IT Again Largest Sector – But This Time They Didn’t Earn It
May 21st, 2008 | Posted by stockInformation Technology yesterday closed representing 16.26% of the S&P 500 market value, overtaking the Financials, which are at 16.19%, an event last seen in early 2002. Energy, at 14.89%, is at an all time high for the GICS sectors (1989).
At the close of 1997 Financials were in first place, representing 17.21%, with IT just surpassing Consumer Staples for second place, representing 12.29%.
By the height of the Bull market on March 24, 2000, IT, after a 77.6% gain in 1998 and a 78.4% gain in 1999, climbed to 34.51% of the index, with Financials in second place, representing 12.86%.
At the bottom of the Bear market, October 9, 2002, after ITs 72.7% three-year drop, IT had again exchanged places with Financials, which represented 19.53% and IT 12.79%.
The markets decline from the October 9, 2007 all time high, resulted in a 29.11% decline for the Financials, compared to a much lower 8.74% decline for IT. The S&P 500 was down 9.70% and Energy was up 14.54%.
The end result is that IT is the largest sector in the index, and Energy, that now accounts for a quarter of the operating earnings is at an all time high for the GICS sectors(1989; but on a proforma basis was closer to 30% in 1980).
In Y2K IT issues earned their way into top place (although their true earnings turned out to be a different story). In Y2K8, the 29% Financial drop gave it to them.
FYI – While the 2009 Financial sector P/E is 9.9 (IT is 15.6), the 12-month March P/E is 29.3 (IT 21.7).
The oil surge ate my tax rebate
May 21st, 2008 | Posted by stockAmericans might want to save those tax rebate checks, because they’ll probably need the extra cash this summer. With the price of oil surging close to $134 per barrel, driving around town this summer could be expensive indeed.
Tony Crescenzi of Miller Tabak did the math today: The price of oil has increased $40 barrel since the federal government approved the $130 billion in rebate checks along with other economic stimulus measures in February. The U.S. uses about 20.5 million barrels a day of oil, so the total bill for oil’s price increase could add up to $300 billion over the next year. That means “the tax-rebate checks won’t go as far as they would have if not for the surge in the price of oil,” Crescenzi wrote.
To add to the trouble, gas prices often go up during the summer driving season when demand is higher. Chris Lafakis of Moody’s Economy.com figures that with oil at these prices gas could conservatively cost $4.15 per gallon or as much as the “unlikely but disconcerting” $4.75 per gallon. Of course, if oil prices move toward $150 per barrel, prices at the gas pump would head even higher.
High fuel costs have a direct impact on the cash flow of companies and households, but they also have a psychological effect that other commodity prices don’t. The price of gas is posted in front of gas stations on every busy roadway in the country, and when those gas prices consistently start with “$4” or even “$5,” Americans are going to get pretty cranky.
The bottom line for investors: Except for oil drillers, the high price of oil hurts nearly every industry in the stock market. Many stocks were expecting a lift from the economic stimulus package, but that might not arrive. Instead conditions could get even worse, and the hardest hit may be consumer discretionary stocks as many American skip on luxuries this summer.
May 20th, 2008 | Posted by innovThere is no doubt most companies today are big believers in the idea of innovation. Its importance is heralded in corporate visions and mission statements. The chief executive officer speaks its glory in almost every speech, and its importance is celebrated on internal posters as well as in the company’s marketing materials.
It’s simple: Wall Street believes innovation is the leading indicator of future growth and profitability. There’s even an index fund that just invests in what it thinks are the country’s 20 most innovative companies. So how come we’re not being overwhelmed by innovative new products and services? Unfortunately, that’s simple to answer as well.
Saying you believe in something is one thing. Living what you believe is another. Let’s not fool ourselves. Even the biggest “glass-is-half-full” optimist has to concede the reality: Most companies don’t believe in innovation enough to do much more than pretend.
You can see the proof of that in three approaches companies typically take to try to show the world they’re innovative:
1. The big sweeping announcement. “Five years from now, we will get 50% (or some other big number) of our revenues from products that don’t exist today,” the chairman announces with great fanfare. Everyone applauds, and then absolutely nothing changes about the way the company does business.
2. Let’s make a list. The company hires an ideation company to help it brainstorm all the things it might want to add innovation to, and then nothing happens—due to turf wars over resources or a lack of commitment to the idea by people who say, “I would have loved to do something with that list, but I had to keep doing my day job.”
3. The innovation drive-by. The organization hires a company like ours to help it create a new product quickly. But like anything new within the company, it ends up being mired in internal politics, bureaucracy (“Whose budget do we charge for this?”), and turf wars. It really shouldn’t be so hard to get a product out the door. No wonder there are only 20 companies in the innovation index.
Why don’t companies make innovation an essential part of the way they do business? Because it’s hard. Because it requires an unwavering, wholehearted leap of faith—backed by a major investment, not only of money, but of people, processes, and infrastructure. It requires audacious goals, evangelism, consistency, education, training, diversity, expert tools, expert processes, and an environment conducive to creating sustainable innovation results that are aligned with financial outcomes.
Google (GOOG) and Apple (AAPL) are the obvious examples of companies that actually do this, of course. But let’s keep it real; if your company didn’t start out like Google or Apple with innovation firmly implanted in its DNA, then you might believe radical innovation within your company is unrealistic.
But it doesn’t have to be. Consider the Sterno Group (a client of ours), the company that invented the “safe, portable fire” category a hundred years ago and continues to dominate the category to this day.
They demonstrate how you can turn around a “battleship”—if you want it enough.
President Bruce Williamson has begun transforming the company with a very simple idea: Instead of taking our (remarkable) technical expertise and creating products we hope customers will like, we are going to go to the customer and say, “What can we do to help you?” In essence, Williamson has restructured the company leadership with believers who share this customer-driven mentality, which now drives both short-term and long-term product development and brand management.
Those who did not want to change are gone. Those who stayed are required to spend 20% of their work week thinking, innovating, creating value-added improvements.
The world’s most innovative companies—think Amazon (AMZN), GE (GE), Nike (NKE), and Procter & Gamble (PG)—demonstrate that innovation is an essential part of their organization by giving it the same level of status, clout, equality, and attention as they do their fundamental core competencies (e.g., operations, customer service, quality). Why aren’t many other companies doing this, too?
Google CEO Eric Schmidt has an answer. He told Business Week‘s Robert D. Hof: “I think it’s cultural. You have to have the culture, and you have to get it right.” The world’s most innovative companies are authentic in word and deed. And it all starts at the top.
The Sterno leadership team’s faith in their innovation initiative is real—individually and collectively. And because they believe, they evangelize. You have to believe—as they do—that this new way of doing business will lead to success. You have to believe—as Wall Street does—that innovation is essential, not just important. (The difference is simple: The important, you put on a to-do list; the essential goes on a to-die-for list.)
The question to ask is this: Are we going to intentionally, strategically, and tangibly align and operate the company around a culture of innovation, or do we just hope the company will evolve into something close enough?
Meredith Whitney Scares Us All — Again
May 20th, 2008 | Posted by stockThe credit crisis made Oppenheimer (OPY) analyst Meredith Whitney a star. Today demonstrated she’s still a force to be reckoned with.
Last fall, as credit markets froze up and big banks reported huge, unexpected losses, Wall Street had a credibility problem: Its fancy securitized products were self-destructing. Into that credibility vacuum stepped Whitney, the loudest of the analysts predicting disaster for Citigroup (C) and other financial giants.
Now, however, many believe the financial crisis is easing. Financial stocks have bounced back from the Bear Stearns (BSC) debacle.
Others might be optimistic, but Whitney hasn’t changed her tune. Today she released another gloomy prediction on the financial sector: “We believe the current credit crisis is far from over,” she wrote. “In fact, we believe that what lies ahead will be worse than what is behind us.”
The culprit, she says, is the breakdown in the securitization market, which ultimately will cause huge losses for banks on consumer loans. Large banks were hit with $70 billion in losses since July, but she thinks more than $170 billion in losses could be coming. The credit crisis could extend through 2009 and beyond, she said.
Pessimists like Ian Cooper saw the report as confirmation that market bulls have gotten ahead of themselves recently.
But let’s hope Whitney is wrong. She’s predicting some very tough times ahead for a large portion of the U.S. stock market.
And, yes, Whitney could be wrong: Just because someone was right in the past doesn’t mean she’ll be right in the future. After so much success predicting the worse, Whitney might be losing her ability to look on the bright side of things. Maybe the banking industry will catch some breaks, like a strong economic recovery.
And yet the market still certainly listens when Whitney speaks. On the day her report was released, banking stocks fell 3.6%.
That’s the kind of power you wield when you’ve earned investors’ trust.
May 19th, 2008 | Posted by stockPosted by: Ben Steverman on May 19, 2008
Stocks hit a four-and-a-half month high today. The S&P 500 is now less than than 9% off its all-time high. As many market commentators have pointed out, this is not a stock market priced for a deep recession. Investors clearly expect earnings and economic data to rebound later this year.
Last week, the respected economist and market strategist Ed Yardeni offered a great summary of economists’ different views:
“Many economists use letters of the alphabet to describe their forecasts for the downturn: There’s the severe V shaped recession followed by a sharp recovery, the double-dip W, the prolonged U, and the dreaded L. I see a saucer shaped pattern for the economy.”
But the true gem was Yardeni’s relay of a description he heard while at a conference up in Canada:
“One wag up North suggested that it might be more like a flying saucer—a UFO recession. We will never be sure if we really saw it, or just imagined it.”
A UFO recession. I like that. It’s probably the best-case scenario for investors. Many have already spotted the UFO and are cowering in their basements — particularly those smarting from falling home prices, banking layoffs or high gas prices. But the rest of us — and most investors — might not notice much at all.
That’s the hope anyway.
Q1 earnings deserves a fitting burial, and maybe even a few words of praise
May 16th, 2008 | Posted by stockBefore we start to focus on Q2, Q1 earnings deserves a fitting burial, and maybe even a few words of praise.
Briefly the bad news that grabbed the headlines resulted in the second consecutive quarter of negative earnings for the Financials. Over the past six months the sector has reported a combined loss of $28 billion, compared to the prior years’ profit of $114 billion – that’s $142 billion shift in earnings, good thing we’re in a low P/E environment.
The words of praise are for the non-financials. Their earnings were up 8.8% for Q1, and while substantially down from their 12.2% gain of Q4, they remain impressively better than the overall indices’ 26% decline. That Q4 growth, along with strong hope for international sales, produced high expectations for the non-Financials for Q1, to which over 60% of them missed their estimate. Maybe we were being greedy in the estimates, but the reality sure seems nice now. Over half of the issues reported at least a 10% gain on a year-over-year basis and the market appreciated it, with those stocks averaging an 11.8% gain since the end of the first quarter. There was also good news in the lack of bad news. The concern of any wholesale spreading of write-offs, layoffs or messages of impending doom didn’t materialize outside of the Financial and Consumer Discretionary sectors.
So that leads us up to Q2. Since the estimates over the last year on the Financials now appear to have little resemblance to the results, I’ll stick with the non-Financials. Those issues are expected to post a 10.8% gain, compared to the 48% decline for the Financials (that I’m not mentioning). IT and Utilities are expected to post strong double-digit earnings growth, with Energy posting a 13% gain and accounting for 24% of the earnings. Overall, given the liquidity concerns, employment, oil and the cost of almost all foods, a rosy prediction, and when combined with ‘hope and prayer’ that we are near the bottom of the liquidity problems, helps explain the recent price rally.
Q3 is when we start to see the gains. Considering the comparisons to Q3 2007, when earnings were down over 9%, the 16% growth is not that great, so the quarter is labeled a building period. Q4,’08 and Q1,’09 is expected to show large gains (get the headlines ready), but again due more to the poor comparisons and the belief that there will be no more mega-billion dollar charges. If the earnings are not good it will be a reflection of the economy and we’ll most likely have much larger problems to deal with – such as unemployment, a renewed liquidity drought, oil or food prices, rapid inflation, or maybe even another recount scenario – hang in there chad.
Q1 Operating earnings:
48.1% beat their estimate and 41.5% did not -> historically over 60% beat their estimates
57.5% beat last years value, 41.0% did not
23.9% of Financials posted earnings gains; 65.2% of non-Financials did
53.3% of the non-Financials posted at least a 10% earnings gain
Q1 2008 posted a -25.9% decline over Q1 2007
Ex/Financials the index posted an 8.66% gain (Q4 2007 was -30.8% and +12.2% for non-Financials)
There was no major negative news or expansion of charges outside of the Financial or Consumer Discretionary sectors; optimism lives
Earnings Shift:
Q1 2008 23.2% came from Energy and -3.3% from Financials
Q1 2007 13.6% came from Energy and 29.7% from Financials
For Q4,’07 and Q1,’08 the Financial sector has lost $28 billion, compared to the prior years’ profit of $114 billion – that’s $142 billion shift in earnings, which resulted in a $617 market decline (from 9/07)
The 216 non-Financials that posted at least a 10% earnings gain have averaged an 11.8% gain since the end of the first quarter, with 116 of them increasing at least 10%
12-Mo Mar,’08 P/Es are much higher than forward numbers due to expected growth; index at 18.6 (12.9 for ‘09), Financials at 30.6 (10.3)
Q2 2007 posted the highest earnings, so comparisons are set high
Q2 2008 is expected to post a 5.4% decline, with the Financials down 47.7% and non-Financials expected to post a 10.8% gain, which would translate into four consecutive quarters of negative growth and three consecutive quarters where non-Financials posted positive growth
Energy is expected to contribute 24% of the earnings for Q2; it is now 14.2% of the index – it’s highest under the GICS sectors (from 1989)
2008 estimated to increase 8.4%, but is due to poor 2007 and Energy’s increased contribution
2009 estimated to increase 23.5%, but estimates lack charges, 2008 has declined and there could be gains due to reversals of prior charges
GE’s confusing signal on earnings season
May 16th, 2008 | Posted by stockMore than a month ago, things were looking grim.
I wrote in early April about General Electric’s (GE) shockingly weak earnings report. Along with bad first quarter news from Wachovia (WB) and other firms, GE’s report suggested the U.S. economy was in far worse trouble than many expected. If GE, one of the world’s best-run companies, could be hit so hard, then economic troubles could decimate corporate earnings and send a depressed stock market even lower.
Looking back, these worries were both right and wrong. First quarter earnings were weak. With only 6% of the S&P 500 still yet to report, Thomson Reuters expects first quarter earnings to fall 17.5%, 2.3 percentage points worse than expected.
But there’s also an emerging consensus that GE’s troubles were unique. GE, which this week announced plans to spin off its appliance division, is facing lots of questions from investors. They mostly blame management, not the economy, for April’s surprise.
Plenty of other big firms reported solid results despite the weak economy. If the financial sector (the biggest loser) and the energy sector (the biggest winner) are taken out of first quarter earnings estimates, profits actually rise 2.9%.
Fellow Investing Insights blogger Howard Silverblatt has far more about earnings and expectations for the rest of the year in the post below.
Gary Gordon analyzes earnings season here, while Mike Burnick offers his two cents here.
Since early April, stocks have moved higher on rising hopes that the economy can revive later this year. Who would have thought that, amid one of the most disappointing earnings seasons in recent memory, the optimists would return to Wall Street?
May 16th, 2008 | Posted by innovWhen the founders of Portland (Ore.)-based Nau first came together in 2005 to lay the groundwork for a sustainable fashion company, their strict eco-principles and innovative e-tailing strategy appeared to be ideas whose time had come. Its stylishly minimal clothes in muted colors, made of sustainable materials such as organic cotton and recycled polyester, went on sale in 2007 and appealed to outdoorsy types and city dwellers, tapping into the growing green fashion trend. Nau’s few bricks-and-mortar stores were eco-friendly showcases for products, but customers were encouraged to buy online with a 10% discount. And as part of the company’s social enterprise initiative, 5% of all sales—from a $38 tank top to a pair of $138 “lean jeans”—were handed over to nonprofit organizations, chosen by the buyer.
“All the ingredients were in place for this business,” recalls Ian Yolles, vice-president for brand communications, about the startup’s corporate, design, and brand philosophy. Indeed, in its first and only year of operation, Nau attracted a cult following; Even today its Web site is jammed as the company sells off remaining stock at half-price. But at a board meeting in Portland on May 1, the directors decided to shut it down, just two weeks after its L.A. store had opened.
So what went wrong?
Nau’s business model, with its multiple retail channels and sophisticated product line—as well as a heavy commitment to the ideals of sustainability, including tracing the origins of the wool it used back to the sheep in New Zealand—was not only ambitious but capital intensive. Yet Yolles believes it was largely external factors, from the liquidity crunch to a general nervousness among investors about retailing in a recessionary environment, that contributed to Nau’s demise. Taken together, “these issues raised larger questions,” Yolles says, about the viability of the fledgling business.
Nau started out on a solid footing, with executives like Yolles and Chris Van Dyke, son of entertainer Dick Van Dyke, all with experience at companies like Nike (NKE) and Patagonia. Before the market went sideways, it raised $35 million from private investors, private equity firms, and hedge funds. This went toward research and development of the company’s signature sustainable fabrics and design of its quirky, slim-fitting style. A third-party distributor working out of a Portland warehouse was contracted to handle online sales. Nau opened five stores—in Chicago, Portland, Seattle, Boulder, Colo., and Los Angeles—and had plans for more this year in San Francisco and Boston as well as second stores in Portland and Seattle. Staff grew to 60 at the Portland headquarters, with about 40 sales associates in the stores.
By the end of the first fiscal year, sales “had met or slightly exceeded targets,” Yolles says, although he declined to provide figures; $250,000 had been donated to charities. But Nau had burned through its initial capital and wasn’t forecasting profitability until late 2009 or early 2010. It needed further financing to open more stores and pump up revenue but was struggling to persuade investors and board members to pledge more money as the economy and the retail sector deteriorated. In the end, Yolles says, the company was $5 million to $10 million short of its financing goal.
Retail analysts agree Nau brought fresh ideas and a sense of social responsibility and green awareness to its business. But they also suggest some aspects of its retail model and design approach were flawed.
Take the clothes. Many fashionistas and design insiders say Nau raised eco-chic—famous for resembling formless, floppy yoga pants or pajamas—to a new level.
“They did a fantastic job creating something out of the ordinary in the eco-fashion frame of mind,” says Cheryl Roth, co-founder of OrganicWorks, a New York eco-focused branding company. “It was different, and very cool.” But others considered the Star Trek-like snugness and neutral colors pricey and uninspired.
“There was a sameness to the merchandise, a certain blandness,” notes Candace Corlett, president of WSL Strategic Retail, a New York consulting company, about Nau’s color palette of charcoal grays and chocolate browns. “Even if you wanted to participate in the goodness idea of Nau, there weren’t a lot of items you felt you just had to take home.”
Yet subdued colors and a pared down silhouette were part of Nau’s performance-meets-sustainability-and-beauty package. Colors were constrained because the company banned toxic dyes and finishes, which often give clothes brighter, sharper colors. As for the style, Yolles says the idea was to make it last and appeal to consumers for at least 10 years, through the ups and downs and changing tastes and colors of “lifestyle” fashion.
Critics say Nau might have been more successful by adopting a traditional retail strategy, including setting up boutiques within department stores. This would have broadened the brand’s awareness and placed the clothes in a setting amid a wider variety of styles and labels. In a department store, “you get tons of traffic and hints about what works and what doesn’t,” explains Howard Davidowitz, chairman of Davidowitz & Associates, a New York retail consultancy and investment bank.
Another mistake, he says, was Nau’s relatively small, low-impact stores, which averaged 2,000 square feet. These were located in different settings, including traditional closed shopping malls, and in Chicago, the best-performing store, on a busy shopping street of boutiques in the Lincoln Park neighborhood. Still, says Davidowitz, “customers don’t want a small selection in tiny stores. They want a large selection at a good price.”
Selling through department stores, however, would have meant rethinking Nau’s corporate philosophy. The company wanted to keep total control over its product presentation, which might have been altered by department stores that tend to cherry-pick what styles they prefer. “We wanted to present the products and our rich story, and design the customer experience, and that would not have been possible” in department stores, says Yolles, who does not regret the decision.
With an emphasis on online shopping, the stores also created the perception that one of the most important elements of retail—a shopper’s instant gratification of walking out of the store with purchase in hand—might not be met at Nau.
But that wasn’t exactly the case. Customers could view all Nau merchandise in the store, try on what they wanted, and then decide whether to buy on the spot and take it home or order online at an in-store computer kiosk (about 45% opted for online, more than Nau executives had anticipated). While stores did stock “every color and size of every model,” Yolles says, and typically restocked twice weekly, the dual strategy meant Nau kept less inventory on hand than conventional retailers. This reduced store square footage, staff size, and the ecological footprint. But, he acknowledges, “there was the possibility that, like at other stores, you wouldn’t be able to get what you wanted.”
Perhaps Nau was too fashion-forward, with its higher production costs—the company’s sustainable fabrics cost 10% to 20% more than commercially available offerings—and unusual products, like a $32 men’s boxer made of a biopolymer derived from corn, sold in a new age-y store. While Nau’s prices were comparable to like-minded retailers Patagonia and North Face, they couldn’t match megaretailers such as Steve & Barry’s, whose $8.99 dresses sold in massive, unadorned stores are wildly popular in tough economic times.
Retail consultant Corlett says shoppers like to keep things simple. “The concept of going into a Nau store and seeing a sparse presentation and unfamiliar products without racks and racks of clothes, and then choosing a charity, and possibly going home without the purchase—it’s too complicated for anyone,” she explains. “We’re just not ready for that.”
More Kindle Fodder: Citi Predicts $750 Million by 2010
May 15th, 2008 | Posted by stockKicked off quite a heated debate back in November when I called out Amazon’s (Symbol: AMZN) ebook reader, the Kindle, as an important future revenue source. Now I’m getting some company. Citigroup Analyst Mark Mahaney has a report out saying Amazon should collect $400 million to $750 million in revenue from the Kindle by 2010 (tip o’ the cap to Mike Arrington). Mahaney says the Kindle’s wireless, on-demand ebook store is the big differentiator from competing products.
Mahaney also uses the iPod adoption model for future Kindle sales, though with numerous conservative reductions built in to his model. He starts by assuming that only 10,000 to 30,000 Kindles sold in the first three months from Amazon versus 129,000 iPods that Apple sold in its first quarter after introduction. Then he figures Kindles track the same sales curve at another 50% to 75% cut down. By 2010, half the revenue would be from Kindles and half from ebooks, he says.
And for what little it’s worth so far, Amazon shares were trading at $78.60 the day before the Kindle announcement versus $75.98 today.
May 15th, 2008 | Posted by stockReporting on consumer stocks in the last couple days (for this), I encountered a surprising amount of optimism about consumer spending. That was especially surprising given the recent run-up in oil prices. And it helps explain why many consumer discretionary stocks have done well recently.
The main reason for the happy thoughts about retailers, restaurants and other companies that make money off the American consumer? Those tax rebate checks, courtesy the federal government’s $150-billion economic stimulus plan, which many Americans are receiving in the mail right now.
Pessimists think the stimulus will provide only a temporary benefit to an economy mired in recession.
Douglas McIntyre says:
“Most of the money handed out by the government is likely to be spent on high food and fuel prices. That will hardly be an incentive for people to buy a new Cadillac or build a swimming pool.”
But Georges Yared of Yared Investment Research told me the other day that he’s optimistic. He figures most consumers have already adjusted – however painfully – to higher gas prices. “As Americans, we are shoppers,” he said. “If you hand me $600, I’m probably going to spend it on something.”
Extra consumer spending causes “a major chain reaction” that actually magnifies the effects of the stimulus, Yared says. Retailers re-stock inventory and, further down the chain, factories and shippers get busier.
Other analysts have looked at previous, smaller stimulus packages and say it helped the restaurant industry, as Americans used extra cash to a night out on the town.
Will Americans spend or save their rebate checks? This site – “How I Spent My Stimulus” – is an amusing attempt to answer that question.
I think many Americans will spend their stimulus checks on at least something extra, and that might provide a boost to consumer stocks or at least their earnings figures this quarter. But the real question is whether this is just a temporary blip or the beginning of a recovery for this beaten-down sector.
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