On May 6, Fast Money asked “Is The Housing Crisis Over?” Guy Adami said the best trade was:
I think the best trade is Home Depot (HD - Annual Report) adds Guy Adami.
Disclosure: At time of publication, William Trent holds no financial position in the companies mentioned in this article.
My latest column is up at RealMoney.
I think Rent-A-Center (RCII) can benefit from the slowdown in consumer spending and the tightening of credit standards.
If Rent-A-Center were to receive the same price-to-book multiple as Aaron Rents, it could trade above $28 per share today. While I don’t believe that will happen overnight, over the next five years Rent-A-Center could see high-single-digit earnings per share growth and also expand its price-to-book multiple to the 1.9 level. The combination of earnings growth and valuation expansion could generate annual returns averaging 15% or more.
Here’s how the company scores on the Stock Market Beat models:
Disclosure: At time of publication, William Trent has no financial position in the companies mentioned in this article.
My latest column is up at RealMoney.
I dissect the jobs report to see which industries are showing the best/worst growth in new hiring, on the thesis that companies in these industries may present investment opportunities.
The fastest growing industries are restaurants, hospitals, mine services, machinery, and oil & gas extraction. The worst were transportation equipment and a plethora of housing-related sectors.
Disclosure: At time of publication, William Trent owns shares of Starbucks (SBUX).
Disclosure: Author is long Starbucks (SBUX) at time of publication.
This article is a reprint of my December 19, 2007 RealMoney column.
An Update of My September 2007 Stock Picks
I wrote six articles in September that included a bullish or bearish stock opinion, and with three months behind them I thought it was a good time to see how they performed and whether any changes were warranted. On the whole, the picks are playing out more or less as planned.
Motorola
On September 10, I wrote that if Motorola (MOT - Annual Report) could get to 2004 free cash flow levels and grow the cash flow a measly 2% per year from there Motorola shares would be worth nearly $23.
Instead, the cash flow position has continued to deteriorate, contributing to former CEO Ed Zander’s recent ouster. The stock is down 7.2% since the article was written, compared to just a 0.5% decline in the S&P 500.
Still, I think the issues at Motorola can be fixed by bringing the costs - particularly research, development and overhead - in line with the current revenue generation. Alternatively, activist shareholder Carl Icahn could push to break the company up into smaller pieces that might be acquired for a higher total than the current company is currently able to garner. Either way, I’m sticking to my guns on Motorola.
Yahoo
On September 11 I made a bearish call on Yahoo! (YHOO), saying I didn’t believe in the consensus growth estimates and that Yahoo isn’t generating enough cash flow today to make waiting for the recovery worthwhile — at least not for me.
Things haven’t gotten any better since then, and the stock has lost 1.1% - although that is a slightly better performance than the 1.7% loss in the S&P over the same period. I remain bearish on Yahoo.
Office Depot
On September 12, I made a bearish call on Office Depot (ODP), saying “things are likely to get worse before they get better.” Things got worse, and after the company missed earnings and delayed filing its required 10Q the stock has lost 23.3%, compared to a 1.7% decline in the S&P 500.
But I also said “it looks like a stock that will pay off in the end,” and I think the current downturn may have taken the worst out of the stock. I have written put options against the shares (a bet that has lost money) and I think there are more reasons to be positive than negative.
Think the worst of the housing downturn is over? Office Depot’s solid cash flow should make it a safer play than homebuilders or financials. Think small-business tech spending will rise? Office Depot’s P/E is a fraction of Dell’s (DELL).
Office Depot could still have some downside, and I don’t expect a quick recovery. But at current valuations I can no longer justify a bearish position, so I’m closing out that call.
Delta Airlines
On September 17 I made another bearish call, this time against Delta Airlines (DAL). Although the stock looked cheap, after I made some adjustments for earnings quality it looked more like a company recently emerged from bankruptcy (which it is.) The stock has lost 17.7% since that call, compared to a 2.1% decline in the S&P.
Short term, anything can happen as airlines have tons of leverage that can lead to wild swings in profitability in pricing. But long-term I don’t think the major airlines have any better prospects than they did before the previous 10 or so bankruptcies, and I remain bearish.
Apple
I weighed in favor of the bulls for Apple (AAPL) on September 17, and was rewarded with a 32.5% increase in the shares, compared to the 2.1% loss for the S&P 500. The share gains cut Apple’s 3.9% free cash flow yield down to 2.9%, so it isn’t the value it was then.
Still, the cash flow rose 250% from the prior year, and Apple’s market share remains small for most of its product lines. The company continues to make desirable products, and if I have to take a chance on a tech name surviving an economic downturn it might as well be Apple.
Adobe
My last September stock pick was a bullish call on Adobe (ADBE) on the 18th. The stock always seems to sell off after a major product introduction such as the Creative Suite launch in May of this year. Investors tend to sell on that news after buying up the shares in anticipation of it.
Although the sell-off wasn’t very pronounced this year, the shares did get stuck in neutral. My own call may have been a bit early, as the shares are down 6.3% since the article and the S&P is only down 4.9%.
On their earnings call, the company reiterated their guidance for next year. As the next product cycle moves closer, I think my bullishness will pay off.
Disclosure: William Trent owns shares of Adobe (ADBE) and has written naked put options against the shares of Office Depot (ODP).
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William Trent currently has a short position in put options related to Office Depot (ODP).
When I wrote about Office Depot (ODP) in September I said “an investment in Office Depot will require patience and possibly a strong stomach, as things are likely to get worse before they get better.”
Not being one to follow good advice, I wrote put options on the stock.
Good thing I have patience and a strong stomach, as things got worse today.
William Trent currently has a short position in put options related to Office Depot (ODP).
Office Depot (NYSE:ODP) announced that it has delayed its third-quarter earnings release, previously scheduled to take place on October 30, 2007. The delay is due to an independent review by the Audit Committee of the Company’s vendor program funds. The review relates principally to the timing of the recognition of certain vendor program funds.
A little over a month ago I said an investment in Office Depot will require patience and possibly a strong stomach, as things are likely to get worse before they get better. The stock, of course, started rallying almost immediately. Today’s news may test investor’s stomachs.
Disclosure: William Trent has written naked put options against shares of Office Depot (ODP).
William Trent currently has a short position in put options related to Office Depot (ODP).
This article was originally published at RealMoney on Sept. 14, 2007.
I’ve always had a soft spot for Office Depot (ODP), where I served my MBA internship. So when I noticed that a sales and earnings speed bump has put the stock in the 50% off bin, I thought I should check it out more closely. After all, at 10x earnings it certainly looks cheap enough. Its primary competitor Staples (SPLS) has weathered the storm far better but trades at a significantly higher earnings multiple. OfficeMax (OMX) has been hit nearly as hard as Office Depot, but also sports a higher valuation.
That comparison begs an obvious question: is Office Depot cheaper than those companies because it is doing much worse than they are? To some extent this is certainly true, as Staples’ same-store sales have been trending down 2% while Office Depot’s are down 5%. OfficeMax has actually seen positive comps, but that is at least partially driven by having closed more than 100 underperforming stores. At any rate, it seems safe to say the whole group is doing poorly but Office Depot’s lower valuation is at least partially merited by virtue of it doing even worse.
At the Goldman Sachs conference last week, management discussed the impact of a slowing housing market, which has apparently been affecting the home-based businesses that constitute a portion of office superstore sales. The company explained that the change in store sales is strongly related to local housing inventory and the number of days houses stay on the market. Since Office Depot has a larger concentration of stores in Florida and California - two of the hardest-hit markets - this may explain much of the underperformance, and is supported by the fact that the biggest drops have been in the furniture category. However, it also suggests that things may get even tougher for all of the office suppliers as the housing decline continues to spread. Fortunately the international business continues to grow, and accounted for more than 25% of total revenue in the latest quarter.
So that brings me to the financial nitty gritty. Is the valuation cheap enough to merit a long-term investment, or is it still time to stay away from a falling knife? Although net income is still up year-to-date, cash from operations is down - and that dichotomy is often a warning sign. The difference has been working capital investments. Inventory on hand has crept up to 54 days from 52 last year, but receivables are down a bit. It looks like the timing of tax payments was the main culprit, which makes me a little less concerned about the decline.
Even in the face of the downturn, the company has generated $636 million in cash from operations over the last 12 months. The pressure is expected to continue into the third quarter but should start to ease next year, if only because the comparisons will be easier. It used up nearly $450 million on capital expenditures and is expected to continue spending about $500 million annually - mostly on store openings and remodels. I estimate that of that, about $200 million is going to new stores and the rest is required maintenance. Since the new stores are presumably expected to boost future cash flows, the “no-growth” free cash flow stands at about $325 million per year, a 5.8% free cash flow yield on the current enterprise value. It doesn’t take much growth from there to get to an enticing total return.
What’s more, if this worst-case scenario does unfold the company has shown that it has the discipline to act on it. Office Depot has already reduced planned store openings to 100 this year (from an initial plan of 150) and 125-150 next year (from initial plans of 200).
Office Depot has also been buying back shares (although in retrospect they were paying too much for them.) The share count is down nearly 6% from one year ago, and further buybacks will help soften the EPS blow during the downturn as well as provide leverage to the recovery.
All that said, an investment in Office Depot will require patience and possibly a strong stomach, as things are likely to get worse before they get better. It looks like a stock that will pay off in the end, but there are probably some names that will pay off sooner.
William Trent currently has a short position in put options related to Office Depot (ODP).
This article was originally posted at RealMoney on Sept. 11, 2007.
As I noted in my Motorola column, I like to take a look at the stocks with unusual option activity on StockPickr to see if there is anything sufficiently interesting to investigate further. Friday’s list was a doozy, with heavy activity listed for deep out-of-the-money October calls for Motorola (MOT - Annual Report), Arch Coal (ACI) and Yahoo! (YHOO). Having found a possible long-term bargain in Motorola I turned my attention to Yahoo! to see if I could pull a two-fer. Alas, it looks as though I may have bagged my limit.
Unlike Motorola, Yahoo! has no chance at a bloodletting fire-the-CEO rally (justified or not) because it has already happened. Instead, any hopes for a short-term pop in Yahoo! shares are probably underpinned by the persistent buyout rumors, with Microsoft (MSFT - Annual Report) and EBay (EBAY) being the buyers most frequently bandied about. But the problem with those rumors is they have been around forever, and so far smoke has yet to signal fire. Anybody buying the name in hopes of a buyout should therefore be prepared (and paid) to wait.
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.
I know, I know - that’s all just academic theory. So let’s consider Yahoo’s businesses to get a feel for what the company can do to boost that ROE and ramp up the earnings growth. According to the latest 10Q, fee-based businesses such as premium mail, web hosting and premium Flickr accounts contribute just 12% of revenue. While they may grow, it is hard to imagine them growing enough to move the needle. That leaves “marketing services” such as HotJobs and display advertising. Somehow, the latest employment report leaves me less than fired up about HotJobs’ prospects. As for display advertising, financial services firms have accounted for anywhere from 12% to 30% of online advertising. A good chunk of that is mortgage refinancing and credit cards - both of which seem likely to suffer as credit standards return to historic norms.
Yahoo! is a great company, with a balance sheet strong enough to carry them through any downturn in the online advertising market. But they aren’t generating enough cash flow today to make waiting for the recovery worthwhile - at least not for me. There are other companies out there that look like safer bets. While Yahoo! could very well return to growth, it just looks too hard to earn a return high enough to compensate for the risk.
According to the Census Bureau ADVANCE MONTHLY SALES FOR RETAIL AND FOOD SERVICES:
The U.S. Census Bureau announced today that advance estimates of U.S. retail and food services sales for August, adjusted for seasonal variation and holiday and trading-day differences, but not for price changes, were $377.6 billion, an increase of 0.3 percent (±0.7%)* from the previous month and 3.7 percent (±0.8%) above August 2006. Total sales for the June through August 2007 period were up 3.8 percent (±0.5%) from the same period a year ago. The June to July 2007 percent change was revised from 0.3 percent (± 0.7%)* to 0.5 percent (± 0.2%).
The 3.7% year/year gain is an improvement from 3.2% in July. Still, looking at the longer-term trend it is too early to call an improvement. Furthermore, with CPI running 2.4% year/year the real retail growth is still pretty light.
I’m sticking to my previous characterization: Good but deteriorating.
Key indicators for business spending include corporate profits and the cost of borrowing. Both have been favorable for years, yet businesses have focused more on cutting costs than on developing their infrastructure. With borrowing costs rising (at least in terms of the spread between Baa bonds and treasuries) I thought it another good opportunity to read the tea leaves from some recent conference calls.
Tech Data (TECD) starts things off on a positive note.
Looking at the Americas, our net sales exceeded our internal growth expectation which called for growth in the mid single digit range through strong execution and focused sales and product management efforts we want incremental business in the second quarter that boosted our growth rate to over 16% in the region, while still delivering our targeted operating margin. This double digit net sales growth was broad based with growth across virtually all of our product and customer segments….
Our Q3 business outlook calls for low double digit year-over-year growth in the Americas and flat to low single digit growth in Europe on the local currency basis.
(Excerpt from full TECD conference call transcript)
Staples (SPLS) is running into some tough spots.
Our North American retail business again experienced softer than expected sales during the quarter with same-store sales down 2% and total sales up 5%, which led to only a modest increase in the bottom line. Our North American delivery business continued to gain market share with top line growth of 16% and operating income of 18%. Finally, we’re happy with the strong improvement we’re seeing in our international business, where total sales were up 18% in U.S. dollars. That’s 11% in local currency. Same-store sales grew 7% and operating margin jumped 225 basis points to 1%.
So while we were very pleased with our results in North American delivery and international, it’s clear we’re operating in a tough retail environment in North America….
We had strong growth in copy center, laptop computers, ink and software, but these gains did not make up for negative comps in furniture, supplies, and tech durables.
(Excerpt from full SPLS conference call transcript)
And since both Staples and Tech Data source a good percentage of their tech products from Hewlett Packard (HPQ - Annual Report) it is important to get their take on the situation as well.
Moving to PSG, we shared an outstanding quarter with excellent revenue growth, market share gains in every region and strong margin performance. Revenue increased 29% year-over-year to $8.9 billion with unit shipments up 33% and double digit revenue in unit growth in every region. These results bring PSG’s year-to-date revenue growth to nearly $5 billion. We have a strong momentum driven by our notebook business which grew revenues 54%, and units 71% versus the prior year period. According to our estimates for the second calendar quarter, we increased HP’s notebook market share lead by over 5 points versus the prior year….
We now expect Q4 revenue to be approximately $27 billion to $27.2 billion, growing roughly 10% to 11% year-over-year. While the sequential increase of 6% to 7% implied by our guidance is less than the historical 10% to 12%, we do not believe it is prudent to set investor expectations that our Personal Systems business can continue to grow at almost three times the market rate, nor do we think it appropriate to build a cost structure on that basis.
(Excerpt from full HPQ conference call transcript)
There don’t seem to be too many signs of weakness, although the GDP numbers suggest there is. I’d argue for cautious optimism regarding tech spending over the next few quarters despite the rise in corporate interest spreads.
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