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.

This article was originally published at RealMoney on October 17, 2007.

Last month I showed how investors can generate investment ideas by using the Producer Price Index (PPI) report prepared monthly by the Bureau of Labor Statistics. The idea is that industries where prices are rising may contain companies where revenue will grow faster and/or margins will improve.

Of course, like any initial screen the PPI report is only a starting place. It is useful to generate ideas, but further research is needed to determine whether they are good ideas. This month, I do some of that further research.

In the technology sector, prices almost never go up. But sometimes they decline at a slower rate than normal, which tends to have the same effect on sales growth and profit margins.

Last month I noted that the year/year price declines for computer storage devices were the lowest they had ever been. Although pricing ticked down in September from that level, it is still one of the strongest readings on record.

Source: Bureau of Labor Statistics

There are plenty of ways to play this one, including Brocade (BRCD), EMC (EMC - Annual Report), Iomega (IOM), Hutchinson (HTCH), Quantum (QTM), SanDisk (SNDK - Annual Report), Seagate (STX - Annual Report) and Western Digital (WDC). It will require a closer look to see which ones seem like the best bets.

Brocade beat earnings estimates last quarter, and although they said the industry remains competitive the competition didn’t seem to be hurting pricing. On their conference call, Brocade noted that “From a pricing perspective, the pricing environment for the past several quarters has been more favorable than historical levels. While we believe ASP declines may eventually return to mid single-digits per quarter, as competitors ramp their new product offerings, our current outlook is for a relatively benign pricing environment in Q4, with ASP declines once again in the low single-digits.”

The competitive environment for storage continues to be mitigated by consolidation. Brocade bought McData, Seagate bought Maxtor and EVault, and Quantum’s purchase of Advanced Digital Information Corp. has since been followed by the Western Digital/Komag merger.

The buzz around EMC has almost entirely been around its holdings of VMWare (VMW), but that is far from all the company has to offer. Compared with the second quarter of 2006, EMC systems revenue increased 18% year-over-year, led by strong revenue growth from the company’s mid-range information storage products. EMC systems revenue represented 43% of total second-quarter revenue. However, on the conference call management said the pricing environment has always been competitive and that they “don’t see any significant sea change here in the pricing environment.”

Iomega saw 46% year/year revenue growth and an increase in gross margins from 16.7% last year to 20.5% this year. That would seem to support the pricing power hypothesis but nobody seemed to notice much. Although the stock rallied ahead of that report it has gone nowhere since.

Hutchinson is one of the disk drive industry’s top suppliers. They actually bucked tech industry norms and raised prices. “Overall average selling price in the fiscal 2007 third quarter was $0.80, compared with $0.79 in the preceding quarter and $0.84 in the fiscal 2006 third quarter. The increase in average selling price compared with the preceding quarter resulted from a higher percentage of newer products in the fiscal 2007 third quarter sales mix. “We expect our average selling price to be flat to slightly up over the next year as our sales mix continues to shift to a higher percentage of newer products,” said [CEO Wayne] Fortun.” How’s that for evidence supporting the PPI report? You wouldn’t guess it from the way the stock has acted over the last year.

Quantum’s GAAP gross margin rate was 31.8 percent, a significant increase over the 27.9 percent rate in the same quarter last year and its best performance in three years. Seagate also beat estimates.

Western Digital raised guidance, and gives credit to improved pricing power. “Western Digital also said its gross margin should hit 17.5%, rebounding from lows in previous quarters and above its prior estimate of 15.5%. The change reflects firmer pricing power after years of price wars with Seagate and Asian rivals like Hitachi.”

The only company that didn’t confirm the PPI result was SanDisk, which operates in a different segment of the storage market. Sandisk’s average price per megabyte sold declined 65% on a year-over-year basis and 26% sequentially.

Other than SanDisk, however, the ideas generated from the PPI report seem very fruitful. Depending on whether you like small caps, large caps, value, momentum or low price strategies there is likely a storage name for you.

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.

Originally published at RealMoney on September 19, 2007.

Tony Crescenzi says the latest PPI report should be tossed because the benign headline reading will almost certainly be reversed in the months ahead owing to the surge in energy costs that has occurred of late. I say not so fast! If prices are rising, that means some companies out there are likely to see better profits. Before tossing out the report, I’m betting we can figure out who a few of them will be.

The Bureau of Labor Statistics, which prepares the PPI report, provides detailed information on an industry basis. The problem is figuring out how to find it on their web site. Starting at the PPI home page, I scroll down to the headline that says “Get Detailed PPI Statistics” then click on Industry Data. You can then pick out which industries you want to see (I pick ‘em all) and click “Retrieve Data.” Then I select “More Formatting Options” and click on the boxes for 12-month percent change, all years, and include graphs. Once I hit “retrieve data” again I have what I’m looking for - graphs that make it easy to tell which industries are gaining or losing their pricing power.

First up is the fruit and vegetable canning industry. At 5.3% year/year inflation, pricing is clearly better than normal. It is down from a recent peak but still looks to be generally in a rising trend.

Possible plays on this industry include can makers such as Ball Corp. (BLL), Crown Holdings CCK - Annual Report), or Silgan (SLGN - Annual Report). Or you can go to the food processors such as Campbell Soup (CPB), Del Monte (DLM - Annual Report), Hain Celestial (HAIN), or HJ Heinz (HNZ).

Looking better still are industrial valves, up 9.3% year/year against tough comparisons.

Some of the industrial valve makers include Flowserve (FLS), Crane (CR) and Curtiss Wright (CW - Annual Report).

But enough with boring “old” industries. How about tech? It is seldom that tech prices actually increase, but sometimes they decline at a slower than usual pace, which can provide a similar opportunity. That may be the case right now with computer storage devices.

Last month’s 2.9% decline from last year was the smallest price drop on record for this industry, and the ongoing consolidation may help the trend continue. Plenty of ways to play this one, including Brocade (BRCD), EMC (EMC - Annual Report), Iomega (IOM), Hutchinson (HTCH), Quantum (QTM), Sandisk (SNDK - Annual Report), Seagate (STX - Annual Report), and Western Digital (WDC).

By contrast, semiconductors are experiencing the worst pricing on record.

That could be the signal for a contrarian play (I happen to think the worst will soon be over for semiconductors) or possibly just an excuse to avoid the group for a while.

The PPI clued me in to the opportunity in railroads a year before Buffett bought in. I hestitate to bet against him, but it looks like the industry’s price increases have ground to a halt.

If you have the guts, I’d count this as bad news for Burlington Northern (BNI), CSX Corp. (CSX), Norfolk Southern (NSC), and Union Pacific (UNP).

Finally, Wired Telecommunications saw pricing decline for years after the 1996 Telecom Act, but recent consolidation is allowing them to raise prices again.

Winners here would be CenturyTel (CTL), AT&T (T - Annual Report), Verizon (VZ - Annual Report) and Embarq (EQ).

By my count, that is 26 potential stock tips, all courtesy of the U.S. government. I’ll take that over tossing the report any day.

Disclosure: Long Semiconductor HOLDRs (SMH).

Last year the companies in the memory segment of the semiconductor industry were working flat out in anticipation of rising demand on the heels of Microsoft’s Windows Vista release. At one point last year they accounted for a significant portion of the investments in new semiconductor equipment as well. With the memory situation now more generally recognized as a glut and more rational investment plans being put into place, some memory prices are actually rising. I decided to take a look at the recent conference calls for some of the most exposed companies to see if there is anything noteworthy to report.

STMicroelectronics (STM) is the third-largest supplier of NOR flash memory and is combining its memory business with that of Intel (INTC - Annual Report) into a joint venture to be known as Numonyx. Flash was not their strongest segment, partly due to temporary customer issues.

Carlo Ferro

Good afternoon, everybody. This is not frankly a particular quarter for pricing pressure on flash when including both NOR and NAND. We’re used to this kind of pressure, which is in the mid-single-digit range. What maybe is somehow peculiar, has been somehow peculiar is that the price pressure on NOR has been somehow higher than price pressure on NAND.

Carlo Bozotti

Yes, but the major issue in Q2 on flash was volume and specifically in the wireless and of course a specific customer where our presence is very important and I think that the major issue that we had was the lack of volume at this customer, or at that customer.

(Excerpt from full STM conference call transcript)

Nokia (NOK) is the largest customer for STMicroelectronics, accounting for about 20% of sales. Last week Nokia announced they would be sending even more business to STM, and STM shares rose on the announcement. I think STM has generally been making the right moves.

SanDisk (SNDK - Annual Report) is one of the world’s largest suppliers of flash-based data storage products for the consumer, mobile communications, and industrial markets. SanDisk is hopeful the industry has hit bottom for this cycle.

The second quarter started under very difficult market conditions but improved markedly as the quarter progressed. April and May were characterized by excess supply, but July is coming to balance and during the distinct possibility the demand for high capacity flash products may outstrip industry wide supply in the second half of this year.

(Excerpt from full SNDK conference call transcript)

Micron (MU - Annual Report) did not sound quite as confident - call it cautious optimism. Micron is a leading manufacturer of both DRAM and flash memory.

The major factors affecting this quarter’s results were, one: significant growth in industry memory supply, which caused average selling price erosion across DRAM and NAND memory; two: noteworthy cost per megabit reductions achieved by the company for its DRAM and NAND devices, which could not keep pace with ASP declines, and three: progress made on reductions and overhead expenditures….
Despite the demand strength and encouraging signs pointing to stronger demand in the second half of the calendar year, the memory business in particular has been under profitability pressure due to persistent oversupply. Moving forward, I am optimistic about a more favorable supply/demand balance as we see the impacts of memory content expansion, new end product introductions, seasonal demand upticks, and a slowing industry-wide output growth rate.

(Excerpt from full MU conference call transcript)

Finally, I turn to one of the companies most at risk should capital spending subside - Lam Research (LRCX). They sound optimistic, but I’m not so sure.

We expect that foundry shipments for Lam will be weak in the September quarter as a function of the pull-ins to June and we expect that shipments in foundry will strengthen in the December quarter. Shipments for Logic, Flash other and MPU are expected to be flat in the second half compared with the first half.

Turning to 2008, as we discussed at our Analyst Meeting last week, we believe that 50% CapEx intensity and memory is not sustainable existing 2007, and in fact the rated capacity additions has already begun to slow. The depth and duration of this reduction in capacity additions will be dictated by the actual demand environment as we go forward in the next 6 to 12 months.

Demand trends to watch here included adoption rates of major products such Vista and the iPhone, as well as, the overall demand for the broad range of other semiconductor intensive consumer digital electronic products.

As we move into 2008 it will also be important to watch the conversion of 200 millimeter memory production to 300 millimeter as memory manufactures ability to generate acceptable profits of 200 millimeter will force additional production to move to 300 millimeter.

Based on current industry dynamics, our very early assessment for calendar year 2008 is that overall wafer side equipment spending is likely to be flattish with memory spending to be down potentially 10% to 15%, and an expectation that foundry logic/other and MPU spending will increase sufficiently to offset the decline in memory spending.

(Excerpt from full LRCX conference call transcript)

Lam got 73% of its revenue from the sale of equipment to memory chip makers in the last quarter. If three quarters of the business declines 10% to 15%, for the overall business to remain flat the remainder would have to grow from 27% to 39%. Semiconductor sales growth has averaged high single-digit, and most forecasts I have seen for semi equipment over the next two years are in that range as well. I think the guidance is too optimistic.

Disclosure: William Trent owns put options against shares of Lam Research (LRCX) and has a short position in put options related to the Semiconductor HOLDRS (SMH) ETF.

William Trent currently owns put options against the shares of Lam Research (LRCX).

The Economic Calendar is fairly active this week.

• PPI (Tuesday) - Look for my usual breakdown of the industries with pricing power
• Industrial Production (Tuesday) - Let’s see if businesses really are picking up steam
• CPI (Wednesday) - We know food costs more. What else does?
• Housing Starts (Wednesday) - Preview: They will be bad, and if not it will be bad news.
• Leading Indicators (Thursday)

The Earnings Calendar is going into overdrive this week. Some names I’ll be watching:

• Tata Consultancy Services (TCS)  - What will they say on Monday about rising wages and currencies?
• Intel (INTC - Annual Report) - (Tuesday) - Estimates seem low enough. Margins will improve ex Flash.
• Yahoo! (YHOO) - (Tuesday) - Low expectations likely justified but perhaps rewarded.
• American Standard (ASD) - (Wednesday) - They are on my Large Cap Watch List (Track at Marketocracy) and they are on the move. They’re picking up momentum and I suspect they will top estimates.
• Silgan Holdings (SLGN - Annual Report) - (Wednesday) - They are on my Small Cap Watch List (Track at Marketocracy) and have been blowing estimates out of the water. This one seems like another beater to me.
• Advanced Micro Devices (AMD - Annual Report) - (Thursday) - Hard to see how it could get any worse, but if anyone can pull it off…
• Landstar System (LSTR - Annual Report) - (Thursday) - This is one of my favorite companies and is on both the Small Cap Watch List (Track at Marketocracy) and the Mid Cap Watch List (Track at Marketocracy). They are trading a touch higher than I would like, though.
• Google (GOOG - Annual Report) - (Thursday) - Numbers are set up for them to beat them. If they don’t beat by enough, however, the stock could still suffer.
• Sandisk (SNDK - Annual Report) - (Thursday) - Who knows?
• SAP (SAP - Annual Report) - (Thursday) - Shouldn’t be much to trade on, but they might say something nasty about Oracle (ORCL - Annual Report) to make listening to their call worthwhile.
• Tempur-Pedic (TPX) - (Thursday) This one also graces both the Small Cap Watch List (Track at Marketocracy) and the Mid Cap Watch List (Track at Marketocracy). Estimates have been rising but they will probably still beat them.

Keep on your toes!

STMicroelectronics (STM), Intel (INTC - Annual Report) and Francisco Partners today announced they have entered into a definitive agreement to create a new independent semiconductor company from the key assets of businesses which last year generated approximately $3.6 billion in combined annual revenue. The new company’s strategic focus will be on supplying flash memory solutions for a variety of consumer and industrial devices, including cellular phones, MP3 players, digital cameras, computers and other high-tech equipment. The partners in the deal were gushing with superlatives, which you can read in the press release.

For my part, I don’t doubt that the new company exudes wonderfulness from a strategic standpoint, being “From the outset, the company will be a leading supplier of flash memory solutions for wireless communications,” with “the scale to benefit from the increasing demand for memory resulting from the growing amount of information and content that is becoming more mobile and is now based almost entirely on digital technology.” Instead, I was most interested in the structure of the deal itself:

Under the terms of the agreement, STMicroelectronics will sell its flash memory assets, including its NAND joint venture interest and other NOR resources, to the new company while Intel will sell its NOR assets and resources. In exchange, Intel will receive a 45.1 percent equity ownership stake and a $432 million cash payment at close. STMicroelectronics will receive a 48.6 percent equity ownership stake and a $468 million cash payment at close. Francisco Partners L.P., a Menlo Park, Calif.-based private equity firm, will invest $150 million in cash for convertible preferred stock representing a 6.3 percent ownership interest, subject to adjustment in certain circumstances. Concurrently, the parties have arranged for the new company to receive firm commitments for a $1.3 billion term loan and $250 million revolver. The term loan will be underwritten by a consortium of banks. Proceeds from the term loan will be used for working capital and payment to Intel and STMicroelectronics for the purchase price. The transaction is subject to regulatory approvals and customary closing conditions and is expected to occur in the second half of 2007.

This structure is interesting for a couple of reasons. First, Intel and STMicroelectronics will be receiving $900 million for the 6.3% stake they give up, but Francisco Partners will only pay $150 million for it. The rest will be provided by new debt held by the venture, with the risk presumably shared proportionately among the owners.
Second, the $900 total payments to Intel and STMicroelectronics for the 6.3% they will not own effectively values the total company at $14.3 billion, or roughly 4x revenues (though that valuation overstates things a bit because the convertible preferred shares offer a superior risk/reward than regular common shares would). Alternatively, the $150 million paid for the stake would assign a valuation of just 0.7x sales. The latter figure is similar to the 0.6x sales “enjoyed” by flash leader Spansion. However, neither appears even close to Micron’s (MU - Annual Report) 1.5x sales, or SanDisk’s 2.9x.

More interesting still is the fact that a partner was brought in for a 6.3% stake at all. One very important consequence is that the minority partner prevents either Intel or STMicro from owning 50% or more, which affects the way the joint venture’s results will flow through to the parent company financial statements.

Intel - the Equity Method

For Intel, the ownership stake of 45.1% suggests that the new company’s results will be reported using the equity method. This means, essentially, that only the JV’s net income and equity will appear on Intel’s financial statements. Assets, liabilities, sales, expenses and pretty much everything else stays off Intel’s financials. The obvious benefit is that net profit margin will be higher as it reflects the net income (numerator) but not sales (denominator) from the JV. In addition, other ratios such as return on assets and debt/equity could potentially appear more favorable.
STMicroelectronics - Equity or Proportionate Consolidation?

For STMicroelectronics, which adheres to International Accounting Standards (IAS) but also reconciles them to U.S. GAAP due to its U.S. exchange listing, the issue is a bit more complicated. IAS 31 states that “proportionate consolidation better reflects the substance and economic reality of a venturer’s interest in a jointly controlled entity, that is control over the venturer’s share of the future economic benefits.” Although the equity method is an allowed alternative under IAS 31, the clear preference is for STMicroelectronics to proportionately consolidate - that is, record its 48.6% share of assets, liabilities, revenue and expenses.

Yet the press release describes both STMicroelectronics and Intel’s ownership as “equity ownership stakes” which may imply that they both intend to use the equity method. That, in turn, suggests that STMicro’s 48.6% stake (making it the largest owner) somehow does not allow it to “jointly control” the entity. Perhaps Francisco Partners has an influence (such as Board membership) that is out of proportion to its 6.3% financial stake.

The Role of Francisco Partners

Without the third partner, Intel and STMicro would either have had to structure the deal to give STMicroelectronics control (which would require them to report all of the venture’s financials as their own) or to arrange a payment that would give them equal ownership. Intel would still be able to use the equity method in either situation, but perhaps would not want STMicroelectronics to be the controlling party. By bringing in the third partner, it knocks both of the primary owners into a more equal secondary status that both may consider more fair.

And of course, the more favorable financial reporting is a nice side effect.

Disclosure: William Trent has a long position in SMH.

Lest you think we were going soft, we hereby balance our earlier enthusiasm for semi stocks with our more customary caution. The five reasons to avoid semiconductor stocks right now include:

1. The fundamentals will get worse before they get better. While supply indications grew slower than demand in April, the turn followed 16 months of too much capacity being ordered. As that capacity comes on line, the inventory situation will worsen and margins will get hit more. It is not at all certain that estimates reflect this.
2. It is May. Sure, sell in May and go away is a cliche. Things often become cliches for a reason.
3. Demand? What demand?
4. Valuations are too high because investors are hoping for more premium buyouts. They will happen, but not to every name in the sector.
5. The last bear may no longer be standing.

Food for thought.

Disclosure: William Trent has a long position in SMH.

A reader complained yesterday that we have been too negative. While we aren’t going to go crazy and have a whole positivity day, we will take the time to outline the bull case for the industry on which we have been most negative: semiconductors.

1. The bad news is known. When we started harping about oversupply, it was the farthest thing from anyone’s mind. Like Heisenberg’s uncertainty principle, the act of observation can alter the experiment.
2. The market is ignoring the fundamentals. Related to point 1, the market knows about the bad fundamentals and doesn’t care. Often this means that the bad news is sufficiently well known to be priced in. This is of course the weakest reason, as the market ignored the fundamentals in 2000 as well.
3. Demand may be ready to pick up. Double-digit growth from a tech distributor for the first time in a long time should not be ignored. The Vista hoopla has passed, now the nuts and bolts work may be beginning.
4. Supply and demand will soon realign. For the first time since 2005, orders for new equipment grew at a slower rate than semiconductor end demand. The longer this situation continues, the healthier it will be for future industry sales, pricing and profit margins.
5. The game has changed. Forget private equity buyers. For the first time a semiconductor management team decided it was more important to take capital out of the industry than to add more. This is a sea change in semiconductor management-think, and the strong positive reaction from investors ensures that the wave will continue to build.

There. That wasn’t so hard, was it? Stay tuned for our five reasons NOT to buy semiconductor stocks today.

Disclosure: William Trent has a long position in SMH.