure: William Trent has no position in the companies mentioned.

Topics: Beverages (Non-Alcoholic), Hansen Natural (HANS), Hershey's (HSY) | 1 Comment

DF: More Sour Milk from Dean

Dean Foods (DF) announced this morning they would sell 18.7 million shares in a secondary offering. The 13% dilution is expected to be “significantly offset” by a $20 million reduction in interest expense. At current prices, the company should raise nearly $400 million through the sale. $20 million is 5% of that – so “significant” seems to be in the eye of the beholder.

Even better, the offering comes because “operating results were below the expectations we had when we recapitalized the balance sheet last March.” By Dean’s logic, apparently, you should issue debt to pay shareholders when the shares are $45 and issue shares to pay off debt if the shares are $21. And I thought they only got on the wrong side of every dairy position. They are wrong on market positions as well.

Dean also reiterated their guidance, which (as I had noted in my article) was below the consensus estimate. I guess we now know why.

If there is any bullish read on this story at all, it is the possibility for a brief relief rally after the secondary closes and the overhang clears on March 5.

Disclosure: William Trent has no position in the companies mentioned.

Topics: Dean Foods (DF) | No Comments

VZ: Make Money Not Owning Verizon


Creative Commons License photo credit: lucasreddinger

This article is a reprint of my February 22, 2008 RealMoney column

Forget the debate over whether telecom is a buy or sell. Make money being indifferent.

The decisions by Verizon (VZ - Annual Report) and AT&T (T - Annual Report) to offer unlimited wireless plans for $100 has launched a furious debate at RealMoney over whether the move is the right thing or the wrong thing to do. I see both sides of the story, and if anything lean toward the side of the bulls. But while the bulls and bears hash things out, I think investors can make money by being neutral.

To sum up the arguments, on the bearish side Tero Kuittinnen notes that “The AT&T and Verizon growth stories rest largely on their mobile service, and the mobile service growth hinges on mobile data, not voice. Investors are going to be deeply disappointed if Verizon’s mobile data growth keeps cooling down from the still-torrid 53% pace of the fourth quarter of 2007. For Verizon, mobile data revenue still generates just $11 a month out of the overall $51 average revenue per user. The data growth has to continue to run hot, or the overall ARPU will start declining.”

Jim Cramer counters that “the stock can trade back up toward the high $30’s over the coming quarters as the market comes to realize that these wireless price cuts are a savvy move to take market share from Sprint Nextel (S - Annual Report), which appears to be in serious trouble.”

In the short term, I’m making absolutely no forecast about the effects of the wireless pricing cut, the effects of a potential recession, or the stock price. But there are a few facts to consider that explain my lean toward the bull side.

First, this isn’t the first time in recent memory that there has been a competitive telecom environment. Since the 1996 telecom act, everybody from CLECs to independent wireless operators to cable and long distance companies has taken their shots at the big integrated telecom firms. Several of those categories of competitors no longer exist in any meaningful fashion. So, while it’s true that the pricing power in telecom may not remain at the high levels enjoyed of late, a competitive environment is nothing these companies haven’t seen before.

Second, Verizon is going to continue churning out massive amounts of cash. Its operating cash flows have been roughly $20 billion or more each year this century, and even the dual wireless/FIOS buildouts have required no more than $17.5 billion in capital expenditures. The $5.8 billion in free cash flow generated over the last 12 months leaves more than enough to pay the handsome 5.1% dividend yield that has attracted Cramer’s attention.

Finally, Verizon is getting close to massive technical support at $30. The only time this stock has traded with a $2-handle is for a couple of months in 2002 around the trough of the telecom bust.

Still, I promised that investors could make money in this name without being bullish, and those who know me probably realize I am talking about writing options. I just wrote March $32.50 put options for $0.95. If the stock stays above that level, I collect a 2.9% yield in the next month. Given that Treasuries pay less than that for one year, getting it in one month simply by being willing to buy a utility-like cash flow stream seems like easy money to me.

If the stock continues to slide, I’ll get an effective purchase price of $31.55, from which my dividend yield will be 5.5%, taxed at a more efficient rate than the smaller Treasury yield. Alternatively, I could turn right around and write covered calls to reduce my exposure still further. Those who currently own the stock could also consider covered call writing to enhance their yield.

Yet another useful option strategy here relates to Cramer’s plan to scale into Verizon over time, potentially bringing his initial 1,000 shares up to 4,000 or 5,000. Why not write some puts with staggered dates to accomplish that? Again, using the $32.50 puts, the following table shows how this could work.

Scaling Into Verizon by Writing Puts

 

 

Shares Cost Effective Price
Initial buy       1,000       33.88             33.88
March $32.50 puts       1,000       (0.95)             31.55
April $32.50 puts       1,000       (1.55)             30.95
July $32.50 puts       1,000       (2.65)             29.85
October $32.50 puts       1,000       (3.20)             29.30
      5,000             31.11

Sources: Option quotes obtained from Fidelity Investments at time of writing

Assuming all the options get exercised against him, Cramer would achieve an average purchase price of $31.11 per share, scaling in over time at progressively lower effective entry prices. If the stock stays right where it is, or goes up, he collects a total of $8.35 in option premiums for the shares he never buys.

To me, that sounds like a winning strategy.

Disclosures: William Trent has written put options against the shares of Verizon (VZ - Annual Report)

Topics: AT&T (T), Communications Services, Sprint Nextel (S), Verizon (VZ) | No Comments

LEE: Should Lee Enterprises Investors Stop the Presses or Pick Up a Scoop?


Creative Commons License photo credit: qnr

This article is a reprint of my February 21, 2008 RealMoney column

The last year hasn’t been a good time to own a newspaper. The best performing stock was Washington Post (WPO), which managed not to decline significantly. New York Times (NYT) and Gannett (GCI - Annual Report) are down as much as half, while smaller firms like Lee Enterprises (LEE), Belo Corp. (BLC - Annual Report), McClatchy (MNI) and Journal Register (JRC) have registered declines ranging from 60-80%.

Always on the eye for a contrarian opportunity, I wondered if the time might be right to take a stake in one of the papers. The one that most attracts my eye is Lee. Lee provides of local news, information and advertising in primarily midsize markets, with 50 daily newspapers and a joint interest in five others, rapidly growing online sites and more than 300 weekly newspapers and specialty publications in 23 states. In 2005, the Company acquired Pulitzer and has since trimmed the combined operations by selling certain local papers and printing operations.

Although its valuation multiples and price performance resemble those of the other small firms, Lee is less heavily leveraged (a mere 3:1 debt/market cap ratio compared to 4:1 at McClatchy and 12:1 at Journal Register) and generates a significantly higher free cash flow yield than those firms. Compared to Belo, its Zacks rank of 2 indicates favorable earnings revisions, while Belo is in the worst category.

However, it will take more than being the best in a rotten bunch to make me take the plunge. Lee has to offer some real value, and pay me for the risk I would be taking by owning the name. At first glance, the 10% free cash flow yield (operating cash flow plus after-tax interest expense minus capital expenditures, divided by enterprise value) and 6.4% dividend yield would appear to do the trick. But are they sustainable?

There doesn’t appear to be much near-term risk to the dividend due to its relatively small share of annual cash flows. Pension plan is under-funded by $75 million, but the annual required contributions are just a few million.

The biggest concern relates to $306 million in notes issued in conjunction with the Pulitzer acquisition, which are due in April 2009. It would be tough to come up with that money in the current credit environment, but at some point over the next year I expect the credit markets to return to normal. Under its credit agreements, Lee can also increase its line of credit by up to $500 million as long as it meets certain financial criteria.

The Best Laid Plans

Over the longer term, Lee will have to generate at least modest revenue growth (the consensus five-year estimate is 5%) and execute according to its plan. Unfortunately, the plan is running into some road blocks.

Lee Enterprises’ Stated Corporate Plan

Plan

Reality

Grow revenue creatively and rapidly

In the latest quarter, revenues declined 6.2% compared to the prior year

Deliver strong local news and information

Presumably going according to plan

Accelerate online innovation

Online ad revenue was sufficient to offset declines in print advertising in FY 2007, but in the December quarter it was not

Continue expanding audiences

Average daily newspaper circulation units decreased 2.0% and Sunday circulation decreased 2.5% for the 13 weeks ended December 30, 2007, compared to the prior year

Nurture employee development and achievement

In 2007, the St. Louis Post-Dispatch concluded an offering of early retirement incentives that resulted in an adjustment of staffing levels

Exercise careful cost control

Costs were cut by 4.9%, but revenue fell at a faster rate

Source: Company filings

Earnings Quality

Until the management can effectively put their plan into action, revenues and earnings look set for continued declines. In 2007 operating income decreased $5,157,000, or 2.5%.

Tax settlements reduced income tax expense by $6,880,000 in 2007. On an apples to apples basis, earnings per share declined from $1.82 to $1.66.

While the earnings are declining, they do appear trustworthy. The accrual ratio measures the difference between cash-based earnings and accounting (accrual) based earnings. The closer to zero, the better. With the exception of a spike in 2005 related to the Pulitzer acquisition, Lee’s earnings quality has been high.

lee-accruals.jpg

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

I Would Look to Enhance Yield With Options

Although a put-write may offer another alternative play on the name, the options are thinly traded. The March 12.50 puts are available for approximately $1.45 at the time of writing, while the March 10’s are trading at about $0.30. The choice would depend upon the investor’s objective: someone wanting to own the shares at a lower price could use the $12.50’s to get an effective purchase price of just over $11.00, while an investor who doesn’t really want the shares could get a 3% one-month yield on money at risk using the 10’s.

I also think if I wrote put options and ended up with the shares, I would turn around and write covered calls to continue enhancing the yield and offsetting some of the risk.

Disclosures: None

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

Topics: Belo (BLC), Gannett (GCI), Journal Register (JRC), Lee Enterprises (LEE), McClatchy (MNI), New York Times (NYT), Printing & Publishing, Stock Market, Washington Post (WPO) | No Comments

Finding the Silver Lining in Durable Goods Orders

New orders for long-lasting U.S.-made manufactured goods fell by 5.3 percent in January, the biggest drop in five months and more than analysts expected, and a key gauge of business spending also declined, a Commerce Department report showed on Wednesday.

But the news wasn’t all bad. Some industries look like a recovery may be beginning.

Consider computers and electronic products.

computers-and-electronic-products.jpg

Or semiconductors.

semiconductors.jpg

Or machinery.

machinery-orders.jpg

These changes are all based on non-seasonally adjusted data from the U.S. Census Bureau.

Topics: Computer Hardware, Durable Goods, Electronic Instruments and Controls, Semiconductors | No Comments

ADSK: Autodesk Not as Safe as I Thought

Clearly Autodesk (ADSK) wasn’t as safe as I thought. The question of what to do with it now would be easier if the miss made more sense. Company claims $0.05 reduction in full year EPS is due to accelerated hiring in order to make “product investments.” But if the products are being enhanced, why isn’t the revenue guidance being increased for the full year?

Stock was already cheap (and is much cheaper today) but until the “investments” start to earn a return they are just “costs.” I’d like a better explanation of what’s going on before feeling comfortable with the name again.

Disclosure: No position held

Topics: Autodesk (ADSK), Software and Programming | No Comments

APOL: Not Buying Apollo’s Earnings Momentum

 

This article is a reprint of my February 19, 2008 RealMoney column

Apollo Group (APOL) is one of the largest private providers of higher education services. Through the University of Phoenix and other subsidiaries, Apollo serves more than 300,000 enrolled students at more than 100 campuses, using a mix of traditional and online educational services.

Over the last month, analysts have been increasing their earnings estimates for Apollo. For the August 2008 fiscal year, estimates have risen from $2.80 three months ago to $2.97 today. The estimates for 2009 have grown from $3.25 to $3.40 over the same period. As a result of this momentum in earnings, Apollo’s Zacks rank was recently upped to 1, which puts the company among the top 5% in terms of earnings momentum.

Byron Wien thinks Apollo is worth playing on the thesis that “a lot of people will be laid off and they’ll be trying to improve their skills.” But that makes an implicit assumption that those students will be able to pay their bills. Last year, Apollo, ITT Educational (ESI) and Corinthian Colleges (COCO) all reported rising bad debt expenses, and the trend has not abated.

Bad debt expense for the first quarter of 2008 as a percentage of revenue was 4.2% compared to 3.5% a year ago. Management also identified “certain items that should have been reported or should have been classified as discounts or refunds, that is, as a reduction of revenue, as opposed to a charge to bad debt expense in prior quarters.” This would have made the prior year number 2.9%, so the deterioration is from 2.9% to 4.2%.

Apollo’s associates degree programs are growing at a far faster rate than their bachelor’s degree program, which contributes to the bad debt issues and may contradict Wien’s thesis that higher growth will be coming from professionals looking to enhance their skills.

As to those rising earnings estimates, it’s hard to put too much faith in them when I see their quality. The accrual ratio, which measures the difference between cash earnings and accounting earnings, ideally should hover around zero. Apollo’s is all over the map, and the trend appears to be getting worse.

 

apol-accruals.jpg

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

At 23x current year earnings and 13.3x book value (compared to an industry average of 3.5) Apollo hardly looks cheap by traditional valuation measures. Apollo’s free cash flow over the last 12 months was $540 million, which amounts to a 4.9% free cash flow yield. Although the paltry Treasury yields currently available result in a favorable comparison, I think there are other names with similar cash flow yield and growth profile but with higher earnings quality.

On the conference call, management noted that “during the first quarter, we didn’t repurchase any of our Class A stock. As I just discussed, with the creation of Apollo Global, our potentially deep pipeline has grown significantly and we are busy evaluating the best use of our capital to create long-term value for our shareholders.” Could that be code for, “the stock is too expensive right now?”

I’m no technician, but Apollo has dropped through several moving averages recently and what looked like decent support at $70. If it drops through the 200-day (currently around $64-65) all bets could be off.

Disclosures: None

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

Topics: Apollo Group (APOL), Corinthian Colleges (COCO), ITT Educational Services (ESI), Schools | 1 Comment

IBM: Maybe I Should Take Up Technical Analysis

Last month I wrote about IBM (IBM - Annual Report) and said:

IBM is now trading at a P/E of 12.7x 2008 earnings, compared to a five-year average P/E of nearly 18x. It offers a free cash flow yield of nearly 7% at a time when 5-year Treasuries are yielding 2.8%.Expected long-term earnings growth of 11% annually marks a modest slowdown from the 13% generated over the last five years. It is also well below the sustainable growth rate of 29%, which is further evidence of excess cash flow that can be used for more share repurchases.

Valuation aside, things seem a little dicey here. The new guidance seemed sufficient to spark a better rally than we got. If IBM can’t move when estimates are jacked up by $0.25, what will make it move?

I can’t claim to be expert in technical analysis, but a look at the charts, especially the moving averages, suggests that $109 may be a make-or-break price point for many investors. In today’s market environment, I think I’d rather keep my powder dry than chase a possibly elusive extra four percentage points of upside.

But I’ll be watching. I also might be tempted to find some approach using options. For example, the March $110 call options would provide upside in the event of a strong rally, and could largely be paid for by writing $100 puts. Since I think the valuation is reasonable, being forced to buy at $5 lower wouldn’t hurt my feelings too badly, and I’d still get the exposure to the additional upside if the stock does rally.

$109 did prove to be a make-or-break area, and the effectively zero-cost call option I proposed would be worth almost $6 as of Tuesday’s close. Maybe I should take up technical analysis.

Or maybe I shouldn’t. Given the way some of my fundamental picks (where I do consider myself an expert) are working lately I may be better off sticking with the naive approach.

Topics: IBM | No Comments

FTO: Forces Aligning for Frontier


Creative Commons License photo credit: Gastev

This article is a reprint of my February 19, 2008 RealMoney column

After peaking above $49 per share last year, refiner Frontier Oil (FTO) sunk to intraday lows in the $20’s last month before starting a rally on the news of Valero’s (VLO) positive outlook on the latest conference call. My biggest surprise, looking over the data for Frontier and the industry, is why it hasn’t rallied even more.

First of all, Valero indicated that “Current industry conditions are setting the stage for rebounding gasoline margins.” If true, that would be equally positive for Frontier and others. Not that I don’t believe Valero, but I thought a check of the PPI industry statistics could provide an unbiased second opinion.

Petroleum Refineries PPI, 12-Months Percent Change

refinery-ppi.gif

Source: Bureau of Labor Statistics

Lo and behold, year/year price increases for petroleum refineries have suddenly shot straight up. If that doesn’t set the stage for rebounding margins, what will?

Hardly a week later, there was actually speculation that Valero would buy Frontier. However, according to the Reuters article, Fadel Gheit, an oil analyst with Oppenheimer & Co, also questioned the rationale behind Valero buying Frontier, especially since Valero has already sold one refinery and has said it would sell two and maybe three others.

Sold a refinery, you say? That sounds like a ripe opportunity for a comparables analysis to see how Frontier’s valuation stacks up against an arms-length transaction between industry experts. And at first glance, Frontier doesn’t come out looking so hot.

Valero’s Lima, Ohio refinery was sold last year to Canada’s Husky Energy (HSE.TO) for $2.1 billion. Lima’s 165,000 barrel per day stated capacity being quite close to Frontier’s total capacity of 162,000 barrels per day, the comparison initially looks valid. And with Frontier’s enterprise value at $3.6 billion, the implications could be that Valero’s management got ripped off, Frontier is overvalued, or the assets aren’t really comparable.

Valero is a good company, and I don’t believe its experienced managers got ripped off. The other two theses can be tested by comparing the assets. According to Husky’s road show slides, it seems Lima was something of a fixer-upper. Running well below the stated throughput, its sales and profitability were not close to those of Frontier. Taking the 2006 performance as an example, I was able to compare the valuation relative to various fundamental metrics.

Metrics

 

Valuation

Frontier Lima Frontier Lima
Stated throughput         162          165        21.7        12.7
Throughput         172          136        20.4        15.4
Sales       4,759       4,119          0.7          0.5
EBITDA         615          327          5.7          6.4
EBIT         574          288          6.1          7.3
Value       3,510       2,100

Sources: Company filings, compiled by William A. Trent

Although Frontier looks more expensive on the basis of throughput or sales, its full-throttle capacity utilization has resulted in a far more efficient operation. As a result, Frontier is cheaper based on EBIT or EBITDA, which are the valuation measures most frequently used in the industry.

Of course, running at full capacity also means there is little room for further improvement other than through the commodity prices themselves. Even considering a fair valuation, that could mean there is significantly more downside risk than potential upside.

I also looked at Frontier on the basis of my favored valuation tool, its free cash flow yield. In this regard, Frontier’s yield on trailing free cash flow is about 6.2%, which is sufficiently above the yield on five-year Treasuries that I don’t need significant growth to justify a purchase. The potential rebounding margins, in other words, is a bonus.

Disclosures: None

Topics: Frontier Oil (FTO), Husky Energy (HSE.TO), Oil and Gas Operations, Valero Energy (VLO) | No Comments

Supply and Demand Outlook for Semiconductors Continues to Improve

According to Semiconductor Equipment and Materials International (SEMI):

North American-based manufacturers of semiconductor equipment posted $1.12 billion in orders in January 2008 (three-month average basis) and a book-to-bill ratio of 0.89 according to the January 2008 Book-to-Bill Report published today by SEMI. A book-to-bill of 0.89 means that $89 worth of orders were received for every $100 of product billed for the month.The three-month average of worldwide bookings in January 2008 was $1.12 billion. The bookings figure is about three percent less than the final December 2007 level of $1.16 billion and 22 percent less than the $1.45 billion in orders posted in January 2007.

22.3%, to be exact. To me, this is good news for semiconductor manufacturers, because the demand for chips is still growing – barely. With equipment installations going down, the oversupply that currently exists will soon be absorbed, recession or no.

Disclosure: Long SMH, MXIM; wrote put options against LRCX

Disclosure: William Trent has a long position in SMH.

Topics: ETFs, Lam Research (LRCX), Maxim Integrated Products (MXIM), Semiconductor HOLDRS (SMH) | 1 Comment