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. In it, I explain why I think the negative reaction to BMC Software’s (BMC) purchase of BladeLogic (BLOG) was overdone. In summary:

BladeLogic is growing nearly 40% annually, compared to just 5% expected growth in BMC next year. By my calculations, it increases BMC’s revenue growth rate by 180 basis points, which should have a significant impact on valuation models.

What’s more, I think there were signs that BMC’s growth was due to accelerate on its own. Deferred revenues had declined slightly over the past nine months, which can act as a drag on revenue growth in future periods. But license sales are up 13.5% so far this year, compared to total growth of less than 9%. Today’s license sales should increase future maintenance and service revenues.

Although the BladeLogic deal is expected to reduce BMC’s 2009 per share earnings by 10 or 11 cents, BMC’s estimates for 2009 had already risen by a similar amount. Effectively, the dilution from BladeLogic offsets BMC’s organic improvements for a year.

Meanwhile, BMC has generated more than $540 million in free cash flow over the last 12 months. Some of that is unsustainable, as it comes from collecting on financed receivables. However, I think the sustainable free cash flow is more than $400 million. That still amounts to a 6.5% free cash flow yield at a time when five-year Treasuries return a paltry 2.2%.

Alternatively, I think the stock can generate double-digit returns over the next few years by virtue of its growth, despite a potential reduction in valuation multiples.

Disclosure: William Trent has no financial position in the companies mentioned.

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.

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.

Earlier today I said “Other signs are pointing to the consumer slowdown extending beyond just housing-related stores. The consumer was the last leg in the economy’s stool, so businesses had better take up the slack or we could be in for more of a slowdown than we already have.”

Right on cue, I learn that CDW’s Average Daily Sales Increase 25.3 Percent in June 2007 and 24.4 Percent in the Second Quarter of 2007:

Excluding Berbee sales in June 2007, and therefore on a non-GAAP basis, CDW’s average daily sales for June 2007 were $31.641 million, an increase of 15.9 percent compared to average daily sales for June 2006 of $27.293 million and total sales for June 2007 were $664.5 million, an increase of 10.7 percent compared to total sales of $600.4 million for June 2006.

That is a pretty darned good number. If it is happening across the board, and not as a result of CDW gaining market share, the GDP chart for tech equipment and software spending won’t look like this for long.

If it is an industry-wide phenomenon, there are positive implications for Tech Data (TECD), Ingram Micro (IM) and Mid Cap Watch List (Track at Marketocracy) member Synnex (SNX) as well as for their suppliers, primarily Hewlett Packard (HPQ - Annual Report).

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.

DRAMeXchange wonders if DRAM prices will bottom out soon:

Current market observations show the DDR2 chip price possibly bottoming out. If this occurs, it should drive up the chip demand, and spur a rebound in the spot price.

Memory chips were the last domino to fall, so to speak, to the oversupply situation.  As such, I would expect them to be the last to recover. The quote above, that demand will rise because prices stop falling, appears counterintuitive at first. Perhaps the suggestion is that buyers were putting off purchases on the expectation that prices would be lower if they waited. I can’t really buy that argument, though, because I don’t think PC makers and other DRAM users would worry about the price if they had their own end demand – they would just buy what they needed and pass along the higher price to whatever extent possible.

In fact, quite the opposite likely occurred. For example, for several quarters Hewlett Packard (HPQ - Annual Report) has been making “strategic buys” of inventory they already thought was excessively cheap.

So while the “bottoming out” is not likely to spur demand, it may well spur a reduction in supply.  The same DRAMeXchange report hints at that as well:

Despite the fact that Taiwan DRAM makers posted a gross profit of nearly 50% in 4Q06, and 30% in 1Q07, DRAMeXchange believes the persisting DRAM price declines in May will cause them to post a loss in 2Q07.

Although DRAM makers must still ship their chips in May, they indicated no additional price cuts would be made, due to the continuing losses. Prices have thus started to increase for last week. Yet, the end market demand is not expected to pick up in May and June, and PC shipments have been performing worse than expected in May, in the wake of a weak seasonality. Furthermore, PC OEMs, major spot market buyers, and module houses still have inventory levels lasting for more than a month. DRAMeXchange believes that by only relying on buyers in purchasing cheaper chips, the DRAM price increase will be limited at least before June.

With prices already dangerously low, Hynix has already started to switch some of its DRAM production to NAND Flash instead.

With capacity being shifted to other products, and the profitability issues impacting the ability to invest in more capacity (as long as the companies heed the signs) the lower supply is what will allow demand to catch up and restore equilibrium to the market.

Stock market uber-blogger Charles Kirk said yesterday that despite the current rally, the U.S. market is looking Like A Bad Stock:

The U.S. market continues to act like a bad stock in a really great sector of the market. In other words, with the global boom worldwide and the gains seen across the globe, the U.S. market is moving higher along with everything else whether deserved or not. That’s also why we continue to see a huge migration toward companies that have international exposure. The more global the better and there’s good reason for that.

I thought the analogy resonated, and decided to dig a little for evidence in support of the idea. For this task I turned to some recent conference call transcripts of companies with global operations.

At least twice the growth overseas as in America for Autodesk (ADSK):

Revenue in America was $184 million, an increase of 8%. Revenue in the America was somewhat impacted by changes in backlog between years as well as the particularly tough compare in the first quarter of last year, which grew 39%.

EMEA revenues were $207 million, an increase of 26% as reported and 14% cost of currency. Asia Pacific increased 16% to $117 million. Revenues in Japan decreased slightly compared to last year, but increased significantly on a sequential basis consistent with historical trends.

(Excerpt from full ADSK conference call transcript)

Hewlett Packard (HPQ - Annual Report) also saw stronger growth overseas, but currency played a big role for them.

On a regional basis, revenue was up 11% in the Americas, up 14% in EMEA and up 16% in Asia Pacific. When adjusted for the effects of currency, revenue was up 11% in the Americas, 7% in EMEA and 13% in Asia Pacific.

(Excerpt from full HPQ conference call transcript)

BEA Systems (BEAS) is also seeing strength overseas:

As I mentioned, we saw a tough selling environment in the Americas. Our close rate in the first two months of the quarter was actually on track with plan, and then we were surprised when close rates weakened at the end of the quarter. Some large deals slipped out of the quarter. The slippage was generally due to poor execution on our part. A few of those deals have already closed in Q2.

Geographically, the Asia-Pacific region performed very well. We continue to see great performance out of China, Korea, and Asia. In Q1, China contributed more license revenue than any territory outside the United States, and we see no end to demand there. EMEA performed fairly well overall. We performed well in Italy, Northern EMEA and other places.

We’re seeing improvement in the U.K., and our new team there is trying to drive better results and better pipeline.

(Excerpt from full BEAS conference call transcript)

Finally, lest you think the issue may be confined to tech, Estee Lauder (EL) chimes in:

Geographically, our international business again led our growth this quarter. In Europe, the Middle East and Africa, despite coming off high single digit local currency growth last year, we grew net sales a solid 13% for the quarter. A few key businesses drove this performance, including travel retail and our largest market in the region, the United Kingdom, which posted healthy double-digit increases. Russia, one of our emerging markets, reported another outstanding quarter.

All countries in Asia-Pacific posted local currency sales increases, with the exception of Thailand. The increases generally reflect a strong economy in the region. Japan, our largest affiliate in the region, was up mid single digits in the quarter. New points of distribution in the region also added to sales growth.

In the Americas, net sales decreased.

(Excerpt from full EL conference call transcript.)

So all are in agreement: sales are better overseas. No wonder, then, that overseas markets have been stronger.

Disclosure: Author is long IShares MSCI Japan Index (EWJ) at time of publication.