PBM Stocks: Unsexy Sector Can Make You Rich
November 2nd, 2010 | Posted by Global InvestorsBy Brian Sozzi
From 2006 to 2009, drug distributor and PBM (pharmaceutical benefit managers) stocks were among the darlings of Wall Street. Profits were booming amidst increased generic drug utilization by those in the US, operating efficiencies, and price hikes on branded drugs.
On a CAGR, the main names in the group (Medco (MHS), Cardinal Health (CAH), Express Scripts (ESRX), AmerisourceBergen (ABC), and McKesson (MCK)) notched average market cap growth of 16%. Since the start of 2009 to present day, the average share price gain for the companies mentioned has been a whopping 61%, more than double the advance in the S&P 500 Index.
However, much of the friendly share price performance for the group was derived in 2009 rather than in 2010. The stocks have either flat-lined or declined in 2010 as the market became jittery on profit growth potential due to heightened competitive pricing on contract renewals and a softer generic drug launch calendar relative to prior years.
Moreover, the companies began to spend the fruits of their labor by investing in assets to fund future growth ahead of new healthcare reform kicking into gear. With some 30 million new entrants arriving in the market long before not, the sector is licking its chops as each can be sold a script (hopefully a generic script through the mail).
As the earnings season for the sector winds down, a few thoughts have come to mind. The first, and perhaps most important, is that now is the time to invest in the sector as growth in calendar 2012 will ramp significantly as big name brand drugs roll off patent protection (Plavix, Lipitor, Lexipro). Second, the strong are becoming stronger through acquisitions. At the end of the September quarter, the sector was sitting on nearly $10 billion in cash and equivalents.
McKesson just plunked down $2.7 billion for privately held US Oncology on November 1. Express Scripts is about to experience strong earnings growth in 2011 fueled by its 2009 acquisition of NextRx. These companies are utilizing their balance sheets to grow, increase dividends, and repurchase shares at an eye opening rate. In addition, they are improving their capital structures by tapping debt markets for attractive financing.
Taken as a whole, there is much to like, so it pays to get in prior to the market sniffing out the future earnings potential. I am overweight the sector (in Wall Street parlance, this means I am positive on the stocks in the sector).
Sector Rundown
Name: Express Scripts The company generally had good things to say on its earnings call, such as an ahead of plan integration of NextRx, strong client retention, new client wins for 2011, and compelling long-term industry trends. Earnings power at Express Scripts is likely to be quite strong in coming years as NextRx clients are up-sold and healthcare reforms promote greater drug utilization (especially generics).
I remain impressed by the execution of the Express Scripts management team, and believe low balance sheet gearing hints at another PBM acquisition in the not too distant future. Moreover, it’s my view that Express Scripts’ initial FY11 EPS guidance, suggesting 30% y/y profit growth, puts to bed numerous concerns held by the market (pricing, integration risk).
Name: MedcoHealth SolutionsI was very pleased by Medco’s 3Q10 report as it displayed healthy sequential growth in revenues, gross margin, and EBITDA per adjusted claim. Following concern among consensus analysts regarding Medco’s client mix and how it would impact margins, the 3Q10 report calms the fire. Medco is driving strong generic drug utilization through its book of business and is increasingly shipping higher profit generics via its mail order pharmacies. Combined with an aggressive amount of share repurchases, the positive trends in the business are likely to cause consensus estimates to edge up for 4Q10 as well.
The major takeaway from Medco was the FY12 EPS earnings power amid big name generic drug introductions, such as the aforementioned Lipitor, Lexipro, and Plavix. In 4Q11 alone, with Lipitor available for one month, the contribution from generics is outlined to be $0.06 P/S, the most robust of FY11. The impact is quite obvious in FY12, which management stated will be the largest in terms of new generic launches up until 2020.
I think the stock will run into analyst day on November 19, where increased granularity on the FY12 generics contribution will be unveiled. Valued at a P/E multiple of 16.9x my new FY11 EPS estimate of $4.12 (top-end of management’s guidance), forecasting at least y/y growth in non-GAAP EPS of 18%, Medco shares are compelling.
Name: AmerisourceBergenThough I acknowledge that AmerisourceBergen shares may have a neutral bias medium-term as the market balances a muted FY11 growth story with a stronger growth story in FY12, I believe the stock should ultimately begin to price in the ramp in the earnings trajectory beyond the current fiscal year. At current valuation, the stock has a favorable risk reward ratio in front of the ramp in earnings growth long-term.
Name: Cardinal HealthCardinal Health reported a strong 1Q11 on October 28, aided by continued momentum behind the Pharmaceutical segment. The Pharmaceutical segment notched 32 bps of operating margin YOY as execution on generics programs improved and sales mix (bulk versus non-bulk) was favorable. Cardinal Health noted margins in both bulk and non-bulk strengthen YOY as well.
I remain impressed by the work Cardinal Health has done at its largest segment of business in addition to working capital, and think there is an upward bias in profit margins in FY11. As for the Medical segment, it was a soft quarter on sales and margins compared to 1Q10, as guided to by management on the 4Q10 earnings call.
Cardinal Health shares are attractively valued in my opinion. The stock trades at 11.3x my new FY12 EPS forecast of $2.92, or 13.4x my estimate for FY10. In each case, the stock trades at a discount to the five-year P/E multiple of 15.0x. With profit margins trending up and cash deployment being robust, the stock sticks out in my drug distributor coverage universe as a best in breed play.
Name: McKessonMcKesson continues to represent one of the more underappreciated large-cap stocks in my coverage universe. The stock trades on a P/E multiple of 11.8x my revised FY12 EPS forecast of $5.50 (+$0.11), a discount of 15% to the five-year mean, and an even larger discount to the broad market. I view valuation as very attractive as McKesson begins to experience a ramp in earnings growth as early as the fourth quarter.
Support for that call include (1) indications of a top line turnaround at Technology Solutions on the back of an influx of government dollars and increased human capital; (2) strengthening mix of sales at Distribution Solutions; (3) increased penetration of customers with the OneStop generics program; and (4) utilization of the new $1.0 billion share repurchase plan. Risks to my analysis include (1) fundamental changes in the Canadian drug market; (2) longer than expected improved at Technology Solutions.
Disclosure: No positions
Cadence: Patient Investors Should Watch Short Sellers Before FDA Decision on Thursday
November 2nd, 2010 | Posted by Global InvestorsCadence has a PDUFA [Prescription Drug User Fee Act] date of November 4th for its drug Ofirmev. Investors are anticipating it will receive approval. Ofirmev (intravenous acetaminophen) is a new drug formulation in development for the treatment of acute pain and fever in adults and children. If approved, it would be the the only injectable non-opiod, non-NSAID pain product available in the U.S.
Ofirmed received a complete response letter from the FDA in 2010 and stated in the complete response letter that:
The FDA only indicated that deficiencies were observed during the FDA’s facility inspection of Cadence’s third party manufacturer, which was completed on Feb 5th, 2010. The FDA did not site any safety or efficacy issues, nor did it request any additional studies to be conducted prior to approval.
It is widely expected that the FDA will approve Ofirmev barring any setbacks with regards to the manufacturing facility.
What has happened in the past 3 months is that a large short position in CADX has been accrued. With 48 million shares in the float and 50 million outstanding, there is a short position of almost 10 million shares. That would be a little over 20% of the float.
Avanir (AVNR), which received an FDA approval on Friday (Oct 30th), had 26% of its float shorted before a bear raid occurred in the final 90 minutes of trading action. This took AVNR shares down from $2.90 to a low of $1.31. The stock traded under $2.60 to close the day at $2.43. A few hours later Avanir’s drug, Nuedexta, was approved for pseudobulbar affect and the stock traded at over $5 in after-hours trading.
The same thing happened with POZEN (POZN), back in April, on the day of Pozen’s PDUFA date, and also within a few hours left in the trading day. That stock traded over $11 when the market-makers dropped it under $5 that day as well. They then moved it back up to close it over $10 for the day. A lot of stop losses were triggered and short covering took place in both instances with POZN and AVNR.
What investors need to look at is the potential that CADX could possibly be taken down similar to the other stocks I mentioned above because of its large short position going into the approval date. The short position has increased 2 million shares since July as it has moved higher into the decision date. The 10-day average volume has only been about 433,000 shares, so any significant volume (outside of a bear raid) could cause some short covering and cause the stock to appreciate in share price. Based on the short position it would take approximately 22 days to cover. The volatility could create good fortune for opportunistic investors who have potentially low bids in an effort to acquire some lower cost shares.
Click to enlarge:
In the remaining days until an approval decision is given, the price action in CADX will be of special interest to investors. In September, Wedbush Securities started coverage on CADX with an outperform rating and a $12 price target. Investors will be watching Cadence Pharmaceutical closely in the days to come as a decision either way is imminent. Thursday the 4th of November is fast approaching.
Disclosure: Long CADX but position could change at any time
Another Good Quarter for Virgin Media
November 2nd, 2010 | Posted by Global InvestorsVirgin Media (VMED) reported solid third quarter results as management continues to execute very well at the operating level and take advantage of VMED’s superior broadband network in the United Kingdom. Overall growth in revenue and EBITDA remains modest, rising mid to upper single digits. Free cash flow is growing double digits as capital spending intensity continues to wane. Free cash flow is key to the VMED as the company’s balance sheet remains highly leveraged following a series of acquisitions and network upgrades by the prior management team. VMED stock benefits directly as excess cash is used to pay down debt and repurchase shares, effectively transferring the corporations value from bondholders to shareholders.
I expect this value transfer thesis to remain in place through 2011 and can see the stock reaching the low $30s. There are a couple of risks to the story, one which was partially evident in 3Q results and the other which may emerge in the next few months. During 3Q, VMED subscriber growth in cable TV fell a little short of expectations. Pay TV in the UK is extremely competitive and Sky Broadcasting’s satellite is the clear market share leader. Sky was unusually promotional during the third quarter and on the conference call VMED management said its October market share improved. Nevertheless, weak subscriber growth is a risk to VMED.
Closely related to the subscriber growth competition is the UK economic situation. The UK government is undertaking extreme austerity measures including massive layoffs of government workers. Austerity could lead to slower economic growth and higher unemployment and impact demand for all competitors in the UK’s multichannel TV, high speed internet, and wireline and wireless telephony industries. VMED is a major player in all of these industries. Thus far, the austerity measures have had no noticeable impact on demand for communications services, but it is early.
Disclosure: VMED is widely held by clients of Northlake Capital Management, LLC including in Steve Birenberg’s personal accounts. Steve s sole proprietor of Northlake, an SEC-registered investment advisor. VMEd is a net long position in the Entermedia Funds. Steve is co-portfolio of the Entermedia hedge funds, owns a stake in the Funds investment management company, and has personal monies invested in the Funds.
November 2nd, 2010 | Posted by Global InvestorsBy Larry D. Spears
The logic is sound: Especially during times of economic uncertainty, companies that have a lot of cash on hand have the flexibility to do all sorts of things – most of them ultimately beneficial to shareholders because they help increase earnings and lead to higher stock prices.
For example, cash-rich firms can invest in new plants and equipment, fund research-and-development (R&D) initiatives for new products, or finance acquisitions that will increase market share or expand their geographic reach.
So-called "cash-cow" firms can also use their accumulated reserves to pay down or eliminate existing debt, increase annual dividends, buy back stock – or simply hold the money as a cushion against further economic downturns. Excess cash in the vault can transform smaller companies into attractive takeover targets, providing the shareholders of those target companies with quick and sizeable capital gains.
Historically, finding true "cash cows" hasn’t been all that easy. In healthier economic times, keen competition demanded consistent corporate outlays to pay for rapid growth, and shareholders expected steady dividend increases to make stock yields competitive with those of other high-interest investments.
These days, though, that’s much less the case. More and more U.S. corporations, faced with economic uncertainties and a lack of high-return investment opportunities, are opting to maintain hefty cash reserves instead of spending to hire or expand.
In fact, a recent survey by Moody’s Investors Service Inc. found that U.S. corporations – not including financial companies such as banks and brokerages – are currently holding liquid reserves in the form of cash and short-term investments of nearly $1 trillion. That represents an increase of 21% from the end of 2008.
U.S. financial firms are estimated to hold an additional $850 billion in cash equivalents.
The increased cash holdings are particularly evident among larger companies, with 20 major players in the technology, pharmaceutical, energy and consumer sectors holding more than 37% of the $943 billion in cash reported by Moody’s. Four high-profile stalwarts – Apple Inc. (Nasdaq: AAPL), networking giant Cisco Systems Inc. (Nasdaq: CSCO), Microsoft Corp. (Nasdaq: MSFT) and Internet-search heavyweight Google Inc. (Nasdaq: GOOG) – alone account for $156 billion of the total.
By contrast, cash-rich companies are far harder to find in the natural products, environmental, aircraft and aerospace sectors.
Of course, merely having a pile of cash in the corporate kitty doesn’t automatically make a company’s stock a great investment. For that, you need other incentives, such as an attractive trading price, a high return on equity (ROE), a strong return on assets (ROA) or, perhaps most importantly, plenty of free cash flow (FCF) – generally defined as cash left over from operations, minus capital expenditures.
Specific criteria that can help you identify potential "cash cow" candidates include:
Most of the above numbers and valuations – or the figures needed to calculate them – can be found on the companies’ balance sheets or in the statistical sections of the "stock quotes" summaries on leading financial Websites such as Google Finance, MSNMoneycentral, Yahoo! Finance or Forbes.com.
Following are three companies that currently meet most – if not all – of these criteria. That turns this trio into an excellent starting point for investors wishing to add a few cash cows to their portfolios.
The three companies consist of:
If you’re interested in tapping into some of the cash held by companies in the financial sector, two other stocks you might consider are:
Disclosure: None
Disclaimer: Money Morning and Stansberry & Associates Investment Research are separate companies, and entirely distinct. Their only common thread is a shared parent company, Agora Inc. Agora Inc. was named in the suit by the SEC and was exonerated by the court, and thus dropped from the case. Stansberry & Associates was found civilly liable for a matter that dealt with one writer’s report on a company. The action was not a criminal matter. The case is still on appeal, and no final decision has been made.
Terremark Worldwide Starting to Ride the Cloud With Q2 Results
November 2nd, 2010 | Posted by Global InvestorsTerremark Worldwide (TMRK), a leading global provider of managed IT infrastructure services, continues to report strong growth for their data center space. TMRK reported 22%YoY growth and 8% sequential growth (see Q2 Report here). Also important is that growth is accelerating with only 20% growth in the prior quarter. EBITDA grew at 27% YoY and 19% QoQ showing that margins are starting to expand as TMRK is reaching critical mass and improved utilization rates.
TMRK also upped guidance for fiscal Q3 and FY 2011 as the outlook continues to improve including growing international demand including Brazil and Amsterdam.
Cloud revenue has now grown to a $30M run rate, and more then double last year’s run rate. While still below 10% of total revenue, it continues to grow at a fast clip and will become a more important part of the story.
Another important part of the story is the interest expense load. TMRK reported a $6M operating profit this quarter, but faced $14M in interest expenses. From the conference call, it sounds like management has a few plans to reduce the cost of capital. This will be key to the success of this company and its future growth. Any ability to tap the ultra low rates provided in this economic environment would be huge in increasing the price of this stock.
via PR:
Business Outlook
Based on these bullish results and the after hours action, it’s very possible that TMRK could challenge the 52 week high at $10.72. It’s funny how weak the stock has traded since competitor Equinox (EQIX) reported weak numbers, fueling concern at TMRK at Rackspace Hosting (RAX). Apparently, the market isn’t as rigged as some think. The fact that TMRK actually had good results was relatively held under wraps.
Samuel Adams: Value at 25x Earnings?
November 2nd, 2010 | Posted by Global Investors
The Boston Beer Company (SAM), the largest craft brewer in the United States, has a lot of great business characteristics that long term investors are constantly searching for in an investment. Good management, strong brand equity, and a small presence in both their industry and around the globe (99% of sales in the US) have kept investors optimistic and the stock trading at a multiple with expectations for strong future growth.
From recession lows below $20/share back in March 2009, SAM is now trading at $72.61/share, an increase of 281% over a 20 month period. On top of that, Samuel Adams is just pennies away from its all time high, and has recently crossed the $1 billion market cap hurdle. With the company set to report earnings after the close on November 4th, the question is are we still at the beginning stages of good things to come, or have buyers had a little too much to drink for the moment?
Taking a look at the income statement, we can see that trailing twelve month net income for SAM is equal to $40.36 million, so we are looking at a current multiple of 24.8x earnings. Net income and EPS growth from year end 2006 through 2009 are equal to 19.6% and 20.28%, respectively. For people who like to use PEG (as popularized by Peter Lynch), SAM’s ratio is currently 1.22, suggesting that it is slightly overvalued; in my mind, this is one of those types of ratios that gives you an idea of the valuation, but is far from a complete picture.
As of the most recent filing, the company had just under $54 million in cash on the books and no debt, so they are financially sound and don’t have to throw away cash to pay off interest payments. From looking at cash flows, we can see that capital expenditures have been consistently inconsistent. The outlier is 2008, when the company spent nearly $60 million on CapEx, the majority of which ($43.9M) was spent on improvements at the Pennsylvania Brewery on upgrades and to restart the brew house after the brewery was purchased from Diageo North America for $56.5 million in June 2008.
Besides 2008, the annual average spend on capital expenditures is in the mid teens, a manageable number, especially considering that all three company owned breweries (Boston, Cincinnati, and now Pennsylvania) have been recently upgraded. As noted in the 2009 10-K, management “believes it could support growth in 2010 in excess of 10% without significant capacity expansion of its owned breweries, and that further growth could be supported through expanding the Company’s use of production arrangements with third parties, including those currently under contract.”
An interesting side note on the shift in the company’s business model is the overall movement away from third party brewing. Since 2007, the percentage of core products brewed at company owned breweries has increased from 35% to over 95%. After issues with the Rochester Brewery, it shouldn’t come as a surprise to shareholders if Samuel Adams tries to avoid third party brewing almost entirely in the future.
The main issues I see at this current valuation is a complete disregard for two things that I personally believe directly affect a company like The Boston Beer Company. The first is increased competition. As the big domestic brewers have attempted to mitigate slow/no growth in their core brands, they have started to move into the one category that continues to take share: craft beers. In the sense of a double edged sword, this has brought in new brands, but has also expanded the shelf, and subsequently the demand for craft beers (think Jamba Juice (JMBA) when McDonald’s (MCD) entered the smoothie business). As noted by Jim Koch on the Q3 call, this can provide an opportunity for Sam Adams in two distinct ways:
I think it does open up opportunities in the short term for us to get distribution of other styles beyond you know, lager and light and seasonal, 6s and 12s; and it’ll depend on the market how many additional styles and SKUs we can you know, we can gain.
I think longer term it does give us an opportunity as our volumes continue to grow to get second facings, because there are starting to be you know, out of stock situations of some of the stronger-selling craft beers like Sam Adams because you’ve got, you know, a shelf, one slot for Boston Lager six-packs. And that maybe holds four six-packs and somebody comes in and buys two of them on Friday at 5:00 and somebody else comes in and buys the other two on Friday at 7:00, and you’ve got an out of stock maybe even for the whole weekend.
In that sense (more shelf space to avoid stock outs), this move will certainly help someone like Sam Adams, who usually only has 3-4 12 packs in the coolers at the supermarket. But on the other side, increased competition brings more choices for consumers, which leads me to my second concern: pricing. In this environment, with consumers looking to save any way they can, I cannot get myself to believe that buyers are grabbing 6 packs at the $9.19 price point (at least in my area).
Even with a superior product, I think Sam Adams risks losing customers to companies that are willing to settle for promotional pricing to push sales. While this is currently happening in a lot of industries (the percentage of branded dollars sold on promotion from 2008-2010 was equal to 40% according to Treehouse Foods CFO Dennis Riordan), I feel like SAM is in a position where they could certainly feel the effects of a weak consumer.
So where does that leave us? In my mind, there is no question that SAM is a great company, and I think that their management team has done a fantastic job developing a brand and a company that consumers want to be a part of. In my mind, the price isn’t unreasonable; this is a company that is hitting record highs for a reason. With that being said, I will not be buying shares in SAM before the call on Thursday.
I see little reason (due to the conditions described above) why this stock should expand the multiple past the mid-20s, even with good results. On the flip side, I think we may see a buying opportunity if the stock gets beaten down on a miss. If it does, I recommend starting a position, and immediately after heading to the store and buying the seasonal 12 pack to celebrate; start of which the Chocolate Bock, it is a truly fantastic beer.
Disclosure: No position
Coach: Expanding Into Men’s Accessories
November 2nd, 2010 | Posted by Global InvestorsCoach (COH) released its earnings for Q1 2011 on October 26, 2010. The company reported stellar numbers with widening margins and gains in market share in all major regions where Coach operates.
The $25 billion global luxury market for handbags and accessories (H&A) is projected to grow at an average annual rate of approximately 5% for the next few years. China is expected to be the major driver in increasing the market size. The country, according to various estimates, accounts for 10% of the global market. According to Coach, by the year 2013, China will double its share and contribute 20% of the total luxury market of handbags and accessories. In my last article on Coach, I outlined the growth opportunities in China and estimated that Coach could generate $1 billion in revenues in China by 2020. In the next 5 years, I estimate that the company will grow its earnings in China at an annual rate of 40% and report sales of approximately $537 million from China by 2015. This is higher than the $500 million the company expects to generate from China by 2015.
Additionally, the company recently launched its products in Europe (a flagship store is expected to open in London by June 2011), a continent responsible for about 25% of the global H&A market. Like North America and Japan, Coach is in the process of developing a multi channel delivery system for Europe and expects to generate $250 million in revenues from Europe in the next 5 years. In the years to come, the company also plans to enter the Indian and Brazilian markets.
Outside of China, Coach believes that its biggest opportunity is in the Men’s premium bag and small leather goods sector. The company estimates that it holds a 3% market share in the men’s segment in the U.S and hopes to improve this to about 14% in the next few years. In Japan, while the broader H&A segment is contracting, Coach reported that the men’s segment was stable. The company opened its first men’s only factory store in addition to its two stand alone stores and hopes to gain a market share of 16% to match that of the women’s segment.
In summary, I expect the U.S. sales to increase at an annual rate of 15% for the next 5 years, Japan by 2%, China by 40% and rest of world by 10%. As mentioned earlier, Europe will contribute $250 million to the top line by 2015. Based on my estimates, the company is projected to report earnings of $7.1 billion in 5 years time compared to the trailing twelve month revenue of $3.75 billion implying a compounded annual growth rate of approximately 14%.
Updating my DCF model, I derive an intrinsic value of $63 a share. My relative valuation model indicates a fair value of $45 a share. Combining these estimates, I estimate a fair value of $54 a share which is also my 12-month price target.
(Kindly use this article for information purposes only. Please consult your investment advisor before making any investment decision.)
Disclosure: Long COH
Semiconductor Industry: Growth Still on Track
November 2nd, 2010 | Posted by Global Investorsby Carlos Guillen
So far, semiconductor industry revenue growth has been surprisingly strong in spite of troublesome macroeconomic fundamentals such as persistently high unemployment rates and sluggish consumer spending. I have been rather bullish on semiconductor industry revenue growth up until now, and in light of earnings results and forecasts from a number semiconductor industry heavy hitters, I still believe the semiconductor industry is on track to meet my 33 percent revenue growth for 2010.
Most recently, I was pleasantly surprised by Semiconductor Industry Associations data that indicated that the revenue momentum was not yet turning negative. In fact, according to SIA data, global semiconductor revenue in September reached a new record high of $26.5 billion, increasing year-over-year by 26.2 percent and increasing sequentially by 2.88 percent. From a quarterly perspective, September quarter revenue grew sequentially by 6.14 percent; this sequential growth rate was higher than my forecast of 4 percent growth. It is worthy, however, to keep in mind that although the September semiconductor industry revenue growth rate was strong, it did run below its seasonal run rate of approximately 8 percent. Nonetheless, given the rumors of a surging inventory buildup and given the fact that PC consumption was less than expected, the six percent growth is certainly encouraging. Moreover, all regions demonstrated growth.
Click to enlarge
Looking back a bit into Intel’s quarterly financial results, one of the heavy hitters of the semiconductor industry, I also saw some encouraging data. Intel’s financial results during the September quarter were strong despite growing fears of a significant consumer pull back. While consumers in the U.S and in Europe did show some weakness, revenue continued to climb and reached a new record high of $11.1 billion; this was mostly the result of strong revenue growth derived from emerging markets and from the enterprise sector. Revenue increased year-over-year by 18.2 percent and was up sequentially by 3.13 percent. The sequential increase, however, was lower than its seasonally run rate of approximately 9 percent. Intel’s outlook for the December quarter was also encouraging as it expects to see revenue in the range of $11.0 billion to $11.8 billion, sequentially increasing by 3 percent to the midpoint of the guided range.
In essence, the softness in PC demand that was experienced in the third quarter has not been enough to derail overall semiconductor industry growth, as demand for semiconductors continues to grow into a wider range of products that go beyond computers, such as smartphones, tables, and industrial applications. Moreover, inventories for the most part appear to be lean. Semiconductor companies have become very quick at correcting inventory issues, particularly since everyone continues to be very concerned about macroeconomic factors. According to my estimates, I still see semiconductor revenue growth of 33 percent in 2010; however, given the faster than expected growth, I am expecting to see a 2 percent decline in the December quarter. I should point out that semiconductor revenue during December quarters is usually down by approximately 1 percent, so a two percent decline would be a bit below seasonality.
Disclosure: No positions
Costco’s Astounding FY 2010 Results: A Management That Favors Shareholders
November 2nd, 2010 | Posted by Global InvestorsCostco’s (COST) 10-K for the recently ended 2010 fiscal year showed up in my mailbox this morning, so I figured I would take the time to write an update on the results over the past year and a look forward based on what management has disclosed on recent conference calls.
The footprint for Costco continues to expand, with a total of 540 warehouses at the end of FY 2010, compared to 527 in 2009. Average warehouse sales jumped from $131 million to $139 million, a 7% increase from a year ago. On top of that, management has already outlined plans to open 29 new locations in 2011 (16 in the United States, 13 internationally), a significant bump from the 13 additions in 2010.
South of the border, Costco Mexico (a 50% owned JV with results of operations being consolidated starting August 30, 2010) currently operates 32 additional warehouses, for which Costco is “contractually responsible for executive, management, and functional duties and operations”. An important aspect of all that warehouse expansion is additional cardholders, a key profit driver for Costco. Management has continued to successfully push the $100 executive membership, which now accounts for more than a third of the total membership base, and two-thirds of net sales. Over the course of the year Costco added another million primary holders, and continues to retain customers year after year with an astounding 88% renewal rate in the United States and Canada.
With talks on the quarterly call of a rate increase once the economy improves, Costco stands to add a significant amount of income to the bottom line if they can successfully push through an increase in memberships costs while maintaining high renewal rates.
Internationally, Costco reached a milestone: For the first time in their history, business in the United States and Canada accounted for less than 90% of operating income. Another astonishing fact is that despite the 4:1 ratio of U.S. to international stores, half of the top 20 warehouses in 2009 (by sales) were located outside the United States. Based on the success that Costco has had in places like the U.K., and to a lesser extent in Japan, Korea, and Taiwan, it is clear that this focus on an international presence for the brand will continue to drive additional growth.
The balance sheet also looks good, which shouldn’t be very surprising considering the conservative growth strategy that Costco has adhered. Cash and cash equivalents were equal to $4.75 billion, while long term debt totaled $2.69 billion, a net cash position in excess of $2 billion.
The operating results were, as usual, impressive. Sales increased 9.1% to $76.25 billion from slightly below $70 billion in 2009. Membership fees were an astounding $1.69 billion, and net income per diluted share increased from $2.47 to $2.92, an increase of 18.2% year over year. Comparable warehouse sales increased 4% in the United States, and an astounding 19% in international markets (positive FX impact). As noted by management in the 10-K:
We believe that the most important driver of increasing our profitability is sales growth, particularly comparable sales growth.
The numbers speak for themselves.
One of the things I love about Costco is that when you listen in on a conference call, management is open and honest with you. In the Q3 call a couple months ago, here is what CFO Richard Galanti told shareholders about buybacks:
On the days that we did buy we bought about 60,000 shares a day as compared to 50,000 during that last week of Q2. During the first couple of weeks of Q4 we’ve averaged 100,000 shares a day and that’s principally a reflection of what I’ve stated in the past.
For the 16-week period in question, 100,000 shares a day would be 8 million shares total. During the fourth quarter, COST repurchased 7.76 million shares (total of 9.9 million for the year at an average price of $57.14). Since June 2005, the company has bought back 98.7 million shares, equal to 18.5% of all shares outstanding when repurchasing began. A business with a sustainable competitive advantage and a management team that is open, honest, AND act in shareholders’ best interests? These are the kind of companies that I want to be invested with.
Disclosure: No position in COST at the time of writing
October Recap: Four Better Valued Opportunities Than Gold
November 2nd, 2010 | Posted by Global Investors[Excerpted from Marks Group Wealth Management's Monthly Market Recap]
In less than 48 hours, we should know the outcome of the much-anticipated mid-term elections. Regardless of their political persuasion, there is strong historical evidence that investors prefer gridlock in Washington. Polls indicate that this is the likely outcome, but if not, there may be a short-term selloff in equities. The market doesn’t like surprises.
INDEX OCT 2010 YTD 2010
DJIA + 3.06% + 6.62%
Nasdaq + 5.86% +10.50%
S&P500 + 3.69% + 6.11%
The rally that began on August 31st continued through October, albeit at a slower pace. It is possible that recent gains were in anticipation of the election, and equities could experience some short-term weakness regardless of the election results. In other words, the election results are “baked into the market”. After the event investors will refocus their attention on other matters, including uncertainty about future tax rates, the continued slump in housing prices, or the stubbornly high unemployment rate.
When the Federal Open Market Committee meets this week, Bernanke and company will give us more clues as to how they plan to use their latest gadget, “QE2”, to stimulate the economy. QE2 refers to a second round of quantitative easing, and it is interesting for both how it is being used and how investors are responding to it.
Quantitative easing is one process by which the Federal Reserve increases the money supply, first by crediting its own account (in other words, printing money), then by using those funds to buy long-term Treasury bonds. In theory, this keeps long-term interest rates low, which has a stimulative/stabilizing effect on the economy as a whole (and housing in particular) and could help avoid a double-dip recession.
The first round of quantitative easing began in late-2008, when the Fed tried to prop up the economy by buying $1.25 trillion in mortgage-backed securities. With the Fed “backstopping” these bonds, and the economy, markets began to recover. So it’s no coincidence that soon after Fed Chairman Bernanke hinted at a second round of quantitative easing in a speech on August 27th, markets began their ascent.
But investors may be less enthusiastic about the longer-term implications of a second round of this strategy. Bill Gross, Chief Investment Officer for PIMCO and a powerful figure on Wall Street, recently stated that further quantitative easing would signify the end of the 30-year bull market in bonds.
Others believe that interest rates could remain low for an extended period as central banks, in attempting to keep their currencies from appreciating vs. the dollar, continue to buy dollar-denominated assets. This consistent demand for long-duration Treasuries will keep prices high, and interest rates low.
Regardless of when interest rates rise, we believe that high quality U.S. stocks offer greater value than most bonds at current prices.
Gold is the other asset that has investors’ attention lately. It is one of the best performing assets over the past five years, and the upward trend continues. We question if it is for the right reasons. Gold bullion ETFs, products created by Wall Street to make it easier for investors to buy gold, now represent most of the demand for gold. The fact that Wall Street created a product to exploit an asset class is, to us, a red flag.
Warren Buffett, who has a flare for putting things in perspective, recently described gold in these terms:
You could take all the gold that’s ever been mined, and it would fill a cube 67 feet in each direction. For what that’s worth at current gold prices, you could buy all of the farmland in the U.S. Plus, you could buy 10 Exxon Mobils, and have $1 trillion of walking-around money. Or you could have a big cube of metal. Which would you take? Which is going to produce more value?
No one knows how high gold prices will go, but we do agree with Mr. Buffet that there are other less popular and better valued opportunities.
Stock News
Noble Corporation (NE) – Noble and other deepwater drilling companies continue to trade at historically low levels due to the lingering hangover from last April’s disaster on the Deepwater Horizon Rig. Now that the government imposed moratorium on offshore drilling has been lifted, we believe that could be a positive catalyst for stocks like Noble.
As the second largest company in its field, we believe that Noble stands ahead of its competition. Nearly 85% of its 62 offshore drilling units are outside the U.S., providing insulation from the recent disruptions in the Gulf. The company also has maintained a very solid balance sheet with their debt equaling a modest percentage of total capital.
Noble’s profit margins of about 50% continue to be far greater than its closest competitors such as Transocean’s profit margin of 35%. During the 3rd quarter, the company repurchased 4 million shares of its stock at an average unit cost of $32.67, bringing the total number of shares repurchased in 2010 to 6.1 million as of September 30th. (Credit Suisse 10/21/10)
TCF Financial (TCB) – For much of 2010, TCF has fought an aggressive battle to maintain its fee income that has been threatened by proposed legislative changes. The bank has encouraged customers to sign up for overdraft protection, following new federal rules that went into effect in August that bar banks from automatic enrollment.
In addition to new restrictions on overdraft fees, TCF faces a potential revenue hit from planned new fee limits on debit-card transactions. As part of the financial regulatory overhaul passed this summer, the Federal Reserve is allowed to severely restrict the amount that banks like TCF can collect from retailers in interchange fees each time consumers swipe their debit cards at the register. TCF has responded by taking legal action against the debit-card fee section of the Dodd-Frank financial reform bill, calling it “unconstitutional.”
Despite these head winds, Minnesota’s third-largest bank reported a strong quarter in which profits doubled compared to the same quarter last year. TCF Financial CEO, Bill Cooper stated last week that the bank’s service fee revenue is down just 13% while similar revenue streams fell more than 20% at Wells Fargo (BWF) and US Bank (USB) during the 3rd quarter. (Credit Suisse 10/21/10)
Starbucks (SBUX) – Starbucks jumped more than 3% in October thanks to increasing demand for breakfast snacks and higher-priced coffee. Despite new competition from frappes and smoothies at McDonalds, the company shows strength and proves yet again the potential for coffee category growth.
Starbucks has continued to invest in advertising and innovation throughout the recession, creating compelling reasons for consumers to support their brand. Multiple industry analysts have raised their price target to $30 or greater within the past month, in anticipation of the quarterly earnings report scheduled for November 4th.
Starbucks said last month it would raise some prices to account for some more labor-intensive drinks and the surging prices of green Arabica coffee beans. Third party research provider Credit Suisse believes Starbucks has enough growth momentum to keep raising their earnings estimates over the next 12 months, and maintains its $34 price target on SBUX. (Credit Suisse 10/12/2010)
Johnson Controls Inc. (JCI) – Since we added JCI to our Core Equity Portfolio in August, the stock is up over 4.6%. Double-digit sales growth in its automotive businesses and increased orders for energy efficiency projects in buildings have helped lead the charge. During a time when many companies continue to pad their earnings by cutting costs, JCI posted their 3rd consecutive quarter of top-line revenue growth.
The company has continued to benefit from higher battery sales linked to its role as the exclusive provider of batteries to Wal-Mart (WMT) and its aggressive expansion in emerging battery and automotive markets. During a conference call with analysts, Steve Roell, chairman and chief executive, said the company benefited from cost-cutting and restructuring early in the year and then capitalized on the recovery of the auto industry and growth in international markets.
The company has become more aggressive in accelerating its growth initiatives, boosting its capital spending plan, said Bruce McDonald, chief financial officer. These plans include a recent expansion of production of automotive batteries for carmakers and the aftermarket in China, the only country where Johnson Controls is not the leading supplier of lead-acid batteries. The company now ranks fourth in market share in China. (Credit Suisse 10/27/10)
Disclaimer: The information set forth herein has been derived from sources believed to be reliable, but is not guaranteed as to accuracy and does not purport to be a complete analysis of the securities, companies or industries involved. Opinions expressed herein are subject to change without notice and are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual. To determine which investments and strategies may be appropriate for you, please consult with Marks Group Wealth Management or another trusted investment adviser. Stock investing involves market risk including loss of principal. Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise. Past performance is no guarantee of future results.
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