TSRA -- I don't expect much from this call just an update on new technologies, guidance probably won't change -- the wireless business is still going to be hurting but DRAM strength should offset again.
One key issue to keep in mind in terms of the stock is the tax rate -- in 2008 the tax rate starts to move up from near zero towards its ultimate level of 40%. That will soak up a lot of income growth in the next couple of years (i.e. pre-tax income might grow 50% but EPS might barely budge because of the increase share going to taxes). Hard to get the stock moving up when that happens. Its possible it will take 2 years to reach 40% in which case TSRA might be able to show 15-20% growth in EPS, which is much better than zero.
NVT -- unfortunately even if the portable GPS business has a big upside surprise its less than half the total -- in dash units account for more than half of revenues and they are unlikely to see much upside. handsets and online maps are too small to make a difference. I sold some because I knew at $57.75 that the price had jumped on deal talk and I figured it would pull back. It has but not too bad. I have read some street reports that point out there is not too much room for upside -- even if you assume 100% growth in portable units, you get a 4 cent EPS increase -- not enough to matter. If the stock pops on a market rally this week (say to $55 or higher), I will look to sell some more.
UEPS -- Three things that matter:
1. Update on what is going on with the South Africa welfare contract?
2. Update on the south africa wage payment system -- what progress have they made and any hint about how big this will be over the next year or so?
3. Update on Nigeria -- have they gotten started yet or when do they think they will get started? early numbers on how many have signed up so far, etc.
Sunday, July 29, 2007
MDT buys Kyphon
My first reaction to this deal was that I need to sell MDT -- if they need to do a deal like this then their growth prospects are worse than I thought. My latest reaction is that I don't have to panic but my bar for finding a better opportunity is lower than it used to be for MDT. BTW, that is what portfolio management is about -- opportunity costs. Its about making sure that your portfolio has the best names that it can have on a secular basis. That means I am not switching just to get a minor improvement in but in MDT's case its not as fast a grower as I thought.
One look through the 291 slides from the recent analyst meeting helped my thinking -- this is a 10% grower not a 15% grower. The stock has had a tough time since it peaked in 2000 -- 7 years and its at $50 -- no movement in 7 years. I bought in 2001 at $40 so I have made some money but that is only on about half of my shares -- the rest were bought in the last couple of years at $48-52. First the stock was at a ridiculous multiple in 2001 -- over 40X earnings. That was way too high for the future growth potential of mid teens.
The company hit its mid teens growth numbers for the next several years -- yet all that happened is the earnings caught up with the stock (valuation multiple dropped). Now just when the valuation is reasonable the growth drivers have been falling away one by one. First we lost the ICD's -- Guidant's safety issues has caused too many patients to have second thoughts about getting an ICD despite the fact that its a life saving device. What was supposed to be a 20% grower (and the biggest driver of results given its 25% of revenues) is now a 10% grower IF the international side grows 20% to offset the US's puny 6-8% growth.
Stents -- too many issues about safety and efficacy -- it is no longer a growth market. This was once considered the main growth driver for 2008 and 2009.
Spinal -- Medtronic was supposed to be able to compete against Kyphon but now they have thrown in the towel and decided to buy them. I would prefer they were able to compete against them -- the fact that they can't doesn't say much for MDT's R&D as well as marketing/sales in the spinal area.
Its still a great company and they are doing everything they can to manage through the issues and come up with more growth drivers but all the good stuff is years away. I think for me the stock is a source of cash -- I will sell half the position and then it will be the right size for its potential.
One look through the 291 slides from the recent analyst meeting helped my thinking -- this is a 10% grower not a 15% grower. The stock has had a tough time since it peaked in 2000 -- 7 years and its at $50 -- no movement in 7 years. I bought in 2001 at $40 so I have made some money but that is only on about half of my shares -- the rest were bought in the last couple of years at $48-52. First the stock was at a ridiculous multiple in 2001 -- over 40X earnings. That was way too high for the future growth potential of mid teens.
The company hit its mid teens growth numbers for the next several years -- yet all that happened is the earnings caught up with the stock (valuation multiple dropped). Now just when the valuation is reasonable the growth drivers have been falling away one by one. First we lost the ICD's -- Guidant's safety issues has caused too many patients to have second thoughts about getting an ICD despite the fact that its a life saving device. What was supposed to be a 20% grower (and the biggest driver of results given its 25% of revenues) is now a 10% grower IF the international side grows 20% to offset the US's puny 6-8% growth.
Stents -- too many issues about safety and efficacy -- it is no longer a growth market. This was once considered the main growth driver for 2008 and 2009.
Spinal -- Medtronic was supposed to be able to compete against Kyphon but now they have thrown in the towel and decided to buy them. I would prefer they were able to compete against them -- the fact that they can't doesn't say much for MDT's R&D as well as marketing/sales in the spinal area.
Its still a great company and they are doing everything they can to manage through the issues and come up with more growth drivers but all the good stuff is years away. I think for me the stock is a source of cash -- I will sell half the position and then it will be the right size for its potential.
GGG
Listened to the conference call on Graco (GGG) and had some more points to make:
1. As I said, cash flow improved, revenue growth numbers showed sequential improvement (not a surprise given stronger GDP of Q2) but they are not out of the woods yet -- growth comparisons get harder in the 2H and both housing and auto production are struggling.
2. These are cyclical issues that will be resolved over time -- note that as growth in the economy accelerated in Q2 the company also saw better growth -- nothing wrong with the franchise that couldn't be fixed by faster growth in the industries they serve.
3. It's a great business -- in a recent presentation that is on the website, the company points out that earnings have a growth rate over the last few years of 23% while their stockholder's equity has only grown 10% and other than recently they have had no debt (short term debt is up due to share repurchases). That means they are able to grow earnings without needing a coresponding growth in capital -- that is a wonderful business.
4. new product process -- they are constantly coming out with new and improved products -- that keeps customers willing to pay good prices for products -- they also use the new product process to appeal to new customers. What I mean is they tweak some existing products to better suit a new set of customers -- that's a great growth driver because you are getting more revenues from little incremental costs.
5. Its a tough time now but this is a wealth builder over time.
1. As I said, cash flow improved, revenue growth numbers showed sequential improvement (not a surprise given stronger GDP of Q2) but they are not out of the woods yet -- growth comparisons get harder in the 2H and both housing and auto production are struggling.
2. These are cyclical issues that will be resolved over time -- note that as growth in the economy accelerated in Q2 the company also saw better growth -- nothing wrong with the franchise that couldn't be fixed by faster growth in the industries they serve.
3. It's a great business -- in a recent presentation that is on the website, the company points out that earnings have a growth rate over the last few years of 23% while their stockholder's equity has only grown 10% and other than recently they have had no debt (short term debt is up due to share repurchases). That means they are able to grow earnings without needing a coresponding growth in capital -- that is a wonderful business.
4. new product process -- they are constantly coming out with new and improved products -- that keeps customers willing to pay good prices for products -- they also use the new product process to appeal to new customers. What I mean is they tweak some existing products to better suit a new set of customers -- that's a great growth driver because you are getting more revenues from little incremental costs.
5. Its a tough time now but this is a wealth builder over time.
Another tough day on Friday -- CME and more on DFR
Market was down 1.6% but the secular value investor's portfolio was down only 1.35% -- another 25bps of outperformance or close to 160 for the quarter and over 300 for the year.
This time AB in a delayed earnings driven boost as well as CME were the standout performers going up on a big down day. In hindsight, CME was the opportunity on Thursday as the stock was down but exchange volumes (i.e. revenues) were soaring. Over the weekend, Barron's had positive comments on CME so its possible the stock will move higher on Monday too.
Is it all over? I have seen some commentary that suggests the market will return to its lows of near 800 -- around a 50% drop and that you should sell now! Its always possible but I believe very unlikely. A fast scary correction designed to get as many investors out of the market as possible so they miss the rebound? you betcha. Right now many investors are afraid and are searching for safety and for liquidity. At some point investors that have liquidity will step forward and offer it to those who want out -- and those that sell will later regret they panic'd. Are we there yet? Hard to say -- my advice as always is to focus on companies and industries and not get so tied up in macro concerns.
That said, I realize now in hindsight I screwed up -- it happens to everyone. I reread a post written a few weeks ago titled "Yeah but what about...." where I tried to address all the concerns being talked about in the market. At one point, I made the comment that I would not want to own high yield bonds right now. That has proven correct as credit spreads have widened -- meaning high yield bonds have lost value. Unfortunately, my ownership of DFR means that I DID OWN high yield bonds in the form of CDO's or CLO's in DFR's portfolio. That stock has dropped hard because of that exposure. What was I thinking? I was too focused on the bullish story with DFR and not on the risks -- or what could go wrong. A mistake I would warn you not to make. This is partly the "value" part of being a secular value investor -- finding situations where the probability of significant upside is far greater than the probability of significant downside is by definition finding value.
I continue to believe there is significant upside in DFR -- a potential $30 stock price in 2-3 years. On the otherhand, it would be foolhardy of me not to recognize that the liquidity issues and widening spreads in high yield bonds translates to a potentially lower probability of that $30 goal being reached. For me its more of a question of position size -- when I bought more recently it was with the goal of making it one of my larger positions because I thought it was one of my best opportunities. In hindsight, I realize I made the position size too big given the risks. If we get a good bounce back in the stock, I may decide to sell those shares I just added as a way of keeping the position size reasonable. All that said, I do not see a reason to panic -- no reason to believe that DFR is about to suffer a permanent loss of capital -- a cyclical one maybe but I believe the stock has value and that its value will hold up even if the market's continue to struggle.
This time AB in a delayed earnings driven boost as well as CME were the standout performers going up on a big down day. In hindsight, CME was the opportunity on Thursday as the stock was down but exchange volumes (i.e. revenues) were soaring. Over the weekend, Barron's had positive comments on CME so its possible the stock will move higher on Monday too.
Is it all over? I have seen some commentary that suggests the market will return to its lows of near 800 -- around a 50% drop and that you should sell now! Its always possible but I believe very unlikely. A fast scary correction designed to get as many investors out of the market as possible so they miss the rebound? you betcha. Right now many investors are afraid and are searching for safety and for liquidity. At some point investors that have liquidity will step forward and offer it to those who want out -- and those that sell will later regret they panic'd. Are we there yet? Hard to say -- my advice as always is to focus on companies and industries and not get so tied up in macro concerns.
That said, I realize now in hindsight I screwed up -- it happens to everyone. I reread a post written a few weeks ago titled "Yeah but what about...." where I tried to address all the concerns being talked about in the market. At one point, I made the comment that I would not want to own high yield bonds right now. That has proven correct as credit spreads have widened -- meaning high yield bonds have lost value. Unfortunately, my ownership of DFR means that I DID OWN high yield bonds in the form of CDO's or CLO's in DFR's portfolio. That stock has dropped hard because of that exposure. What was I thinking? I was too focused on the bullish story with DFR and not on the risks -- or what could go wrong. A mistake I would warn you not to make. This is partly the "value" part of being a secular value investor -- finding situations where the probability of significant upside is far greater than the probability of significant downside is by definition finding value.
I continue to believe there is significant upside in DFR -- a potential $30 stock price in 2-3 years. On the otherhand, it would be foolhardy of me not to recognize that the liquidity issues and widening spreads in high yield bonds translates to a potentially lower probability of that $30 goal being reached. For me its more of a question of position size -- when I bought more recently it was with the goal of making it one of my larger positions because I thought it was one of my best opportunities. In hindsight, I realize I made the position size too big given the risks. If we get a good bounce back in the stock, I may decide to sell those shares I just added as a way of keeping the position size reasonable. All that said, I do not see a reason to panic -- no reason to believe that DFR is about to suffer a permanent loss of capital -- a cyclical one maybe but I believe the stock has value and that its value will hold up even if the market's continue to struggle.
Friday, July 27, 2007
Earnings updates (AB, GGG)
Another icky day in the market thanks most likely to liquidity concerns in the bond world and fears that private equity is "over". The Secular Value investor outperformed again -- only down 1.83% vs. the S&P 500's -2.33%.
That was partly due to lucky timing -- the portfolio actually had 2 stocks that were up yesterday -- GGG which had better than expected earnings and ILMN which went up for a second day on the strength of their earnings. Several of the low beta stocks continued to do their job by not going down nearly as much as the market. That's the key to this game -- diversification. Make sure you are diversified enough to survive the down days so that you are still around for the rebound.
GGG's earnings weren't great -- they showed organic revenue growth of 1% year to date but they weren't bad either. Key points were improved cash flow, industrial sales rebounded and unless I'm mistaken the contractor business in the US did not get any worse. Improved cash flow means earnings quality improved and suggests the pressures on the business from the US housing slump are no longer getting worse. The stock popped 6% or so mostly on relief and short covering. I would not expect the stock to break out of its trading range on these results -- though I would certainly appreciate it if the stock did!
AB's earnings were strong -- 1.16 vs. consensus at 1.08. They also raised the range of expected earnings for the year to $4.90 to $5.25 with almost $2 of that coming in the 4th quarter. Hedge fund assets are up 45% year to date to $10.5 billion -- that's mostly high net worth money right now and it bodes well for performance fees in Q4. They plan to start selling hedege fund services to their institutional clients -- that could really raise some money and grow management/incentive fees since they have $500 billion in existing institutional assets under management vs. only $106 billion in high net worth assets. Even if the growth in hedge fund assets comes entirely from existing money under management, the higher fees for the hedge fund services would make that a great deal for AB.
I will have more to say on the markets this weekend.
That was partly due to lucky timing -- the portfolio actually had 2 stocks that were up yesterday -- GGG which had better than expected earnings and ILMN which went up for a second day on the strength of their earnings. Several of the low beta stocks continued to do their job by not going down nearly as much as the market. That's the key to this game -- diversification. Make sure you are diversified enough to survive the down days so that you are still around for the rebound.
GGG's earnings weren't great -- they showed organic revenue growth of 1% year to date but they weren't bad either. Key points were improved cash flow, industrial sales rebounded and unless I'm mistaken the contractor business in the US did not get any worse. Improved cash flow means earnings quality improved and suggests the pressures on the business from the US housing slump are no longer getting worse. The stock popped 6% or so mostly on relief and short covering. I would not expect the stock to break out of its trading range on these results -- though I would certainly appreciate it if the stock did!
AB's earnings were strong -- 1.16 vs. consensus at 1.08. They also raised the range of expected earnings for the year to $4.90 to $5.25 with almost $2 of that coming in the 4th quarter. Hedge fund assets are up 45% year to date to $10.5 billion -- that's mostly high net worth money right now and it bodes well for performance fees in Q4. They plan to start selling hedege fund services to their institutional clients -- that could really raise some money and grow management/incentive fees since they have $500 billion in existing institutional assets under management vs. only $106 billion in high net worth assets. Even if the growth in hedge fund assets comes entirely from existing money under management, the higher fees for the hedge fund services would make that a great deal for AB.
I will have more to say on the markets this weekend.
Wednesday, July 25, 2007
Earnings updates (CME, ILMN, LH, PEP)
CME -- good solid report but nothing great. I was hoping for more on the volume growth front but it turns out the big volume gains I saw merely offset the volume weakness of the early part of the quarter. I still think estimates are too low for the next several quarters. Volumes on the acquired CBOT were stronger. Free cash flow remains strong. Company intends to do a tender offer for shares at a price less than $360 -- this could have a positive effect on EPS growth if they are able to buy a lot of shares. Volatility usually leads to gains in derivative volumes.
ILMN -- not much detail yet -- they just reported tonight and I have not had the chance to listen to the conference call. Revenues and EPS were better than expected and the stock popped a little after the news. This is a great secular story about the growth in genetics -- genomic analysis. New products have meant an order of magnitude improvement in the cost of genomic tools and that means big jumps in volume.
LH -- solid quarter with in line revenues and cash flow. steady as she goes.
PEP -- have not had the chance to look at this one but headlines suggested they beat and raised guidance -- always a good thing.
ILMN -- not much detail yet -- they just reported tonight and I have not had the chance to listen to the conference call. Revenues and EPS were better than expected and the stock popped a little after the news. This is a great secular story about the growth in genetics -- genomic analysis. New products have meant an order of magnitude improvement in the cost of genomic tools and that means big jumps in volume.
LH -- solid quarter with in line revenues and cash flow. steady as she goes.
PEP -- have not had the chance to look at this one but headlines suggested they beat and raised guidance -- always a good thing.
More on DFR
Ugly -- so the secular value investor decides to buy more DFR and within 24 hours he has already lost $1 per share or about 7%. The portfolio had a few other uglies like AB, Genvec (biotech), UEPS, Navteq and the energy related stocks. Bright spots included Asia, some of the lower beta stocks (FDS, LH, EPD, PEP, TECH, etc) and Illumina -- just got upgraded on Monday and reported after the close (next post). Overall, the portfolio was flat with the S&P 500 -- meaning down 2%, which means its still outperforming by 2.3% for the year.
DFR is a bet on management -- their ability to differentiate credit risks so that the portfolio is able to produce the kind of dividend income that will get the stock moving towards $30. Today they announced the dividend for this quarter will be 42 cents -- 3rd quarter in a row at that level but I am guessing they are waiting for high yield debt/loans to get more attractive before boosting their exposure to alternative assets and they are waiting for the deal to buy the management company to close before raising the dividend.
Was I early in buying more DFR? You betcha! Will I be vindicated in the future -- I expect to be but I expect the stock could see more pain before it gets better.
Right now DFR has about 25% of its equity invested in alternative assets -- mostly higher yielding areas like CDO's and high yield bonds. The management company's status as a manager of CDO's -- that's what makes up about 80% of their assets under management provides the source for the deals that DFR participates in. The goal for DFR's alternative assets is to reach 50% of equity or about 20% of assets. Once that happens the ROE potential will be higher and therefore the dividend potential is higher too.
Deerfield has a track record of managing credit risks that is very impressive -- I am betting that continues. If they suffer credit losses in either the mortgage portfolio or the alternative asset side, the dividend will be vulnerable and the stock will keep dropping. A rise in credit losses could also offset the expected increase in income from the higher percentage of equity invested in alternative assets -- meaning DFR's portfolio could complete the shift to 50% of equity being in alernatives and yet due to credit losses the firm could see the dividend remain at 42 cents. I do not believe that is likely.
One reason I like the deal to buy the management company is the potential for growth from new products -- Deerfield capital management develops a new fixed income product; they use the new product in the REIT -- the REIT provides seed money to build a track record for a new product. Over time the management company markets the performance of the new product and is able to grow client assets under management. This way the combined firm has a growth path to go along with the high yield.
DFR's stock is dropping in line with other financials -- including the banks, brokers and other credit related financials. To me that means the stock is not assuming a worse result -- there are no company specific issues that have led investors to question the company's future any more than they are questioning the future of all credit related entities. While today was ugly, I still believe the future is higher -- $20's.
DFR is a bet on management -- their ability to differentiate credit risks so that the portfolio is able to produce the kind of dividend income that will get the stock moving towards $30. Today they announced the dividend for this quarter will be 42 cents -- 3rd quarter in a row at that level but I am guessing they are waiting for high yield debt/loans to get more attractive before boosting their exposure to alternative assets and they are waiting for the deal to buy the management company to close before raising the dividend.
Was I early in buying more DFR? You betcha! Will I be vindicated in the future -- I expect to be but I expect the stock could see more pain before it gets better.
Right now DFR has about 25% of its equity invested in alternative assets -- mostly higher yielding areas like CDO's and high yield bonds. The management company's status as a manager of CDO's -- that's what makes up about 80% of their assets under management provides the source for the deals that DFR participates in. The goal for DFR's alternative assets is to reach 50% of equity or about 20% of assets. Once that happens the ROE potential will be higher and therefore the dividend potential is higher too.
Deerfield has a track record of managing credit risks that is very impressive -- I am betting that continues. If they suffer credit losses in either the mortgage portfolio or the alternative asset side, the dividend will be vulnerable and the stock will keep dropping. A rise in credit losses could also offset the expected increase in income from the higher percentage of equity invested in alternative assets -- meaning DFR's portfolio could complete the shift to 50% of equity being in alernatives and yet due to credit losses the firm could see the dividend remain at 42 cents. I do not believe that is likely.
One reason I like the deal to buy the management company is the potential for growth from new products -- Deerfield capital management develops a new fixed income product; they use the new product in the REIT -- the REIT provides seed money to build a track record for a new product. Over time the management company markets the performance of the new product and is able to grow client assets under management. This way the combined firm has a growth path to go along with the high yield.
DFR's stock is dropping in line with other financials -- including the banks, brokers and other credit related financials. To me that means the stock is not assuming a worse result -- there are no company specific issues that have led investors to question the company's future any more than they are questioning the future of all credit related entities. While today was ugly, I still believe the future is higher -- $20's.
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