Archive: August, 2008

Order Cancellations

Econoday has an article out today showing the relationships between the durable goods accounts: shipments, new orders, backlog and inventory. They note that there are now some signs of order cancellations, which demonstrates that the apparent strength shown by strong new orders in recent months was somewhat illusory.

A major risk for the outlook is that aerospace backlogs are making up an unusually high proportion of total backlogs, now at 43 percent vs. 35 percent only four years ago before recovery in the airline sector began to feed a rush of Boeing and Airbus orders. But the airline sector is, as are many other sectors, now slowing, putting pressure on the finances of airlines and raising questions over their commitment to prior orders. To close, the graph below tracks year-on-year percentage changes between unfilled orders for aircraft (black) and total unfilled orders (red). –Mark Pender, Econoday senior financial writer

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OMI: Is Owens and Minor a Major Bargain?

This is a reprint of my 25 August 2008 RealMoney column.

Owens & Minor (OMI) is the nation’s leading distributor of medical and surgical supplies to the acute-care market. It’s also a health care supply-chain management company and a national direct-to-consumer supplier of testing and monitoring supplies for diabetics.

Most of its revenue is derived from fees based on a percentage of the value of products distributed, but 32% of its revenue is contracted on the basis of the company’s costs. Its primary competitor in medical/surgical distribution is Cardinal Health (CAH) . In the direct-to-consumer diabetes supply business, its largest competitor is Liberty Medical, a subsidiary of MedcoHealth Solutions (MHS) .

Owens & Minor has been establishing a track record of earnings surprises, beating analysts’ estimates in each of the last three quarters. Analysts are beginning to reward the company with higher full-year 2008 and 2009 estimates, which now stand at $2.36 and $2.64, respectively. By contrast, estimates for MedcoHealth have been steady, and those for Cardinal are falling. Owens is expected to post higher revenue growth than its peers, and that may account for the differential in earnings trends.

Over the next three to five years, the consensus among analysts is that OMI earnings per share can grow 18% annually. Much of this growth is likely to come from acquisitions, such as its recent agreement to purchase privately held Burrows. Given the uncertainties surrounding the timing of acquisitions and the fact that they will likely require additional investor financing, my valuations are based on a more conservative 10% growth rate, in line with the company’s sustainable growth rate. Combined with a 1.7% dividend yield, the double-digit total return potential isn’t too shabby — and the acquisitions could provide a boost to that, if and when they materialize.

Better still, the growth has a backstop in the form of strong cash-flow generation. Over the last 12 months, Owens & Minor generated free cash flow (cash flow from operations less expenditures on capital assets and software) of $190 million — a whopping 10.5% of the company’s market capitalization. Over the last year, most of the free cash flow has been used to pay down debt. Long-term debt was $369 million in June 2007, but it declined to $221 million by June 2008. The debt reductions free borrowing capacity for larger acquisitions, or alternatively the company could turn to share repurchases as debt levels decline further.

For a company growing 10% annually, I believe the 10.5% free cash flow yield represents a huge risk premium. By contrast, the free cash flow yields at Medco and Cardinal are less than 5%. I don’t see why a company with this growth profile should yield more than 6%, which would still be twice the current yield on five-year Treasuries and a premium to the cash flow yields of its peers. Were it to trade at a 6% free cash flow yield, the shares would be at $75, which is 65% above the current level.

That’s not the kind of valuation change I’d expect to see overnight. Over the next few years, however, I believe it is likely. Even if it took five years for the valuation to converge with that of its peers, the total return would exceed 20% per year.

Overnight or over time, those kinds of returns look good to me.

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

Topics: Cardinal Health (CAH), MedcoHealth Solutions (MHS), Owens & Minor (OMI) | No Comments

Corporate Profits

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LPNT: Are Analysts Missing the LifePoint?

The following article is a reprint of my 26 August 2008 RealMoney column.

Since 2001, hospital stocks have been looking green around the gills. Shares of LifePoint (LPNT) , Universal Health Services (UHS) and Community Health (CYH) have pretty much gone nowhere. Tenet Healthcare (THC) and Health Management Associates (HMA) look even worse, having lost more than 50% of their value.

That may be about to change. As I have noted before, employment statistics show hospitals as being one of the few industries reporting significant hiring. Unfortunately, I believe the lean years have left analysts who are covering the stocks too shell-shocked to notice improving fundamentals.

Evidence of the high degree of skepticism can be found in a Forbes article published on Aug. 8, when LifePoint issued a positive earnings report and raised guidance. The article focused on declining admissions and fears that a sinking economy could increase bad-debt expense. JPMorgan analyst Dawn Brock was quoted as saying, “We are concerned about the sustainability of margins given the weak admissions growth, especially as we do not believe the company can continue to see bad debt improvement given the overall macro environment.” Stifel Nicolaus analyst Robert Hawkins said the company had done a poor job of managing its expenses.

Investors weren’t listening to the analysts. LifePoint shares soared 10% on the increased guidance and have held steady since. I believe the company’s strategy may finally get the shares out of their multiyear rut. If I’m right, the analysts covering the name will probably be the last to hear about it.

Better Than Its Price

LifePoint operates hospitals in non-urban communities in 17 states. Of the company’s 48 hospitals, 44 are in communities where LifePoint is the sole community hospital provider. Its strategy is to increase the services available at such hospitals to capture more of the revenue opportunity in these communities. On the recent conference call, LifePoint CEO Bill Carpenter said that “early deep dive hospitals have already through the first six months of the year met or exceeded their full year 2008 targets.”

Even after the 10%, rally the shares certainly don’t seem excessively priced. At less than 13 times the 2009 consensus earnings estimates, many would likely consider them cheap. Given that the company has exceeded earnings estimates in three of the last four quarters, the current consensus estimates could be too low. That would make the shares cheaper still.

The earnings also translate into strong free cash flow, measured as cash from operations less capital expenditures. Over the last 12 months, LifePoint’s free cash flow totaled $127 million, or 6.9% of the company’s market capitalization. With five-year Treasuries yielding barely more than 3%, that represents a pretty healthy risk premium, even before considering growth opportunities due to the company’s strategy.

Analysts expect LifePoint to increase earnings by 10% annually over the next three to five years, a rate that is in line with the company’s sustainable growth rate on the basis of fundamentals. Meanwhile, at 1.2 times book value, it is trading well below the industry average of 2.1 times.

If earnings grow as expected and the price/book multiple expands to the industry average multiple over the next five years, total returns could approach 25% per year.

Maybe by then the analysts will have caught up to the story.

Topics: Health Management Associates (HMA), Tenet Healthcare (THC) | No Comments

Motor Vehicles and Parts

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Source: U.S. Census Bureau, Durable Goods Report

Topics: ArvinMeritor (ARM), BorgWarner (BWA), Genuine Parts (GPC), Lear (LEA) | No Comments

Semiconductor Shipments

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Source: U.S. Census Bureau, Durable Goods Report

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Durable Goods Orders – Machinery

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Flight to Safety

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JAH: Can Jarden’s Niches Translate to Riches?

This article is a reprint of my August 19 2008 RealMoney column.

Can a market leader in clothespins hang short-sellers out to dry? Investors in Jarden (JAH) may soon find out. The company has acquired a portfolio of leading brands in outdoor and consumer products that includes Sunbeam, Oster, Coleman, Rawlings and Mr. Coffee. I think these market leaders, sold in a wide range of stores, are generating more than enough cash flow to service debt and fuel additional growth, making life uncomfortable for their considerable short float.

According to its latest 10K, Jarden is now a leader in a variety of categories, including (deep breath) alpine skis and bindings, snowboarding and snowshoeing, baseballs, bats, softballs and gloves, camping gear, cordage, firelogs and firestarters, soft baits, rods, reels and combos, home canning, home vacuum packaging, matches and toothpicks, personal flotation devices, playing cards, boxed plastic cutlery, selected small kitchen appliances, warming blankets and a number of other branded consumer products. (Does that give you an idea of the breadth of their product lines?)

The 2007 acquisitions of K2 and Pure Fishing helped make outdoor solutions the company’s largest business segment. Unfortunately, they also helped saddle the company with $2.8 billion in total debt just as the consumer slowdown began in earnest. Investors headed for the exits, sending the shares down by nearly half since last summer’s peak. Short-interest stands at nearly 23% of the floating shares.

I think the shorts may now be pressing their luck. For example, some investors consider Jarden’s high exposure to Wal-Mart (WMT - Annual Report) a cause for concern. However, judging from last week’s earnings report, Wal-Mart looks like exactly the place to be supplying these days.

Meanwhile, I think the same credit crunch that is giving investors such concern is likely to prove the remedy for their concerns. If Jarden does not have additional access to debt, obviously the debt load won’t get any bigger — and they can use their cash flow to reduce the current debt load while waiting for the market to improve.

And quite a flow of cash it is. Over the last 12 months, the company’s operations generated $402 million in cash flow and required just $89 million to build and maintain productive capacity. The remaining $313 million can be used for anything the company wants. Historically, it has been acquisitions, but in the current environment, I’m betting they will clean up the balance sheet.

Finance theory says there shouldn’t be a difference in the value of a firm based on whether it is financed by debt or by equity. But we all know that theory and reality don’t always mesh. Last year when debt was cheap, the sensible thing to do was to grow by borrowing money to acquire other companies, and that’s what the company did. This year, with the debt load higher by $1 billion, and the market capitalization $1.5 billion lower, the debt/equity ratio is all out of whack. I think nervous investors have taken the market cap lower than is justified by the cash flow, and that each dollar used to repay debt will increase the value of the company by more than one dollar as investor concerns subside.

Without any further growth in cash flow, I think a strong debt reduction effort could increase the market capitalization from $1.9 billion today to at least $2.2 billion next year and $2.5 billion the following. While that would not be sufficient to restore the stock to its previous highs, the 15% annual returns and $33 potential value after two years are well worth the effort. Jarden management did the right thing in last year’s credit environment, which leads me to believe they will do the same in this one.

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

Topics: Jarden (JAH) | No Comments

NCS: Contrary on Construction with NCI Building Systems

This article is a reprint of my 14 August 2008 RealMoney column

I know, I know … the construction industry should not be touched with a 10-foot pole right now. But the depth of conviction investors have in that belief sends my contrarian side looking for names that might buck conventional wisdom. I didn’t have to look far to find one.

Despite a market capitalization under $800 million, NCI Building Systems (NCS) is one of North America’s largest integrated manufacturers and marketers of metal products for the nonresidential construction industry. With 44 manufacturing facilities located in 18 states and Mexico it sells metal coil coating services, metal components and engineered building systems, offering one of the most extensive metal product lines in the building industry.

The metal-coil-coating segment cleans, treats, paints and slits continuous steel coils before the steel is fabricated for end use. The metal-components segment sells metal roof and wall systems, metal partitions, metal trim, doors and other related accessories. The engineered building systems segment manufactures mainframes and Long Bay Systems, and includes value-added engineering and drafting. This last segment is both the largest and the highest-margin business for NCI.

NCI management pursues a four-pronged strategy of (1) developing new markets and products; (2) successfully identifying strategic growth opportunities; (3) controlling operating and administrative costs; and (4) managing working capital and fixed assets. The limited focus seems to be working.

New market opportunities include the shift toward metal roofing systems from conventional tar and gravel systems. Though more expensive to install, metal roofing systems are more durable and require less maintenance. As a result, they are gaining share in commercial-building applications.

For NCI, “strategic opportunities” means just that. The 1998 acquisition of Metal Building Components Inc. doubled its revenue base, making the company the largest domestic manufacturer of nonresidential metal components. The 2006 acquisition of Robertson-Ceco II Corporation resulted in product and geographic diversification, a stronger customer base and a more extensive distribution network.

Control over operating and administrative costs is exemplified by the fact that SG&A expense declined from 18.1% of revenue in the first half of 2007 to 17.7% in the same period this year. Meanwhile, working capital has been reduced, as have expenditures on fixed capital.

The operational discipline is translating into financial success. Sales in the second quarter grew 13.1% from the year-ago period. The $0.76 in earnings per share reported far exceeded the consensus analyst expectation. The company also narrowed its guidance for full-year 2008 earnings per diluted share to $3.19 to $3.44, compared to the prior consensus estimate of $2.90 per share. Estimates for 2009 were subsequently boosted from $2.88 to $3.39.

Over the last 12 months, NCI has generated $114 million in free cash flow (measured as cash from operations less capital expenditures). At 14.6% of market capitalization, the free-cash-flow yield is enticing enough that I don’t really require any growth to justify an investment. I could even tolerate some declines in cash flow, particularly if they were of a temporary nature related to the economic cycle.

Analysts, however, expect the company to grow 13% annually over the next three to five years. I think that estimate is probably too high — at least without tapping external financing. The sustainable earnings growth rate based on ROE is closer to 11%. With a 1.3 price/book multiple (in line with the industry average) and a P/E of just 11.5, I think the valuation is more than reasonable.

I think the shares could trade to a free-cash-flow yield of 10%, which would ultimately justify a $58 share price (45% above the current level), based on the most recent year’s free cash flow. While this may take some time to play out, I think double-digit returns over the next three to five years are quite possible.

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

Topics: NCI Building Systems (NCS) | No Comments