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).

My latest post is up at RealMoney.

In it, I extend yesterday’s observations about the hidden strength in durable goods orders to specific industries that might benefit. Among those industries were primary metals, computers and electronic products, and motor vehicles and parts.

These industries may prove to be a good starting point for further research.

My latest column is up at RealMoney. Here is a summary:

Government economic reports can do more than just indicate the state of the economy. Since many of the reports include industry-level data, digging deeper in the reports can help investors find specific industries to consider more closely. For example, the Bureau of Labor Statistics, which prepares the PPI report, provides detailed information on an industry basis.

Since I wrote about the PPI data in September, the pricing power has shifted to some different industries. Therefore, I thought an update would be in order.

Some of the industries that look interesting are petroleum refineries, industrial gases, computers, computer storage devices, and line-haul railroads.

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

The following is a reprint of my December 12, 2007 RealMoney column

Printer manufacturer Lexmark, Inc. (LXK) started out this year at $73 and hasn’t looked back. Unfortunately, its motion has all been to the downside. Now less than half the stock it used to be, is it time to consider a nibble?

The stock is certainly cheap enough. Not only is it trading at a mere 12x expected earnings, $6.60 of the $34.50 current valuation is literally cash in the bank.

Over the last 12 months, Lexmark has brought in cash from operating activities totaling nearly $500 million and used less than $200 million for capital expenditures, resulting in free cash flow of $309 million and a FCF/Enterprise value yield of 11% - a very juicy premium to the current Treasury yield.

Of course, any juicy reward is bound to come with some risks, so let’s take a good hard look at those.

Second Fiddle

Even before Hewlett Packard’s (HPQ - Annual Report) recent resurgence, Lexmark was a distant runner-up in the printer business. Lexmark countered this position by forging an alliance with Dell (DELL) under which Lexmark makes all of the Dell-branded inkjet printers and half of their laser printers. Unfortunately for Lexmark, they inked that deal just in time for Dell to start its own tailspin.

Then, even if Hewlett Packard were to falter there are plenty of other competitors in the wings. First there are the traditional rivals like Seiko Epson (SEKE.Y) and Canon (CAJ), and Brother (BRTHY). Then, converging technologies have made competitors out of Ricoh (RICOY), Xerox (XRX), Samsung, and Kyocera Mita (KYO).

Declining Business

Everyone knows that obsolescence is a key risk for technology companies, and Lexmark is currently feeling the pain of the industry’s ongoing shift from inkjet to laser technology. I’ll let Lexmark explain it themselves (courtesy of the latest 10Q filing:)

Lexmark believes it is experiencing shrinkage in its installed base of inkjet products and an associated decline in end-user demand for inkjet supplies. The Company sees the potential for continued erosion in end-user inkjet supplies demand due to the reduction in inkjet hardware unit sales reflecting the Company’s decision to focus on more profitable printer placements, a mix shift between cartridges resulting in a higher percentage of moderate use cartridges and the weakness the Company is experiencing in its OEM business. Additionally, Lexmark expects to see continued declines in OEM unit sales, aggressive pricing and promotion activities in the inkjet and laser markets….

As the Company analyzes the situation, it sees the following:

• Some of its unit sales are not generating adequate lifetime profitability due to lower prices, higher costs and supplies usage below its model.
• Some markets and channels are on the low-end of the supplies generation distribution curve.
• Its business is too skewed to the low-end versus the market, resulting in lower supplies generation per unit.

Cheap Enough?If the risks haven’t sent you running for the hills, you are probably wondering whether the current share price is cheap enough to justify taking those risks. With the prospects for a decline in sales, earnings and cash flow being more than a distinct possibility, any price paid is going to have to be justified for a declining business.

The traditional valuation model says that value is equal to the cash flow in the coming year, divided by the difference between the company’s cost of capital and its growth rate. The 11% free cash flow yield I calculated above is a version of this model, and it provides the denominator in the equation: lexmark’s return, less its growth rate, should equal 11%.

Since the growth rate is negative, the return will be something less than 11%. If the current declines of approximately 3%, the implied return works out to 8%. That probably doesn’t sound like a huge payoff for many investors, but it is still a nice premium to Treasuries. Depending on the outlook for the rest of the market, value investors might find it worth a shot.

This article was originally published at RealMoney on September 26, 2007.

My article last week about mining the PPI report for stock ideas was so well received I thought I’d share another of my favorite taxpayer-provided idea generators, the durable goods report. Published by the U.S. Census Bureau, the report has a similar breakdown by industry of durable goods orders, shipments, inventories and backlog.  I came away with 28 potential ideas for further research.

In line with much of the recent economic data, the headline durable goods number was weaker than expected. To quote from the report, “New orders for manufactured durable goods in August decreased $11.3 billion or 4.9 percent to $219.5 billion, the U.S. Census Bureau announced today…. Shipments of manufactured durable goods in August, down two of the last three months, decreased $3.4 billion or 1.6 percent to $216.7 billion.”

But in this case, I think focusing on the forest means you could miss out on some of the more attractive trees. I gathered the data from the Census Bureau and created charts showing the year/year change in durable goods statistics for a variety of industries hoping to find some areas worth further consideration. Keep in mind, this is an initial screen for idea generation, not a full-fledged analysis of any of the names. You wouldn’t want to buy the stocks listed here without further research. That caveat aside, let’s look at some of the better performing industries.

First up is technology – computers and electronic products. Although 3.3% order growth year/year and essentially flat shipments may not be the type of growth investors typically look for from tech, it is a clear improvement from recent months. Inventories are starting to be drawn down and backlog remains strong.

But there are areas of strength and weakness within tech. Specifically, computers (and related products) themselves are starting to look strong, with backlog headed through the roof and inventories in check.

The fairly obvious stock ideas from this industry include Apple (AAPL), IBM (IBM - Annual Report) and Hewlett Packard (HPQ - Annual Report). If things keep getting better (and the company figures out how to file its required regulatory reports) Dell (DELL) might even look interesting again. Stretching a bit further, Sun Microsystems (a href="http://stockmarketbeat.com/blog1/category/tech/sunw/">SUNW - Annual Report) and Lexmark (LXK) come to mind. And don’t forget the storage plays, which also showed up on the PPI hotlist. The names I mentioned then were Brocade (BRCD), EMC (EMC - Annual Report), Iomega (IOM), Hutchinson (HTCH), Quantum (QTM), SanDisk (SNDK - Annual Report), Seagate (STX - Annual Report) and Western Digital (WDC).

Communications equipment is also showing some signs of strength. Though the latest month was down, the trend seems to be up.

I have actually analyzed Motorola (MOT - Annual Report), so that would be a play to include here. Cisco (CSCO), Research in Motion (RIMM), 3Com (COMS), Nokia (NOK) and Corning (GLW - Annual Report) also come to mind.

And finally, turning away from technology, I hope you didn’t think the aircraft boom was over. If anything, it looks to be picking up steam.

Ways to play this include Boeing (BA - Annual Report), Embraer (ERJ), General Dynamics (GD - Annual Report), United Industrial (UIC) and Cessna parent Textron (TXT). Parts suppliers include Rockwell Collins (COL), Curtiss Wright (CW - Annual Report), and LMI Aerospace (LMIA).

So there you have it: 28 potential stock ideas from what looked at first glance to be a negative report on durable goods.

Disclosure: Long RIMM put options at time of publication.

According to the Census Bureau’s durable goods report:

New orders for manufactured durable goods in July increased $12.9 billion or 5.9 percent to $230.7 billion, the U.S. Census Bureau announced today. This was the fifth increase in the last six months and at the highest level since the series was first stated on a NAICS basis in 1992. This increase followed a 1.9 percent June increase. Excluding transportation, new orders increased 3.7 percent. Excluding defense, new orders increased 4.9 percent.

The news was generally treated quite favorably, such as this article from Reuters:

Analysts polled by Reuters were expecting durable goods orders to rise by 1 percent. Non-defense capital goods orders excluding aircraft, viewed as an indicator of business spending, gained 2.2 percent, the steepest climb since March.

U.S. stock index futures and the dollar rose on the strong economic news, while government debt prices pared gains….

Orders for computers and electronic products and machinery posted their sharpest gains since November 2006.

All of which, I suppose, is true - on a seasonally adjusted, month-over-month basis. On the year/year basis I prefer, which should not require any seasonal adjustments, the picture is a little - just a little - darker.

There was a clear improvement - but in the longer outlook it wasn’t exactly breaking free of a downtrend and essentially resembled the September 2006 and April 2007 spikes that turned out to be head fakes. While it is certainly better than yet another decline, I’m not ready to throw a party. I did, however, shift the durable goods chit in my economic data table from the “bad and deteriorating” column to the “bad but improving” column. (By the way, subscribers can download my full spreadsheet with tables for all the major industry groups.)

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EconomicData

As to that spike in computers and electronic products, attribute it primarily to electronic products. The year/year change for computers continues to plummet.

Given the strength we’ve seen from several of the computer manufacturers, the data doesn’t bode well for Dell’s (DELL) earnings report this week.

Dell (DELL) reported preliminary results for the first quarter of fiscal year 2008, with revenue of $14.6 billion, operating income of $947 million and earnings per share of $0.34. Analysts were only expecting the company to earn $0.26 on $14.0 billion in revenue.

The company took deliberate actions to concentrate on solutions sales, realign pricing and drive a better mix of products and services in the quarter. While these actions slowed overall unit growth, a 14 percent year-on-year improvement in average selling prices contributed to improved gross margins, revenue growth of three percent and operating margins of 6.5 percent.

Three percent top line growth still pales compared to  Hewlett Packard’s (HPQ - Annual Report) results, but given the weak overall corporate spending on tech equipment isn’t too shabby.

In the quarter, gross and operating income margins were positively affected by a favorable decline in component costs.

Nothing like having your suppliers be in worse shape than you are to improve profitability, eh?

The company noted, of course, that not only this year’s numbers but last years are subject to revision based on the ongoing investigation into the company’s accounting practices. Investors must hope they can put the issue behind them once and for all, and sooner rather than later. For myself, not being able to trust the numbers is keeping me on the sidelines.

After the holiday on Monday, the Economic Calendar picks up toward the end of the week with two of the most important reports.

• On Thursday the Preliminary GDP figures will be released. Consensus estimates call for just a 0.8% gain.
• The Employment Situation report on Friday is supposed to show a net 135,000 jobs added to the economy.

Earnings all but over, Dell reports on Thursday. Not that it will have much to say.

One question I have had regarding DELL’s (DELL) recent slide is whether the horse that got them here has gone lame. In the past, DELL’s model was more efficient because declining prices meant that having a low inventory and no retail markup carried a large enough advantage to offset the cost of shipping the PC. Now, with the PC selling for $500 rather than $1,500 the shipping costs per unit are much higher and may actually make bulk shipments to retailers more cost effective than individual shipments to buyers.

When Dell’s first test was to open retail stores that were nothing more than showrooms I thought they were missing the point. The beauty of a direct model is that you can customize things the way you want, while the beauty of a retail store is that you can walk out a few minutes later with product in hand. Retail stores without instant gratification equal nothing more than a real estate expense. Dell soon came to the same conclusion.

Things are different now. Dell to sell 2 desktop PC models in 3000 Wal-Marts:

Computer marker Dell Inc. plans to start selling personal computers at 3,000 Wal-Mart (WMT - Annual Report) stores in the United States and Canada as of June 10, launching a major drive to sell its PCs through retailers, a company spokesman said on Thursday.

You don’t get any more retail than Wal-Mart. This should be a true test as to whether the sands have shifted in favor of mass distribution.

When we previewed earnings this week we said “Lexmark (LXK) - Estimates are doable but we’re always waiting for this company to trip up.” Right on cue, the company tripped up.

Lexmark reports first quarter results:

Lexmark International, Inc. (NYSE: LXK - News) today announced financial results for the first quarter of 2007. First-quarter revenue was $1.261 billion, down 1 percent compared to revenue of $1.275 billion last year. First-quarter earnings per share were $0.95. Earnings per share for the first quarter of 2007 would have been $0.96 excluding $0.01 per share restructuring-related charges. First-quarter 2006 earnings per share were $0.78. Earnings per share for the first quarter of 2006 excluding $0.31 per share restructuring-related charges and $0.06 per share pension curtailment gain would have been $1.03.

Consensus estimates called for $1.03 on $1.26 billion in sales. For next quarter the Street was expecting $1.00 in EPS on $1.24 billion in sales, which will also be missed:

In the second quarter of 2007, the company expects revenue to be down in the low- to mid-single digit percentage range year over year. It expects second-quarter 2007 EPS to be in the range of $0.82 to $0.92. EPS in the second quarter of 2006 were $0.74, or $1.09 excluding $0.35 per share restructuring-related charges.

Challenges included OEM unit sales that continued to be weak, declines in inkjet supplies sales, and hardware pricing that was fairly aggressive in both laser and inkjet markets,” [CEO Paul] Curlander said.

In particular, the OEM with the weak sales is Dell (DELL), with whom Lexmark has a distribution arrangement. Given the well-known weakness at Dell it is somewhat surprising Lexmark shares had done as well as they did. Our experience with Lexmark over the last four years has taught us that the only thing we can count on is not to count on anything.