Archive: April, 2008

RSH: Dell Shacking Up With RadioShack?

Somehow I missed this early in the week. Hat tip to Todd Sullivan’s – ValuePlays:

Apparently on Monday there was heavy call buying in RadioShack (RSH) – ironically a day I was writing puts on the name. Rumor is that Dell (DELL) is kicking the tires. It would be an easy way to get into retail in a bigger way.

Here’s a video discussing the rumor.

Anyhoo – my original thesis was that RadioShack’s valuation is cheap, at ten or eleven times earnings. My preferred measure, the free cash flow yield, is a downright juicy 14.3%. With that kind of cash flow yield, RSH could generate double-digit returns even if cash flow declined 4.3% per year. With five-year Treasuries yielding just 2.5% the declines could be even larger and still earn investors the typical risk premium that would be expected for holding stocks.That and the fact that there seems to be solid technical support contributed to my writing put options at $15 each of the last two months.

Disclosure: At time of publication, William Trent has written put options against shares of Radioshack (RSH).

Topics: Dell (DELL), Radio Shack (RSH), Retail (Technology) | No Comments

WFR: MEMC’s Problems Continue

MEMC (WFR) reported first quarter net sales of $501.4 million versus fourth quarter 2007 net sales of $535.9 million and first quarter 2007 net sales of $440.4 million. Non-GAAP diluted EPS, excluding warrants, was $0.84 per share, compared to the consensus analyst estimate of $0.85.

As previously disclosed, the impact associated with the accelerated chemical deposit buildups at the company’s Pasadena, Texas polysilicon manufacturing facility was the primary factor contributing to the sequential reduction in volumes, revenue and gross margin.

The problems in Pasadena continued after yesterday’s report. “The company reported that at approximately 4:20 PM this afternoon a transfer line from a transport vehicle developed a leak and caused a release of STF, a raw material gas used in the manufacturing process. The leak was quickly contained by the on-site emergency response team and the flow of material was stopped. At this time the company does not believe there was any offsite impact from the release due to the quick dissipation of the material in the atmosphere. Approximately 18 people were transported to area hospitals for further evaluation and/or treatment.”

During the first quarter, the company generated operating cash flow of $197.2 million, compared to $238.5 million in the 2007 fourth quarter. Capital expenditures for the first quarter totaled $81.9 million, or 16.3% of sales. The resulting lower trailing 12-month free cash flow yield curbs my enthusiasm for WFR shares.

“Although we are pleased with the results of the actions we have taken to address the issues that caused the lower than targeted polysilicon volume in the first quarter, given the unplanned issues that were encountered with our expected polysilicon ramp in the first quarter, we feel it is prudent to be extra cautious regarding our polysilicon output expectations in the second quarter. As a result, we are targeting revenues of approximately $540 to $570 million for the second quarter. In addition, we are targeting gross margin of approximately 54%-55%, with operating expenses of less than $40 million,” added Gareeb.
The consensus sales estimate for next quarter was $566 million.

The stock is looking to open down today, but I think if it can maintain above its 200-day moving average it will signal that investors continue to view the disruptions as temporary. Below the 200-day moving average, I’d say all bets are off.

Disclosure: At time of publication, William Trent holds no financial position in the companies mentioned in this article.

Topics: MEMC Electronic Materials (WFR) | No Comments

RS: Reliance Steel, Reliable Cash Flows

My latest column is up at RealMoney. It is a bullish piece about Reliance Steel (RS - Annual Report).

Prices for sheet metal work have been rising, and the durable goods orders show a rising trend.

Over the last 12 months, free cash flow (cash flow from operations less capital expenditures) has come in at $540 million, or 12.2% of Reliance’s current market capitalization. In 2007, it used $270 million to grow via acquisition and $82 million to repurchase shares. Even counting acquisitions as an alternative to capital expenditures, the free cash flow yield would be 6.1% — more than twice the current yield on five-year Treasuries. Modest growth from the acquisitions would allow for double-digit returns.

Reliance traded off somewhat when it reported earnings and guided to $1.50 to $1.60 per share in earnings for the June quarter. The consensus estimate prior to the report had been for $1.66, and it is currently $1.62. The guidance reflects uncertainty over demand and “flat to rising prices” and may thus prove conservative. Management was similarly uncertain when offering guidance for the recently reported quarter, and ended up beating estimates by 8 cents.

For the full year, earnings estimates continue to rise. Reliance is expected to earn $6.01 this year and $6.36 in 2009. Reliance’s nearest competitor, Worthington Industries (WOR) , is currently trading at 11.4 times forward earnings. At that multiple, Reliance shares could rise 20% to $72.50 over the next six to 18 months.

Disclosure: At time of publication, William Trent holds no financial position in the securities mentioned in this article.

Topics: Reliance Steel (RS), Worthington Industries (WOR) | No Comments

Credit Spreads Showing Modest Signs of Easing

The spread between the return on 10-year Treasuries and Baa-rated corporate bonds was 336 basis points last week. In historical terms, that is very high. In fact, the only times in the last 50 years that it was higher were the trough of the tech wreck and the 1982 recession/stagflation busting cycle.

interest-rates.jpg

High credit spreads make it harder for corporations to borrow and invest. As spreads widen, the economy tends to slow.

For investors, however, high spreads represent additional potential returns for a given unit of risk-taking. Peak levels of risk premia typically precede strong returns on risky assets – even if the strong returns are short-lived, as was the case in 2003.

Spreads have hooked down slightly as the credit woes that peaked following the Bear Stearns (BSC) debacle may finally be stabilizing. Time will tell whether that was “the” peak or whether the current easing is simply a lull.

Topics: Bear Stearns (BSC), Economy, Investment Services, Risk Premia | No Comments

CE: Celanese Beginning to Ramp

A couple of weeks ago, I wrote on Celanese (CE) for RealMoney, saying it could rise 40% simply by earning the average P/E in its industry.

Today Celanese increased its full year outlook for adjusted earnings per share to between $3.60 and $3.85 from its previous guidance range of between $3.40 and $3.70.

As I noted when I first wrote up Celanese a couple of weeks ago, consensus had already risen to $3.74. Although the stock is up 7% since that recommendation, an industry-average P/E multiple on that number would equal a $60 price for the stock, 33% above the current level.

Since I was away at the time the original article was published and thus failed to link to it, I am reprinting it below.

I’ve been taking a look at chemical maker Celanese, and I have to say I like what I see. I think the shares could rise 44% over the next year simply by expanding its P/E ratio to the average for its industry.

Originally based in Germany, Celanese was incorporated in Delaware in 2005. However, it continues to generate a significant portion of its sales outside North America. In 2007 the company earned 29% of its $6.5 billion in revenue in North America, 43% to customers in Europe and Africa, and the remaining 28% in Asia and the rest of the world.

Celanese is an industry leader in acetyl products and high performance polymers used in a wide variety of industries. The company competes primarily with BASF, Dupont (DD - Annual Report), Eastman Chemical (EMN), Dow Chemical (DOW), Rohm & Haas (ROH), and Air Products (APD). Celanese claims to be the low-cost producer in the industry, an assertion backed by its industry-leading profit margin and return on equity.

Sales rose 12% in 2007 due to favorable currency effects and rising prices. The latter trend has, if anything, accelerated so far in 2008.

Year/Year Percentage Change in PPI for Chemicals

chemical-ppi.jpg

Source: Bureau of Labor Statistics

Celanese has also shown itself to be shrewd when it comes to financial matters. Last year it took advantage of the then-favorable credit market to refinance $2.5 billion of debt, reducing its effective interest rates from approximately 10% to 175 basis points over LIBOR. It also borrowed to repurchase 1.5% of its shares, paying what now appears to be a bargain price of $30.50 per share in a Dutch auction.

The company recently authorized, and began to implement, a $400 million share repurchase. Based on their track record, the repurchase may indicate shares remain a bargain.

As an early cycle recovery play, there is of course some risk that a call on Celanese is… well… early. But I see no point in waiting around for a company that has beaten earnings estimates handily quarter after quarter. In the December 2007 quarter, the $0.93 per share earned compared to estimates of just $0.81. Since then, estimates for 2008 have risen from $3.66 to $3.74, and estimates for 2009 have expanded from $3.61 to $3.91.

The ongoing earnings surprises, surprisingly, have not resulted in an excessive valuation. At 11 times current year earnings, the price compares favorably to the industry average of 15.7 times, as reported by Hemscott. Its free cash flow yield of 4.3% is not eye-popping, but compares favorably to the current yield on five-year Treasuries.

I also think the earnings at Celanese are of higher quality than those of its peers. In fact, its 0% accrual ratio indicates that there is essentially no distortion being caused by accounting accruals, compared to reporting earnings on a cash basis.

If Celanese were to trade at the average P/E multiple for its industry, its shares could rise to $60 over the next year. That would mark a gain of nearly 44% from current levels.

I think there is limited downside due to its already low valuation. There is also potential technical support at the 50-day and 200-day moving averages, both within 10% of the current share price.

Disclosure: At time of publication, William Trent has no position in the companies mentioned in this article.

Topics: Air Products (APD), Basic Materials, Celanese (CE), Chemical Manufacturing, Dow Chemical (DOW), DuPont (DD), Eastman Chemical (EMN), Rohm & Haas (ROH) | 1 Comment

LXK: Lexmark Sells Less, Makes More

Printer manufacturer Lexmark International (LXK) said first-quarter quarter profit rose, beating expectations, helped by a 42 percent drop in inkjet printer sales.

You read that right. Since printer makers typically lose money on printers (hoping to make up for it in future sales of ink or toner) the fewer printers they sell in a given quarter, the more money they make.

Of course, if the model is working the lower sales today would translate into lower future profits, as the unsold printers will not require ink refills. Part of Lexmark’s current problem appears to be a decision by Best Buy (BBY) to at least temporarily eliminate Lexmark printers from their stores.

Lexmark still has lots of cash on the balance sheet and is now trading at a 12.3% free cash flow yield, which offers room for a decent return even if the company’s earnings decline over time. It remains, in my opinion, worth a look for value investors. However, it offers a bumpy ride – and I’d like to see it hold the 50 day moving average as evidence against the stock being a value trap.

Disclosure: At time of publication, William Trent has no position in the companies mentioned in this article.

Topics: Lexmark (LXK) | No Comments

COH: Coach Earnings In Line, Lack of Outlook Disappointing

Leather goods maker Coach, Inc. (COH) announced an increase of 19% in earnings per diluted share to $0.46 for its third fiscal quarter ended March 29, 2008, up from $0.39 per diluted share a year ago. The results were slightly ahead of expectations on both the top line and the bottom line.

At first glance, my only significant concern with the report is a faster rise in inventories than in sales. This could indicate sales running below expectations, the potential for future inventory clearance at reduced margins, or a number of other potential operational issues.

When I said Coach shares were selling on the bargain rack Coach had $900 million in cash and virtually no debt, so even the toughest recession should be survivable. With an enterprise value of just under $10 billion and $679 million in free cash flow (cash from operations less capital expenditures) over the last 12 months, its free cash flow yield of 6.8% offers a 400 basis-point premium over the current 5-year Treasury. That would almost justify buying the shares even if no growth were expected.

Since then cash has come down, apparently due to accelerated share repurchases. It repurchased and retired 11,349,802 shares of its common stock at an average cost of $28.85, spending a total of $327 million during the quarter.

Disclosure: At time of publication, William Trent has written put options against shares of Coach (COH)

Topics: Apparel and Accessories, Coach (COH), Consumer Cyclical | No Comments

The Case for the Semiconductor Rally to Continue

My latest column is up at RealMoney. In it, I explain why I think the recent rally in semiconductor stocks should continue.

First, as I have mentioned before, the supply/demand balance remains favorable.

Second, pricing power appears to be improving, based on the most recent PPI report.

I think the names that will perform best are those whose gross margins are currently depressed, as improving margins would result in accelerating earnings power.

Disclosure: At time of publication, William Trent holds shares of SMH and MXIM, as well as put options against the shares of LRCX.

Disclosure: William Trent has a long position in SMH.

Topics: Altera (ALTR), Cypress Semiconductor (CY), Intel (INTC), Marvell Technology (MRVL), Micron Technology (MU), ProShares Ultra Semiconductors (USD), Semiconductor HOLDRS (SMH), Semiconductors | No Comments

WFR: Can Tight Polysilicon Supply Really Result in Lower Prices?

According to Digitimes, Polysilicon spot price drops 20% in two weeks:

Most industry players buy expensive polysilicon because they have scrap materials to mix with it, the sources explained. Most of these scrap materials are sourced from semiconductor companies, with overall volume being very limited. The brisk demand from the solar sector has also led to a surge in the price of scrap materials from US$100-200 per kilogram in 2006 to US$200-300 per kilogram in 2007. The average price of scrap materials currently is above US$300 per kilogram.

Tight polysilicon supply, combined with favorable long-term contracts with solar players, is a key reason MEMC Electronic Materials (WFR) is my favorite semiconductor play. I think the current situation, where the price went so high as to actually reduce demand, will be short-lived. Longer term, the supply and demand will meet at a clearing price. As long as the price is a solid one, MEMC should benefit.

Disclosure: At time of publication, William Trent has no position in the companies mentioned.

Disclosure: William Trent has a long position in SMH.

Topics: MEMC Electronic Materials (WFR) | No Comments

HAS: Hasbro Looks Like it is Worth Watching

Earnings at toymaker Hasbro (HAS)  rose 14 percent in the first quarter on growth in brands such as Transformers and Littlest Pet Shop. The results beat expectations and drove its shares up almost 10 percent in morning trading.

Hasbro had recently shown up on my radar screen, and has several things going for it:

  • 2007 free cash flow of $510 million, good for a 10.4% free cash flow yield based on the current market value. Even using the average free cash flow of the last three years, the yield is more than 8%.
  • High earnings quality, with the difference between cash- and accounting-based earnings (as measured by the accrual ratio) less than 5%.
  • High earnings momentum, with rising estimates for the current and next fiscal years.

The stock has had a heckuva run since the January lows, but on a 12-month basis has gone essentially nowhere. It looks a bit overextended to me right now, but would probably look interesting on a pullback to the 50 day moving average – which is currently $28.17 and rising.

Disclosure: At time of publication, William Trent has no position in the companies mentioned.

Topics: Hasbro (HAS) | No Comments