Tuesday, October 27, 2009
- Morgan Stanley is issuing Research Technical Idea, saying they expect the stock will rise in absolute terms over the next 30 days.
This is because the stock has traded off recently, making short term valuation much more compelling. Although LO's 3Q09 results trailed our forecast, we do not believe there has been any change in the Company's long-term prospects and/or value, and as a result, we believe that the 7% decline in Lorillard's share price is both an over-reaction and unwarranted. We expect strong absolute returns to be driven by: (i) Improved reported shipment volume, with a declining negative impact from trade inventory movements. We forecast LO's shipments to decline by 5.2% and 2.4% during 4Q09 and 2010, respectively. (ii) Stronger pricing (note PM USA's 3-4% hike on Friday). (iii) More favorable menthol competitive conditions (e.g., the Blend 54 launch impact will moderate). (iv) Increasing share repurchases. (v) An attractive valuation at ~8.0x 10e EV/EBITDA (=RAI), and a 5.4% dividend yield.
- UBS notes that every stock has its role in a given portfolio. Investors own companies because they are best-in-class, others look for cash return/income stories and another type of investor looks for event driven ideas. Lorillard has all 3 of these traits. We believe Monday’s 7% (unwarranted) pull back offers many types of investors an opportunity to buy a best in class company that is a legitimate M&A candidate.
How Much Do You Get Paid to Wait for the Take-Out? 15% Per Year
While we have limited visibility on when Lorillard will get taken out, we would be surprised to see the company as a stand alone entity beyond 2 years. We see Reynolds American or Imperial Tobacco as logical buyers. We estimate investors waiting for an eventual take out can expect 15%+ total shareholder return per year to wait (10% EPS growth, 5-6% dividend yield).
Pricing Environment Stable and That’s What Matters for Tobacco Stocks
We believe concerns over potential disruption in the healthy cigarette pricing environment should abate as more cigarette companies send out price increaseletters to the trade. Altria raised prices Friday night by 3-4% across its portfolio and Commonwealth Brands just raised prices Monday afternoon. We expect Lorillard and Reynolds American to follow shortly.
Valuation: Raising Target to $100 Based on Blended Methodology
We are raising our target to $100 from $80 based on adjustments to our blended valuation, which includes: 1) M&A ($108)—weighted 50%, 2) DCF Value ($90), 3) Dividend Yield ($93), and Relative PE vs. Food ($85)—the other 50%.
- Goldman Sachs reiterates their Buy rating on LO shares and views yesterdays’s selloff as an attractive opportunity for longer-minded investors to buy a premier US tobacco company with healthy fundamentals and significant balance sheet optionality at a compelling valuation. First, while reported shipments fell 6.3%, underlying shipments were only down 1%, relatively in-line with our expectations. Second, LO pricing remains healthy, as the lowernet pricing per pack relative to our estimate is a primarily a function of negative mix. Maverick grew almost 40% in 3Q09 versus Newport shipment down 10%. Third, Newport is still gaining market share and has seen relatively limited impact from new Menthol brands. Fourth, LO repurchased over $350 mn shares in 3Q09, which suggests the company could repurchase at least $1 bn of shares annually over the next few years. Lastly, valuation is increasingly attractive with shares at 11.6X 2010 P/E (80% relative), well below historical averages closer to 14X P/E (95% relative) despite a healthy 10% EPS growth in 2010.
- Credit Suisse believes that concerns about volume declines and perceived pricing weakness are overdone and consider the stock attractively valued at the current level.
Action: I usually do not like buying on defenses but this time there are a few catalysts that might make it work:
- Morgan Stanley's RTI will bring buying interest today
- Potential for cigarette price increase in the next few days
- LO is a very strong candidate for M&A and once the dust settles, I would expect the speculations to return.
Sum it up and I would expect the shares to be up around 3+% today.
Thursday, October 22, 2009
Analyst comments following Citrix Systems (NASDAQ:CTXS) results last night leave an impression that the outlook might weight on the shares near-term:
- Credit Suisse says that although revenue results and guidance were relatively in line with expectations and management continued to control expenses to report upside to September quarter operating margin estimates, the company’s operating margin guidance of 75-100 basis points expansion for 2010 fell short of consensus expectations of approximately 200 basis points. The lowered margin guidance relative to expectations reinforces our belief that the company will return to “investment mode” as the economy recovers given management’s commitment to the desktop virtualization market.
- JP Morgan believes the revenue guidance of 8-9% growth implies material contribution from the Desktop Virtualization market, raising the risk of achieving these goals. However, if this growth is realized, it appears to us that the margin guidance is relatively conservative.
- Morgan Stanley believes cons. margins for CY10 are too high as a) VMW is outspending CTXS on VDI—which will drive a CY10 investment cycle, and b) our universe in general will see discretionary spending return in a recovery. Mgmt. prudently guided margins below cons. for Q4, and for 75-100 bps of expansion in CY10, vs. the 170 bps in consensus and our 80bps. While this will weigh on the stock near term, it removes the margin overhang.
- Merrill Lynch lists reasons to stay cautious:
1. CY10 not a ‘cyclical’ rebound. Investors view CTXS as a growth cyclical leveraged to an economic rebound. Hence the premium multiple. But CY10 outlook implies license and total rev of +5% and +9% y/y, not that faster vs. mature companies like MSFT, ORCL, and SY trading at a lower valuation.
2. Core XenApp business implies a tepid growth. For CY10, we expect Networking and Online to grow at 8% and 18%. Moreover, we model XenDesktop to grow 126% to $65mn albeit off a small base of $29mn. On the flip side, this implies core XenApp growth of only 2%. Moreover, starting 1Q10, Citrix will report XenApp and XenDesktop as a single segment, making it hard for investors to discern the underlying growth rate for core XenApp as well as XenDesktop (a key underpinning for the premium stock valuation).
3. Near term disruption from XenDesktop Trade-up. A Trade-up program starting 4Q would allow current XenApp customers to move to a super set XenDesktop for an upgrade fee. But XenDesktop charges on a per user or per device model vs. XenApp that allows concurrent users, which could imply higher costs for some customers, potentially causing NT disruption.
There were many positives as well and JMP Securities lists them:
1) While we still think it’s early in the ramp of desktop virtualization, the company reported 10 large desktop deals over 2,000 seats each, (compared to ten 1,000-seat deals last quarter), a positive indicator for this potentially large market, in our opinion. 2) Deferred revenue grew to $556 million (vs. our $541 million estimate), up from $481 million last year, resulting from the strength in the subscription business. 3) From a geographic perspective, the company noted ongoing improvements in the Americas and Asia with particular strength in Japan. 4) The company’s Online Services business(its SaaS offering) posted solid growth, up 21% for the year vs. our up 18% estimate driven by customers looking to reduce travel and increase productivity through tools like web conferencing. 5) The company recorded 12 deals over $1 million (five of which were XenApp, three were XenApp/XenDesktop combos, and four Netscaler) compared to seven deals last quarter, an encouraging trend, in our opinion.
Action: This is a deja vu for me with PLCM yesterday serving as an example. Both co's had decent quarters with in-line revenue and EPS helped by cost cuts.. however, they both seem to go into spending mode to fight off bigger, better-equipped competitors. This extra spending pushes operating margin leverage further away, which scares off some of the investors.
Basically it is yet another case of share vs margin.
The commentary is not as scary as it was with PLCM yesterday, so I don't expect the same kind of punishment for the stock. Still, I would expect the shares to fall more than the 4% decline in after hours trading.. say around 8-10%. That means anything above $39.5 is a short.
Tuesday, October 20, 2009
We are downgrading OSG to Underweight (from Neutral) as the recent share-price strength has disconnected from the company’s deteriorating near-term earnings outlook resulting in an all-time high valuation for the shares. Specifically, based on our new tanker rate estimates for 2H09 and 2010 (detailed in our industry note published today), we now expect OSG to post losses for 3Q09, 4Q09, and full-year 2010, and the stock’s estimated 2010 EV/EBITDA multiple of 15.1 times represents an all-time high, the highest multiple in the peer group, and a 42% premium to the industry average. All told, after months of outperformance, we look for the shares to underperform the peer group through the earnings trough we forecast for 2010.
Lowering EPS estimates and now forecasting losses through 2010. We are lowering our tanker spot rate forecasts through 2010 and based on these new estimates, we now project that OSG will post a loss in 3Q09 and 4Q09 as well as in full-year 2010. OSG’s increasing spot-market exposure, particularly as time-charter and FFA hedges expire in 2010, exacerbates the magnitude of the EPS declines associated with our new rate forecasts, with OSG having close to the highest earnings leverage within the tanker peer group. We now estimate that OSG will post 3Q09, 4Q09, and 2010 per-share losses of $1.03 (versus our prior forecast of a $1.14 loss), $1.41 (versus a $0.01 profit), and $1.90 (versus a $0.43 profit), respectively.
Share-price strength far too early for a recovery trade. OSG shares have increased by 23% month-to-date (versus a 4% appreciation of the S&P 500), easily outperforming the tanker peer group and the next strongest stock (FRO). We believe much of the share-price strength can be attributed to a shift to commodity-focused stocks as the US$ weakens and oil prices increase. In addition, OSG’s heavy short interest likely exacerbates positive price moves. However, we think the optimism in the shares also likely reflecting a global economic recovery ignores the current oversupply situation in the tanker industry which is likely to materially lag a rebound in demand and the estimated pressure that this overcapacity is likely to have on earnings and cash flow through 2010.
Valuation unappealing; lowering price target. Based on our new 2010 forecasts, OSG is now trading at a 2010E EV/EBITDA of 15.3 times, which represents an industry-high multiple and a 42% premium to the peer group average. We are also lowering our December 2010 price target to $24 (from $38) to reflect our new 2010 rate and earnings forecasts.
Action: This is actually a sector call as JP Morgan is updating estimates on all of the Oil Tankers, but OSG stood out for me. There are some other rating changes as well:
- Tsakos Energy Navigation (NYSE:TNP) to Underweight form Neutral with tgt to $13 from $20
- Capital Product Partners (NASDAQ:CPLP) to Neutral from Overweight
- Knightsbridge Tankers (NASDAQ:VLCCF) to Overweight from Neutral with tgt up to $20 from $18
TNP is also quite strong call, but the other stocks are too thin for my taste.
There are some good reasons to like this call:
- EPS estimates cut way below the Street. In fact, for 4Q09 JP Morgan's EPS est goes from Street high to Street low
- Price target lowered way below current share price
- Overall bearishness of the call
- Stock price at the 52-week high
However, I don't know if this is enough. Charts like this do not break to the downside without a very good reason. This downgrade gives a good reason, but might not be enough..
So how to play this? In current market stocks like OSG and TNP fall only when there is strong selling pressure. When the volume fades, stocks tend to bounce quickly. So that's what I would be looking for - as long as the stocks are sold on good volume, I would like to be short. Once the volume dries up, I would cover. Not the best plan, but wouldn't want to get caught by a nasty squeeze.
Thursday, October 15, 2009
We are upgrading shares of Donaldson to Outperform from Underperform. Our upgrade is based on 1) upside from the engine aftermarket business driven by a bottoming out of utilization rates which the market is not baking in, 2) long term opportunity to increase aftermarket penetration rate, and 3) consensus forecasts for 2010 and 2011 appear low. The Credit Suisse Investment Policy Committee (IPC) is adding Donaldson to the U.S. Focus List.
Top-quality blue-chip company levered to a cyclical recovery. Donaldson has grown earnings and consistently earned high teens return on capital for 19 years in a row before this downturn and the extent to which they can benefit from a cyclical recovery is underappreciated. Global IP which is bottoming out has had a 0.7+ correlation to overall company sales. We believe the track record of earnings growth returns in FY2011 with earnings power of close to $3.00 by FY 2013.
2010 and 2011 consensus too low. We believe over 40% of Donaldson’s portfolio is early cycle (a number not many know) where signs of a recovery could lead to faster growth combined with a low US dollar which likely helps earnings come in higher than expectations.
We are raising our target price to $41 from $28 based on our FY 2013 EPS estimate of $2.80 at a 18.5x P/E multiple discounted back. The 18.5x P/E multiple is consistent with what DCI shares have traded at for almost a decade. The stock has lagged more cyclical industrial names, although it should see double-digit top-line growth and close to 2x that in earnings in a recovery.
Action: So many reasons to like this upgrade:
- Double upgrade from Underperform to Outperform is usually enough to move stocks on its own
- Addition to the Focus List means Credit Suisse is out there buying the stock
- Stock has been weak lately due to lackluster FY10 guidance given on 1st of September.. Note that Credit Suisse estimates are near the high end of the guidance range and also close to the original consensus prior to the guidance. This suggests CS views this guidance as conservative and expects upside. As CS points out, DCI might be more early cycle than the market gives it credit for and mgmt team of DCI is rather conservative.
- Stocks of some of the biggest customers (Caterpillar, Deere) are right at the highs
DCI isn't a stock that would make a huge gap up.. and even if some enthusiastic pre-market trader drives it too high, it will probably offer decent entry levels after the open - around 2..2.5% above yesterday's close, maybe even lower if the market stays red. That's where I would be buying as I expect to see shares up at least 5% at some point today.
Tuesday, October 13, 2009
Downgrading to Underperform (from Hold) after a round of channel checks into the capacitive touch screen market. We believe CQ4 orders are tracking below guidance with stronger headwinds in 2010 due to share loss and a negative mix shift to modules likely driving another leg down in the stock.
- Capacitive touch screen market likely larger our previous expectations with a faster shift to chips from modules. Our checks suggest the capacitive touch screen market continues to expand and is likely larger than our previous expectations as (1) handset OEMs push touch capabilities into even low-end phones and (2) handset OEMs move more quickly to capacitive screens. We have increased our capacitive touch screen forecast to 84MM (from 50MM) in CY09 and 188MM (from 100MM) in CY10 (See Exhibit 1). Our checks suggest the market is moving faster to chip solutions (from modules) likely driving additional share loss and ASP compression for Synaptics.
- Downgrading to Underperform - Cracks in fundamentals only getting started. We are downgrading Synaptics to Underperform (from Hold) as our checks suggest its business has deteriorated further since our downgrade in late July. We believe orders for its December quarter are tracking in the $130-135MM (+10-15% Q/Q) range, below implied guidance of $140MM, likely driven by inventory issues at LG and a delay in the ramp of its two high profile wins at Nokia (X6) and RIM (Storm 2). Looking into 2010, our checks suggest stronger headwinds due to (1) a faster mix shift to lower ASP module solutions (chip ASP of $1-1.50 vs. module of $4-7), particularly at LG which had been the last module holdout and (2) increased competition and share loss at LG, HTC, and RIM (see Exhibit 2). Despite our expectations for significant unit growth in the capacitive touch market of over 100+% Y/Y in 2010, we believe these headwinds cause Synaptics' mobile business to be only flat Y/Y (units up 25-30% Y/Y with blended ASPs down 20%) and we have reduced our estimates.
- Expect inline CQ3 results with CQ4 guidance below. We believe CQ3 results will be roughly inline with our est and St. of $117MM/$0.41 yet believe CQ4 guidance will be below St. of $139MM/$0.60. We lowered our CQ4 est to $132MM/$0.53 and decreased our St. low CY10 est to $476MM/$1.63 vs. St. of $560MM/$2.30 to reflect our reduced mobile estimates.
Action: This is a strong call that should be read by all the shareholders of Synaptics. Pressure on ASPs and margin is neverever a good sign for a technology company and is almost always followed by share price decline. Even the increase in units doesn't help due to shift to module solutions that have way lower ASPs.
Basically the stock is in nobody's land. It isn't a growth story, it isn't a margin expansion story, it isn't a share gain story.. so basically there aren't many logical owners of the shares. One might be tempted to see some valuation support but the future earnings are very difficult to predict.
The shares already saw a huge decline after the problems first came evident with guidance for F1Q10 & FY10 but there should be more downside ahead. I would expect the shares to decline at least 5% today, possibly even 7+%. So if the market allows you to get fills for shorts at around 3% below yesterday's close, these should be worth taking.
Friday, October 9, 2009
We are downgrading Ralcorp from Outperform to Neutral and lowering our FY 10 EPS forecast from $5.10 to $4.75. We have reduced our target price from $75/share to $64/share based on a P/E multiple of 12.5x against our FY 11 EPS forecast. Our view that the company was well-positioned to benefit from private label share gains and from earnings accretion from the acquired Post cereal business has not played out particularly well.
We believe the company will need to make a significant investment in promotional spending on Post to regain the market share it lost this year to aggressive competitors. Over the past 12 weeks, Post's market share is now at 11.2%, down 260 bps compared to a year ago. To make matters more challenging, we find that the growth rate of private label food in general is slowing as the economic shock that drove consumer trial has now faded.
We expect downward earnings revisions heading into the 4Q earnings release on November 10 as analysts recognize the high sensitivity of RAH’s EPS to Post’s operating margin. Every 100 basis points of margin erosion in represents $0.13/share to RAH. If FY 10 is truly going to be a reinvestment year for Post, then our Post operating margin estimate of 21% (down 100 bps) in FY 10 may be too high.
With the stock trading at such a big valuation discount, it certainly feels like we are getting off this stock too early. Indeed, if we put a hefty valuation on the private label business akin to TreeHouse’s (8.8x EBITDA), then the market is valuing the Post business at only 4.4x EBITDA. However, we can’t justify supporting an Outperform rating until we get more comfort that management has accurately diagnosed the problems that Post is facing and has developed a compelling strategy for solving them. So far, we have not heard or seen enough proof.
Firm is also removing stock the U.S. Focus List.
Action: Somewhat mixed feelings on this one. There are some good arguments supporting a rather hefty sell-off today and in the coming days:
- Credit Suisse FY10 EPS est is going from Street high to Street low. How often do you see this kind of change in view? Once a year? At the moment I cannot recall anything else like that.
- Comments regarding promotional activity and margins do not sound good at all. It is a typical case of margin vs market share and co hasn't performed that well in that area recently.
- Removal from Focus List should add shares that need to be sold.
However, the stock is not too expensive, which might limit the downside. Also, the stock has been rather weak since mid-September and stocks have had a tendency to shed off anything negative recently.
I would expect to see around 2 points of downside today, maybe even more. The stock will probably gap down a point or so, leaving another point for early shorts.
We are upgrading SVNT to Outperform from Perform based upon increasing confidence in Krystexxa's approval and commercial prospects, and a more attractive valuation following the recent stock pullback. Importantly, (1) The announcement of a proposed offering of up to 4.6M shares on 10/7 drove SVNT down ~12%, which we feel is unwarranted and believe presents an attractive entry point. (2) We continue to believe SVNT will adequately address outstanding manufacturing issues and will re-submit data in 1Q10. (3) We are confident in Krystexxa's approval ~3Q10 and believe any incremental short-term (1-2-month) delays are not likely to hinder the drug's long-term prospects. (4) We moderately increase our Krystexxa sales estimates and establish a $17 price target.
Stock Move Overdone; Takeout May Be Possible. We believe SVNT's recent financing strengthens the balance sheet and should fund SVNT through late 2011, a clear positive. We do not believe the raise in any way signals lack of partnership or acquisition interest. On the contrary, we believe an acquisition following FDA approval is certainly possible.
Krystexxa De-risked; Manufacturing Approach Likely To Succeed. We continue to believe SVNT will adequately resolve manufacturing concerns. We expect SVNT to re-submit data in 1Q10 addressing 1) CMC issues, 2) labeling, and 3) REMS data. Importantly, while Krystexxa's label may include a black box warning, we do not believe this will impact its commercial prospects.
3Q10 Approval Expected For Krystexxa. We believe 3Q10 approval is likely, even though 6-month stability data will be submitted close to the new PDUFA date. Given the severity of the refractory gout population, we do not believe FDA wishes to delay approval. Also, any additional delay would be immaterial to SVNT's valuation in our view.
Market Opportunity May Be Underestimated, Introducing PT of $17. We have modestly increased our U.S. and ex-U.S. Krystexxa sales estimates based upon our assumption that a higher percentage of patients with gout tophi are likely to receive Krystexxa. Our increase in worldwide Krystexxa sales estimates results in our PT of $17.
Action: First of all, note that SVNT 4.3M share secondary was priced at $13.29 last night, right at yesterday's close instead of usual discount. Yes, the stock had already tanked yesterday, but still, it is a strong sign that the secondary was very well received.
Also, take a look at how HGSI acted in back in July after secondary. There was so strong demand that the shares traded way above secondary pricing the next day. Might be the case here as well.
The only question is how much to pay up? The shares were down 12% yesterday and I expect this decline to be reversed today. Still, greedy as I am, I wouldn't like to pay above $13.8 or so. More agressive accounts might want to go higher to get more size.
Oh btw, I like the upgrade by Oppenheimer as well. It has all the ingredients of a good call and without the secondary it might be worth around 5% of upside by itself. Now it just adds fuel to the fire.
Monday, October 5, 2009
It’s time to buy GD, drivers could take shares beyond our $80 PT. GD’s current valuation prices in an extended trough, whereas we project a Gulfstream recovery starting in 2011. Anecdotal evidence from industry contacts, a pickup in used jet sales (leading indicator of a turn) and some new orders indicate the upper end bizjet demand is thawing, warranting a higher aero multiple for Gulfstream. Although early, GD offers investors an option on the Chinese business jet market that could drive substantial incremental demand. Weeks ago the Chinese government announced changes to open up its airspace for business jets, effectively unlocking the Chinese market (only 100 or so business jets in operation in China today). Gulfstream would be a lead beneficiary of a sea change in Chinese bizjet demand, which could drive a re-rating for Gulfstream.
Where We Differ: GD’s valuation reflects enduring concerns about Gulfstream’s outlook, but improving demand internationally heightens confidence in deliveries, especially in 2011-12 and we’re raising our EPS estimates. GD trades in-line with defense peers at 9X 2011 EPS, implying an equivalent 9X P/E on the Gulfstream business. But if the business jet recovery plays out, Gulfstream could more rightfully enjoy a mid/high-teens multiple (adds $13 - $17 per share) excl. China upside, pointing to $80 or higher.
Revising Industry View to In-Line: Defense is down 1% YTD (15% underperformance rel. to S&P), and has sizably missed the S&P rally this year. But we believe that a bearish view on Defense is now consensus and has more or less fully played out.
Action: I really like this call. Not much is expected from biz-jets so Morgan Stanley's comments stand out. And China as a source for upside - sounds sexy, doesn't it?
This call will definitely generate some buying interest. I expect the shares to trade to at least $65 today, maybe even making a new 52-week high this week.
If GD goes too high too soon then TXT represents a good secondary play.
Thursday, October 1, 2009
We are downgrading Leap Wireless and MetroPCS to Neutral from Overweight. We have become increasingly concerned with wireless fundamentals as the industry faces secular challenges, with high penetration and heavy competition causing downward movement on price and increased acquisition costs. We believe Leap and Metro have been forced to operate more and more defensively, and we expect to see additional ARPU erosion over time while long-term margin guidance could be challenging. ˇ
Competitive landscape poses challenges. Recent months have brought a slew of competitive announcements in the wireless industry, particularly at the low end from Tracfone and Sprint’s Boost Unlimited. Leap and MetroPCS, we believe in large part as a reaction to these new competitors, began offering additional features into existing price points in early August, effectively lowering pricing. Metro added to these features just yesterday, more than doubling roaming coverage. We are expecting additional competitors over time as well. For example, AT&T recently noted a prepaid trial it is running in a few markets; though at a large premium, we believe price reductions could come should AT&T see a market opportunity. We could also see T-Mobile, a victim of Leap, Metro, and Boost’s success over the past several quarters, become more aggressive.
Profitability at risk. Both Leap and Metro guide to long-term margins in the mid-40% range. However, we believe the carriers could run into challenges achieving that level of profitability amid recent ARPU compression and further potential pricing pressures. ARPU is now expected to dip below $40 in the near term and could fall further, following recent pricing changes. Both companies have demonstrated an ability to get margins to the 40% level in mature markets thus far; however, that was achieved with ARPU at higher levels. In addition to using price as a lever, Leap and Metro may need to increase acquisition costs to win market share. As a result, we are cautious on both companies' ability to continue scaling effectively over the long-run.
Changes to expectations. We expect seasonal pressures to impact 3Q09 results for Leap and Metro, though new price plans launched in early August could mitigate some of the impact. Nonetheless, we are reducing our net add estimates for both companies given our expectations for seasonality to outweigh new promotions. We believe ARPU will continue to trend downward, dipping below $40, and we expect it could fall further as customers transition to the new plans. Our estimate changes drive modest changes to EBITDA for 3Q09. However, we are making more significant changes to 2010 estimates, reducing our net add estimates as we expect competition to hinder growth.
Potential near-term upside likely to be short-lived. Both companies are entering a seasonally stronger period as 4Q and 1Q results typically benefit from the holiday selling season as well as tax refunds, and we could see shares outperform, although we believe that is a widely held view. Despite potential near-term outperformance, we are very cautious on long-term fundamentals. We are adjusting our price target for MetroPCS to $10 from $11.
Action: While this call contains nothing that's not already known by the market, it is strong enough to generate some selling pressure today. Both stocks are great trading instruments so I would expect traders to jump on board as well, trying to push the shares lower. LEAP & PCS both should be good shorts at the current pre-mkt levels ($19.30 and 9.08, respectively).
We are downgrading the shares of BMC to Underweight from Neutral and establishing an end-December 2010 price target of $30, representing 20% downside from current levels (our end-2009 price target was $30, too). The stock appears to imply material improvement in operations, which we view as unlikely. At this point, we believe the risk to the shares outweigh the potential reward.
Great Expectations. While the BladeLogic assets are probably leveraged to improved enterprise software spending, we do not expect much change to the demand for the remaining assets of BMC from historical rates.
Historical Weak Free Cash Flow Likely to Persist. We expect the surprisingly weak long-term free cash flow characteristics of BMC to persist, even with the much anticipated mainframe software renewal cycle that is expected this year.
F10 Guidance Risk. While this is not a call on the quarter, we do believe BMC’s F10 guidance could be at risk since this is predicated on an improving software spending environment. Though non-GAAP EPS will likely at least come in line due to accounting flexibility, cash flow could be at risk (though BMC also enjoys flexibility in reporting operating cash flow).
Not Likely to Be Acquired. We recognize the risk of BMC being acquired but view that as unlikely at these levels or even meaningfully below these levels.
Action: JP Morgan is trying to spoil the bulls' party and I'd say they they will succeed, at least near-term. Comments about weak cash flow and F10 guidance will definitely hurt the stock.
Should be good for at least 3% of downside today. Even more if the market stays red.
Wednesday, September 30, 2009
Investment conclusion: We believe Family Dollar will issue reassuring guidance next week, contrary to market concerns, and therefore think the risk/reward is positive headed into earnings. FDO is down 16% in the past month and currently trading at 11.7x our F2010 estimates, close to a trough multiple. We believe once guidance is given and the air is cleared, the stock could see a relief rally.
What the Market is Nervous About:
• Next year’s comp guidance given the most recent quarter comped a 1%
• Inventory levels given the weaker comp
• FDO’s ability to improve margins as overlaps of improved distribution costs, sourcing costs, and markdowns get more difficult
• EPS guidance given sales and margin outlook
• Execution risk in space re-allocation and product assortment initiatives
• New initiatives that may take up SG&A spend
• Benefits of lower gas prices ending in 1Q which could impact lower income spending
Our Take: We believe Family Dollar’s guidance will be reassuring and management could guide to 1%-3% (or even 2%-4%) comps and EPS of $2.10 to $2.30. We also believe management could state that September sales improved from August and explain part of the weaker 4Q comp due to store re-models. As part of those re-models, SG&A was pulled forward into F2009 and should moderate SG&A growth in F2010 to ~2.5%. Furthermore, we believe there will be commentary on a renewed focus on store level profitability.
Firm is also issuing Research Tactical Idea long on FDO:
We believe the share price will rise in absolute terms over the next 15 days. This is because the stock has traded off recently, making short term valuation much more compelling. We believe Family Dollar will issue reassuring guidance when the company reports on Wednesday, October 7th. Investors are concerned that EPS guidance will be well below street estimates, while we believe the company's guidance can encompass street estimates. Furthermore, we believe the call could give other positive data points such as improved September sales and a renewed focus on store level profitability. The stock has underperformed the S&P by 22% over the past month and is currently trading at 11.7x our F2010 estimates. We believe the earnings call will help clear the air and spark a relief rally in FDO shares.
We estimate that there is about a 70% to 80% or "very likely" probability for the scenario.
Action: FDO has sold off recently after comps / preannouncement on Sept 3rd. Morgan Stanley is listing all the concerns above and they do a good job refuting all of these. Given their conviction I would expect the market to listen and send the stock higher today - $27 is very possible.
Friday, September 25, 2009
* Airlines sector upgrade at UBS - not sure it is going to work in this market, also the stocks have already seen a nice rally after JP Morgan upgrade. Still, if it gets going 5+% moves are very possible
* TEX upgrade at Credit Suisse - CAT and PH were also upgraded but TEX is the best one out of these. Should move regardless of the market
* BC upgrade by RBC
* STEC upgrade by B. Riley
* GNK & DSX downgrades at Stephens
These might work but don't have enough conviction with any of these.
We had the opportunity to meet with MNKD management to discuss AFRESA and partnership developments. Importantly, (1) in contrast with investors who have bid up MNKD stock price, we do not believe an AFRESA partnership agreement will be secured by 3Q09. (2) In our view, MNKD's ~$60M financing in August suggests MNKD had to seek alternative sources of cash since near-term upfront partnership payments are unlikely. (3) We believe the FDA may require a 4-mos bioequivalence study comparing dreamboat and medtone inhalers, potentially delaying approval past the 1/16/10 PDUFA. (4) In our view, inclusion of AFRESA in metabolic advisory panel committee (12/15) may suggest FDA has concerns; however, AFRESA program may not be available for review by December.
Partnership Timing Slipping, May Not Surface During 2009. We believe a partnership around inhalable insulin product AFRESA is unlikely by 3Q09 and doubtful before approval. In our view, much of MNKD's recent stock move surrounded expectations for this partnership. As a reminder, MNKD had an internal goal of establishing a partnership by 3Q09.
Recent Cash Raise Suggests Partnership Unlikely. In our view, the fact that MNKD raised ~$60M in August suggests that management chose to access alternative sources of funding since the upfront cash from a partnership agreement likely would not be coming in 2009.
Additional Bioequivalence Study Could Delay Approval. Should MNKD launch AFRESA with the dreamboat inhaler, we believe the required ~4mos bioequivalence study would start in November, potentially delaying approval beyond the 1/16/10 PDUFA. We believe MNKD will launch the dreamboat inhaler, given insulin administration advantages, but FDA is likely to require bioequivalence at a minimum.
AFRESA Advisory Panel May Suggest FDA Has Concerns. We believe the FDA may review AFRESA at the Endocrinologic and Metabolic Drugs Advisory Committee meeting scheduled for 12/15 given safety concerns for inhaled insulin. Also, the safety bar for AFRESA is expected to be high, since millions of patients could be treated with the drug.
Action: I expect these comments to pressure the shares today. Nothing completely new as the reasons are basics for any bear case for the stock, but over the past few days seems like investors have less appetite for risks. I would expect the shares to fall below $9.50 and even more if the market stays red.
Thursday, September 24, 2009
After a recent meeting w/ mgmt and following a major update of our model to better reflect the launch of digital services and recent currency exchange rate changes, we are revising our forecasts, upgrading our recommendation to Buy from Hold, and initiating a 12-month price target of $60 (23% above current levels). For 1QFY10, our revenue and adj. EPS estimates increase to $142MM and $0.39, resp., and are above guidance and the consensus means. For 2QFY10 and beyond, our revenue estimates are above guidance and consensus but our EPS is at the low-end (or below is some cases) due to recent currency exchange rate changes. We believe business continues to perform at least in-line w/ expectations, w/ order growth >25% YoY, stable AOVs, and continued favorable customer acquisition cost trends. The company is also pursuing strategies to sustain growth, such as establishing a presence in the APAC region, infrastructure expansion in Europe, enhancing customer support resources, expanding its consumer/home offering, and rolling out a partnership w/ FedEx Office, among other things. Our model assumes digital services (i.e., websites and email marketing) could contribute $22MM in high-margin revenue in FY10. The strong U.S. Dollar (USD) on a YoY basis should still negatively impact revs and gross margins in 1QFY10, but likely not as much as contemplated in current guidance. For forecasting purposes, if we assume exchange rates remain stable at current levels, we estimate an F/X benefit to revenues but a slight negative to gross margins and EPS. However, we believe this possible F/X headwind will be more than offset by growth in digital services as well as other growth initiatives.
Action: This is a controversial name with a business model that has many doubters - just look at Citron's comments or 33,9% short interest. Yet the analyst community is overwhelminly positive on the stock with just about everybody having positive rating on the name. That makes me wonder if there is new longer-term money willing to come in at these levels.. even with new Street high estimates for current quarter from Needham.
The traders will definitely try to push this one as high short interest makes it an attractive target for a short squeeze. They will probably succeed initially and send the stock close to $50 and maybe higher. Just don't mistake it for real buying interest. Most likely the day highs will be made in the first 15-30 minutes and the stock will tick down afterwards - like GYMB did on Tuesday.
Wednesday, September 23, 2009
We are downgrading BDK to SELL this morning on concerns over the divergence between recent share price valuations and what we perceive to be continuing weakness in underlying NA and European power tool fundamentals. We are reducing our earnings estimates to 4Q09E: $0.37 (-$0.06), FY09E: $1.66 (-$0.06) and FY10E: $1.90 (-$0.25). Our target price is $35 based on 18.5x FY10E EPS. The shares last traded at $35 on July 24, 2009.
Weak Power Tool Fundamentals in NA – As our survey research this month indicates, we do not believe the NA category is undergoing a significant recovery. Promotional activity remains high and appears necessary to induce sales volumes. While August volumes were up sequentially, we attribute this to (a) a cold, wet July throughout large portions of the U.S., and (b) pent-up demand from deferred purchases all summer. We are not seeing any convincing evidence of a recovery in construction activity sufficient to provoke tool purchases. In fact, STAFDA pro category tool dealers are telling us they are continuing to see yr/yr sales comparisons of negative 20%. While we expect a better 2010, we think the recovery will track a very gradual slope and fall below current Wall Street expectations.
Weak European Tool Fundamentals – The European market represents 25-30% of BDK revenues. From our survey research this month we know that the market looks slightly better than NA, but not by a meaningful amount. Mix remains weak and by our tally, could represent a couple of percentage points of revenue decline in 2H09. Retailers are being extremely cautious with their inventory investments and are gravitating towards stocking opening/value (read low margin) products. As we begin in September to compare with more ugly 2008 numbers in both Europe and NA, we will undoubtedly see the negative comp numbers reflect smaller magnitudes, but we do not believe we will see a significant upturn in tool demand until 2H10.
Raw Materials Cost Inflation – With various raw materials seeing price rallies since earlier this year, we expect BDK to feel increasing pressure on variable cost margins in 2010. This extends beyond the Power Tool business as both the locksets and the faucets businesses have large exposures to base metals such as copper ($2.85/lb, up 28% past 90 days), zinc ($0.87/lb, up 27% past 90 days) and nickel ($7.92/lb, up 18% past 90 days).
Low Probability Surrounding Fall 2009 Channel Fill – As evidenced by comments from a large home center at their analyst meeting held yesterday, retailers are still very cautious on their outlook for 2010. This will invariably be reflected in how they manage their inventory investments around key power tool sales events like Fathers Day and Christmas. In speaking with retailers, we continue to hear about how this year’s channel fill will be light, even by last year’s standards. We expect this will have an adverse impact on 4Q09 earnings performance and are reducing our 4Q earnings forecast accordingly.
Low Degree of Operating Leverage is a Negative in Recovery Phase of the Cycle – As the economy slowed, we saw the benefit of having sold off or closed manufacturing assets and out-sourced a big part of the company’s production. The company’s high variable cost model did not experience as rapid an EPS decline as its more capital intensive peers. But now we are looking forward to the recovery phase of the cycle and with variable costs proportionately higher (fixed costs proportionately lower), we expect to see less operating leverage, and therefore less EPS growth as industry volumes recover. Furthermore, if raw materials prices continue to rise and BDK is not successful in fully passing through increases, contribution margins will be even further reduced and the EPS recovery will be even further muted.
Valuation – As the accompanying chart illustrates, BDK is trading at a valuation well above the typical level seen at this point in the business cycle. At 25.5x FY10E EPS (a 55% premium to the S&P500 multiple), we must go back 16 years (1993) to find so rich a valuation. In the table below, we consider what BDK might earn over the next four years. If we take the 2013 forecast of $4.33 per share and apply a 14x P/E multiple, the implied January 1, 2013 share price should be $60.67. If we NPV this at 20% (our guess at what an investor would need as a minimum target return to invest over that period of time), we get $35 per share as a January 1, 2010 fair value. For those with lower hurdle rates, we present a 15% and a 10% discount scenario, none of which gets to the price of the shares on last night’s close.
Action: Just take a look at the chart of BDK. It has nearly doubled since the beginning of July. Now Longbow is saying that things are WORSE than expected. Not what you usually hear after such rally. I would expect these comments to pressure the shares today and possibly longer. I expect BDK to be a 5% decliner today so early shorts should be rewarded.
We are downgrading our ratings on the U.S. coal sector to Neutral from Overweight as we believe demand for seaborne metallurgical coal in China is slowing following discussions with Macquarie’s network of global physical coal traders and our commodity team. We have heard from Canadian producers that the Chinese have pushed back on deliveries and there appears to be an absence of new demand in Australia, suggesting that coking coal imports for September and October could fall sharply. The main export markets for U.S. coking coal of Europe and Brazil remain very weak and prices for spot met coal in the Atlantic Basin remain well below the Pacific Basin, limiting upside for U.S. companies.
If China really slows down, high-beta US coal stocks at risk. We have been very bullish on the US coal sector since June when global met coal and Chinese steel fundamentals were starting inflect to the upside and sentiment on the met coal market was generally bearish. The U.S. coal sector is up ~100% in the past two quarters and we see risk in the short run. We forecast Chinese imports to slow in 4Q owing to lower steel production and rising local mine supply which would be a negative catalyst for U.S. coal equities in our view. Also, thermal fundamentals continue to worsen and we expect producers to lower 2010 volume expectations this quarter offsetting much of the benefits of better coking coal fundamentals.
Increased Pacific met demand does not benefit US producers that much. US met coal producers ship very little met coal into Asian markets as the majority of tons are sold to US and Canadian customers. Brazil, and Europe account for 75% of U.S. met export volume and these markets remain extremely weak with excess inventory of coke and depressed steel mill operating rates. U.S. coal producers have not seen any major pick up in orders from Europe yet.
Met prices are soft in the US and Europe; thermal market remains very weak. The strength in met prices in the Pacific has not translated into higher European or US met prices. We believe prices for high-quality met are not higher than US$100/ton into Europe right now and are around US$95/ton in the US. The high-vol market remains oversupplied with weak prices near US$85/ton. US thermal prices continue to weaken and we expect rising inventories in the fall should drive new production cuts and reduced volume / price expectations for 2010.
Macquarie is lowering ratings on individual coal stocks as following:
Alpha Natural (NYSE:ANR) to Neutral from Outperform
CONSOL Energy (NYSE:CNX) to Neutral from Outperform
Massey Energy (NYSE:MEE) to Neutral from Outperform
Patriot Coal (NYSE:PCX) to Underperform from Outperform
Peabody Energy (NYSE:BTU) to Underperform from Outperform
Action: This is a call everyone invested in coal stocks should pay attention to. There hasn't been anything negative said on the sector recently, maybe only that valuations are getting a bit expensive. And now Macquarie is saying Chinese are pushing back deliveries & no new demand from Australia.. Wow. That doesn't sound too good, does it?
The only problem I have with this call is (potentially unfounded) relative lack of recognition of Macquarie among U.S. investors & traders. If this call was coming from a Tier-1, it would make headlines all over the media.. now it might go under the radar. Well, at least until some better known house comes out saying the same thing and everybody finds out that hey, there was somebody saying it before.
It also makes it difficult to make a call on the stocks. I would really like to go short in all the stocks mentioned, but it might take a bit too long until the word spreads. Maybe the best idea would be start with like 1/2 of position early on to be involved and add the rest after seeing this call making any headlines.
Update: Note that ANR & BTU were upgraded to Buy at Citigroup yesterday, getting only somewhat muted reaction in stock prices.
Update 2: FBR is downgrading WLT on valuation.
Tuesday, September 22, 2009
We are upgrading shares of GYMB based on (1) market share gains from compelling product, (2) best-in-breed management, (3) accelerating unit growth, (4) potential return to sustained positive comps, and (5) valuation still compelling in our opinion.
Gaining market share with target- and price-right product. Management discussed the popularity of “recent fashion,” and noted strong customer reception to product on its recent quarterly call. Store checks have shown strong reception to the value message, as well as compelling product. On the 2Q09 conference call, the company pointed out that it oversold in some basic denim, and it expects the reorders to arrive in November. We believe GYMB is gaining market share, as GapKids continues to undergo a consolidation into the Gap adult business, Talbots Kids has now closed, and Children’s Place (PLCE-Not Covered) struggles with the top line. With sharpened price points, but retaining the quality Gymboree is known for, we believe GYMB is now one of the “go to” brands for parents.
Let there be growth; GYMB joins the ranks of the “growth” stories in specialty retail. As we have discussed, there is a shrinking pool of square-footage growth stories in specialty apparel. As a result, investors have awarded this select group higher multiples for their potential organic growth. We have seen shares of companies with the promise of mid-single-digit square-footage growth bid up by investors. On the 2Q09 conference call, management alluded to three vehicles for growth going forward: Crazy 8, boys, and international. We believe the product looks significantly improved at Crazy 8, and management noted it expects the concept to break even in 3Q09. It expects to have 66 stores by the end of FY09 and plans to open a minimum of 50 stores in FY10, implying annual square-footage growth in the high-single to low-double-digit range. Additionally, management pointed to potential growth from international markets and Gymboree boys, suggesting that without square-footage growth, the company believes it can grow boys' sales by $100 million over time.
Despite the share runup, GYMB remains at a compelling valuation. Although we recognize that investors may shy away from a stock that has run significantly, we believe that there remains upside, as 3Q09 guidance appears conservative, and shares trade at 13.7x our FY10 estimates compared to the peer average 21.4x. Based on our belief in the product, management, and unit growth, we rate shares Outperform and recommend accumulation.
Action: It would be lovely, lovely upgrade.. if only the shares hadn't had such a wild run over the past 6 months. I still think the shares will catch a bid today due to combination of FBR comments, strength of overall market, continued momo and high short interest. How much will it run today? My guess would be 4-5%.
Our Take — Following recent proprietary mtgs. with mgmt., we are upgrading M from a Hold (2H) to a Buy (1H) rating based on: 1) M’s ability to drive the topline as the My Macy’s localization initiative cont. to gain traction; 2) operating margin tailwinds from product cost deflation and Macy’s speed to market initiative, and 3) upside fr. current levels based on our $30 price target.
Rationale #1: My Macy’s to Fuel Topline — We are encouraged by the consistent, positive early results that Macy’s has reported from its 20 pilot markets since 4Q08, and believe that this localization initiative should lead to improved topline (and margin) trends ahead, particularly beginning in 2010.
Rationale #2: Margin Tailwinds Abound — Macy’s expects benefits from product cost deflation to be greater in ‘10 than in ‘09. Based on our proprietary analysis, cost deflation could boost gross margins by 50 bps next year! Also, Macy’s speed to market initiative is underway, and while Macy’s is a small step behind the competition, we view this as an investment positive, as a majority of the benefits are ahead of us.
Rationale #3: Upward EPS Revisions Warranted — Our previous EPS estimates and consensus are too low in light of the topline and operating margin drivers discussed above. We also view mgmt’s ‘09 guidance as conservative. As such, we raised our 2009-2011 EPS estimates and target price for M. Lastly, we raised our Sept. SSS estimate to (-4) to (-6)%, up from (-5) to (-7)% previously.
Action: This call has everything one might expect from an upgrade: real research by the analysts, near-term catalyst (higher Sept SSS estimate), strong case for longer-term upside, hefty price target - you name it.
I expect investors to take notice and come buying today, sending the shares close to $19 level today. It will be difficult to get fills at decent levels, so you probably need to pay up to get involved.
Friday, September 18, 2009
We are maintaining our 2-Equal Weight rating on ARNA following release of BLOSSOM results for lorcaserin in obesity. While the study met its 1ary endpoint results were disappointing relative to prior BLOOM results, well below the standard set by Vivus's Qnexa, at the bottom of the range for late stage candidates, only approximating regulatory requirements, of questionable clinical significance and unlikely to support partnership. We expect shares to pull back on these results
ARNA reported results today from the BLOSSOM study of lorcaserin in obesity. Results of the 4088 patient study suggest placebo adjusted weightloss of only 3.1% (5.9% vs 2.8%), below FDA guidance of 5% with categorical 5% weightloss in 47.2% vs 25% for placebo, in the range of regulatory guidance for approximate doubling. Results are below the 8% placebo adjusted weightloss with competitor Qnexa and no better than intensive lifestyle modification in a recent Contrave study
While topline safety appears relatively clean with no difference in valvulopathy and no apparent CNS AEs we would note a higher discontinuation rate for AEs at 7.2% vs 4.6%. We believe results are disappointing relative to expectations
Action: When you are developing a drug in a area with so many competitors then so-so results are not good enough. Despite meeting the primary endpoint these results should be considered as a disappointment and expect the stock to react accordingly today.
It is a short above $4 and I expect it to fall close to $3 level today.
Thursday, September 17, 2009
We are downgrading our rating on BorgWarner Inc. (BWA-NYSE) to HOLD from BUY and lowering our earnings estimates to $0.07 from $0.27 for 2009 and to$1.35 from $1.58 for 2010 as we are incrementally concerned that: 1) BWA could report 3Q09 earnings below consensus expectations or that the Street may lower estimates prior to its earnings release, both of which could be a negative catalyst for the stock (we are lowering our 3Q09 estimate to $0.10 from $0.18; First Call mean is $0.13); 2) negative factors affecting 2Q09 and 3Q09 earnings could persist for several more quarters; and 3) potential weakness in stock price could present long-term investors with a more attractive entry point given the solid longer-term fundamentals at BWA.
We are incrementally concerned that BWA could report 3Q09 earnings below consensus expectations or that the Street may lower estimates prior to its earnings release, both of which could be a negative catalyst for the stock. As such, we are lowering our 3Q09 estimate to $0.10 from $0.18 (First Call Mean $0.13). We believe investors may be particularly sensitive to lowered expectations given disappointing 2Q09 results and the overall positive sentiment for the rest of the group.
We believe that the negative factors affecting 2Q09 and 3Q09 earnings (i.e., negative product mix, lower profitability in Europe, sluggish commercial vehicle sales, higher than expected interest and incentive compensation expense) could persist for several quarters before dissipating and becoming tailwinds in 2010.
We believe that potential weakness in stock price could present long-term investors with a more attractive entry point as we remain confident in solid longer-term fundamentals driven by an improving production environment, a strong new business backlog, and a robust product portfolio.
Action: Estimate cut below consensus might catch some investors as a surprise after all this excitement in the sector, sending the shares lower near-term.
I suspect BWA is going to trade around $32 in the pre-market and it should be considered as entry point for shorts. I expect shares to sell off after the open, possibly close to $31.
Wednesday, September 16, 2009
Rodman & Renshaw is downgrading Fuqi International (NASDAQ:FUQI) to Market Perform from Market Outperform:
Downgrade To Market Perform We are downgrading our rating onFUQI to a Market Perform from Market Outperform based on valuation.FUQI is currently trading at P/E multiples of ~16.5x and ~14.0x to our2009 and 2010 earnings estimates. We believe that current valuationbeing assigned to the stock fairly reflects earnings opportunities andrisks associated with the company’s near term growth strategy.
Near Term Drivers Priced In FUQI traded above our 12-month pricetarget of $32.00 yesterday (closing at $31.86). We believe that near termearnings and revenue growth from the roll-out of its retail strategy is nowreflected in this price. We continue to maintain that FUQI should beviewed as an opportunity to out-compete the fragmented Chinesejewelry market. However, given current levels we would refrain fromadding to our positions until there is more visibility into management’sexecution of its strategy and application of proceeds from the recentcapital infusion.
No Room For Higher Estimates We are not making any changes to ourfinancial model. We are maintaining 2009 revenue and EPS of $532 MMand $1.97 respectively. We are also maintaining our 2010 revenue andEPS estimates of $745 MM and $2.31. Our prior $32.00 price target andMarket Outperform rating were driven by estimates that are alreadyslightly aggressive compared to management’s guidance. Our higherestimates are partly driven by management’s history of providingconservative guidance. Investors should note, for 2009, managementexpects total revenues of ~$509 MM - $527 MM (wholesale and retail).Net income for the full year is expected to range between $44 MM to $47MM, or $1.83 - $1.94 in diluted EPS. We would like to see 1) thecompany perform towards these numbers or 2) any meaningful pull backin the stock before we revisit our rating and price target.
Action: While this is valuation call only, I expect it to provide a nice trading oppty. Rodman's positive calls sometimes tend to get viewed as biased at least by some, but when they're negative, investors seem to listen. Just take a look how ARNA sold off yesterday following Rodman's downgrade.
I expect to see some profit taking in FUQI today, sending shares below $31 and possible even $30 so shorting above $31.5 should be good. Don't overstay your welcome, though, this one is always willing to squeeze.
California Retirements Are A Negative — The recently announced retirements of Potrero and Contra Costa and likely retirement of Pittsburg units 5 & 6 will result in either lower EBITDA (Potrero) or cash outflows to replace the plants (Contra Costa – Pittsburg). We have reduced our 2011E EBITDA estimate by $(15) million to reflect the retirement of Potrero, and we subtract $(365) million of NPV from our valuation due to high likelihood that Contra Costa and Pittsburg (both use once-through cooling) will eventually need to be replaced.
Reducing Target Price To $13.00 — In our view, Mirant trades too high on Open EBITDA valuation multiple relative to its peer group. This high valuation is apparent in our EBITDA estimates – as Mirant’s hedges roll off by 2011, its Adjusted EBITDA declines year after year. In addition, Mirant burns primarily CAPP coal – a fuel type that has a high degree of $/MWH correlation with natural gas prices. This limits Mirant’s ultimate sensitivity to natural gas, in our view, and accordingly limits its valuation multiple as well.
Downgrading To Sell — The bull case on Mirant is 1) cyclical trough exposure to the Merchant sector, 2) a solid balance sheet versus competitors, and 3) its high EBITDA sensitivity to gas. But we believe: 1) the stock is currently trading expensively on EV/Open EBITDA and implied gas, while consensus seems too optimistic on 2011 EBITDA, 2) its CAPP coal reliance means its natural gas sensitivity is less than its peers' on a $/MWH basis, 3) the recent California power plant retirements seem to have been ignored by the market, and 4) its adjusted EBITDA value significantly declines into 2011. Given these factors and our new target price of $13.00, we are downgrading MIR to 3H.
Action: Well-founded out of consensus call, just the way I like. I expect MIR to be under pressure today, falling below the $17 level as investors are forced to take a second look on their expectations.
- Lowering our EPS estimates below consensus Based on guidance provided at a recent investor conference, we are lowering our EPS estimate on VZ to $2.42 in 2009 (consensus at $2.53) from $2.52 previously, equating to a 4.7% annual decline. For 2010, our EPS estimate goes to $2.45 from $2.70, putting us meaningfully below consensus at $2.64.
- Wireline fundamentals still deteriorating We believe the business market continues to worsen and is unlikely to improve until 2010. We also expect a slowdown in consumer metrics in 3Q. Combined with slower than expected progress on headcount reductions, we estimate this should drive a 170 bp sequential decline in wireline margins, leading to a 21% annual decline in wireline EBITDA.
- Cracks beginning to appear in wireless We no longer expect wireless ARPU to grow in 3Q after the ~1% growth in 1H as pressure on voice offsets growth in data. We believe there could be further downside to ARPU given the iPhone’s ability to attract high-end subs, S/T- Mobile’s attempts to turn their businesses and increasingly aggressive prepaid plans. As a result, projected services revenue growth slows to 6.8% from 9.0% in 2Q. We have slightly lowered wireless EBITDA margins in 3QE to 45.8% (prev.46.2%).
- Valuation: Downgrading to Neutral from Buy We think VZ will be range-bound as the market absorbs the lower EPS outlook for2009-10. Given these changes, we are lowering our 12-month price target to $32 from $34 per share (DCF based using 8% WACC; 2% FCF growth in perpetuity).
Action: VZ is not a stock that would make wild moves, but I think this call should provide a nice trading oppty. Telco sector has gotten a lot of attention recently with S, PCS and LEAP all being mentioned as takeover candidates. While consolidation would be positive for the sector and VZ, it also highlights slowing growth. And this is also why UBS is downgrading.
New 2010 EPS estimate from UBS is well below consensus and also below expectations for current year. With general expectations of improving economic conditions, y/y decline should send some investors looking for better opportunities.
VZ probably will not gap down more than 1%, but I expect the shares to see constant selling pressure throughout the day. So my plan would be shorting above $30.60 early on and covering around $30.
Bank of America / Merrill Lynch is upgrading Amazon.com (NASDAQ:AMZN) to Buy from Neutral and raising price tgt to $103 from $95 based on following six factors:
1) Leader in a growth sector – We believe eCommerce sales will rebound to double-digit y/y growth in 2010 (see our eCommerce industry report), resuming the secular shift Online that was interrupted by the recession. Amazon has built sustainable competitive advantages in eCommerce including customer loyalty, distribution infrastructure, as well as technology investments, and these advantages have shown through with a sales gap to ecommerce growth between 1,700 and 2,800bps over the past six quarters. The gap shrank a bit in 2Q due to Amazon’s added exposure to video game category, but we think the gap could re-expand if the category improves (we have the gap shrinking in our estimates). This seems too conservative. Our improvement in y/y industry growth to 11% in 4Q is driven by easy y/y comps. as well as our assumption that the industry could see a normal 4% sequential growth in 4Q, consistent with 2006 and 2007.
2) Upside potential vs. eCommerce group - We believe the street is underestimating the potential eCommerce sector growth acceleration benefit for Amazon’s (just 54bp acceleration in 2010 growth vs. 2009 growth in street estimates) relative to other eCommerce stocks. Table 1 shows that street is modeling a much better growth rate in 2010 vs. 2009, while this isn’t the case for Amazon, and Amazon screens best on this metric. We note that Amazon has the second best underlying metrics in eCommerce/travel sector (behind Priceline) as measured by unit/transaction growth which, if sustainable, should drive revenue upside. The company grew units 28% in 2Q’09 and if this growth rate is sustainable in a 2010 recovery, we think revenue growth will accelerate to better match unit growth.
3) Positive eCommerce channel checks - Our online retail checks indicate accelerating growth for the sector driven in part by higher traffic conversion rates. We see Amazon as a play on an improving economy and think sector is starting to see improvements from increasing discretionary spending. See our eCommerce sector report published Sept. 16th outlining our expectations for the gap in growth between eCommerce spending (which is more discretionary in nature) and retail to re-expand in 2010.
4) Positive seasonality – Amazon’s stock outperformed from Sept. 15th through Nov 30th in 2005-2008 and we think this year’s 4Q seasonal acceleration will likely be aided by easy currency comps. Looking back at last 7 years, the average P/S multiple has expanded 6% from September through December, and excluding the recession in 4Q’08, this expansion has been 10%.
5) Valuation upside based on history, with valuation support expected at 18x FCF. Amazon’s stock has traded at between 0.8x–2.0x sales over the past 5 years, and when company was beating estimates in 2007 stock moved toward higher end. We believe a similar scenario could play out over next 12-months. Assuming results just match expectations, while P/E is high relative to group, we believe stock will see support at around 18x FCF.
6) Competitive risks overblown, at least for next 12-months - Amazon’s stock has underperformed the Internet peer group since April due, in part, to competitive fears. This concerns have been driven by weaker media sales in 2Q (video game exposure) and a corresponding closing of US sales growth gap vs. eBay, loss of Target as a 3rd party partner in 2011, launch of Wal-Mart’s 3rd party online marketplace, and eReader announcements from Barnes and Nobel and Sony. We believe that none of these competitive developments will impact Amazon’s sales in 2009 or 2010 (Wal-Mart’s sales are a small fraction of Amazon’s, and eBook sales barely impact Amazon’s total sales this year), with the outside possibility that Amazon lowers Kindle HW price to increase sales at the expense of margins. While there could be competitive margin pressure in sector long-term, Amazon’s customer, distribution and technology advantage position the company well long-term.
We are raising our estimates for currency and for expected integration of Zappos. For 4Q, we are at revenues/GAAP EPS of $8.3bn/$0.64, above street at $8.1bn/$0.62. Adding $725mn for Zappos in 2010, we are now at $28.5bn/$2.29 vs. street at $27.0bn/$2.16. We believe our 24% growth rate for 2010 could be conservative given Zappos (300bps of growth) and currency benefits.
Action: This call will get some attention anyway, but I believe the market will underestimate the stock reaction, at least early on.
I like the fact that BAC/ML is calling for upside to estimates, not just making a case for valuation. Well, they do make a case for valuation too, but that's not the focus of the upgrade.
I also like how confident the analysts seem to be in this call. Sure helps selling the idea to the clients when you believe in the idea.
I also like that AMZN has lagged the recent moves by EBAY and YHOO. Some catch-up to do.
To sum it up, I believe AMZN has 4-5% move in it today, which calculates to roughly $87- 87.50 range. Early birds can probably get shares below $85.50, offering up to two points of upside.
Tuesday, September 15, 2009
We are upgrading TER to Outperform and raising our PT to $13 based on general tightness in semi test, sufficient wafer bank inventory buffering it from foundry wafer starts, and specific to TER, 1) a salient win for single-chip basebands at QCOM and 2) visibility for volume orders in Q4 for BRCM's ramp. In winning at QCOM, TER delivers a gut-punch to competitor VRGY and walks away with a 15-20 unit UltraFLEX order ($30-$40M) from QCOM near term and ~5% pts of share gain longer term. Combined with unprecedented cost cutting, TER is now ripped, with big muscles underpinning mid-cycle EPS of $1.00 in 2010.
Upon arriving in Asia, it's clear TER is rife with positive catalysts: 1) a key decision by QCOM to switch from VRGY's 93K to TER's UltraFLEX tester for its single-chip baseband; 2) visibility for volume orders in Q4 to support BRCM's ramp, and 3) positive revision to order forecasts for Q1:10 by IFX, QCOM, and MCHP
Near term, checks indicate QCOM has placed a 15-20 unit UltraFLEX (with UltraWave 12G cards) order to support this platform change; we estimate partial rev recognition in Q3 will underpin rev/EPS upside, relative to stated guidance for $190-$205M, ($0.02)-$0.02. Thus, we are raising our Q3 rev/EPS to $210M/$0.04.
Longer term, we estimate the QCOM win could net TER ~5% pts of share gain. Assuming the SOC test buy rate re-normalizes to 1% (implying a ~$2B market), and TER gleans ~45% share, we calculate TER's qtrly mid-cycle rev run-rate at ~$300M. At a 15% operating margin, this equates to $0.85 in EPS.
In this light, our EPS model for $0.57 in 2010 is conservative, yet every time TER makes the initial ascent to nominally $1.00 in EPS power, the stock discounts this ahead by ~6 months and trades to $13-$15. Arguably, this time, the tailwinds for TER are finally much stronger—even without DDR3 test.
Action: Gary Hsueh and Wenge Yang from Oppenheimer do it again! They were the first to break the news on NANO winning at Intel (check the archives) and the stock did 100%+ in less than a month in response. Now they are making a very strong call on TER.
TER is not that forgotten stock as NANO and it won't do 100% in a month, but I still expect win at QCOM win over VRGY to drive the stock higher near-term. I suspect we will see $9 as soon as today with $9.50 not out of the question later this week.
More aggressive accounts might want to consider VRGY as a short due to the share loss at QCOM.
Kudos guys, great work!
Friday, September 11, 2009
Buckingham Research is upgrading their rating on Manitowoc (NYSE:MTW) to Strong Buy with $14 price target from Neutral:
We are raising our rating on Manitowoc to Strong Buy from Neutral as 2 important factors are unfolding; 1) the company is set to continue generating very strong free cash flows in 2009 and again in 2010 which, in our opinion, will take any covenant concerns off of the table and 2) the Crane business continues to see “pockets of strength” which likely takes our trough EPS estimates of $0.35-$0.40 in 2011—more in the range of $0.50-$0.60 in 2011. One factor overall that has been different this cycle is investors willingness to look further out for cyclical names. While cyclical recovery is likely not until 2012 or later, other names set to see recovery in 2011 have already moved strongly off of the bottom.
We are raising our 2010 EPS estimate to $0.55 from $0.40 to reflect the better than expected crane demand. Additionally, while investors are still focused on all of the negatives associated with the Enodis acquisition, the company is busily paying down debt and should remain profitable during this steep downturn—a testimony to the improved balance brought to them from Enodis.
Using a 25X trough P/E multiple on the mid-point of our $0.50-$0.60 trough EPS estimate range brings us to our $14 price target. While we acknowledge that a likely bottom for the crane cycle is 2+ years away and recovery even further out, the longer term upside remains tremendous. Manitowoc earned over $3 in the last cyclical peak and improving margins at Enodis plus some cyclical rebound could push longer term EPS above those levels. Also, staying profitable during this steep downturn should result in longer term multiple expansion. While there is still some residual risk in these shares, the shorter and longer term upside well outweighs the nearer term issues.
Action: With investors looking further and further in the future to find upside, MTW is as good pick as any. If you believe Buckingham about 2010 trough not being as bad as expected, it would be reasonable time to buy.
I expect shares to see continued strength today on these comments, potentially going as high as $9.25-9.50.
Thursday, September 10, 2009
- Goldman Sachs is raising coverage view on the Entertainment sector to Attractive and TWX to Conviction Buy from Neutral:
Raising coverage view to Attractive
We raise our coverage view on the Entertainment sector to Attractive from a Neutral view. A stronger-than-anticipated rebound in national advertising – a primary driver of fundamentals and sentiment across the group – is the single most important factor in our updated outlook. We acknowledge what we think will be continued weak consumer spending and local advertising trends but think these will be more than offset by rebounding national advertising, stable affiliate fee growth and solid content trends as secular disintermediation risk remains distant. Also, we view valuations as attractive relative to historical levels and other market sectors.
Source of opportunity
We are adding Time Warner to the Americas Conviction Buy list from Neutral driven by upside from a stronger-than-expected national ad rebound and raising our 2010/2011 EPS estimates by 7%/5 %. We see about 20% upside to our new $33.50 (from $25.50) price target and think corporate profit growth is likely to fuel a rally in national ads by 2Q10 at the latest, displacing direct response squatters and leading to 20% EPS growth in 2010 ex-AOL. We forecast Cable Network revenue/OIBDA to grow +7%/13% in 2010. This segment accounts for 75% of OIBDA ex-AOL but over 100% of expected 2010 growth, while our estimates allow for upside from Film and Publishing outperformance.
We believe Time Warner’s leading cable network properties are best positioned to outperform expectations icapturing a stronger than expected rebound in national advertising. TWX only receives about 25% of its revenue from ads, but it is all sourced from national brand accounts and represents about 33% of operating income. The return of higher price point advertisers should squeeze out the direct response filler inventory that buffeted the 2008-2009 ad slump and drive above-peer growth. The pending AOL spin renders about 75% of EBITDA sourced from branded cable networks, second only to Viacom in exposure to our favored media asset class on a mix basis, but greater in absolute revenue exposure. With about $2.5+bn in annual FCF, Time Warner can support its 2.7% dividend yield and $1.5bn in annual buybacks (about 6%-8% of outstanding shares) while preserving $5bn in cash for strategic assets or shareholder initiatives.
Our $33.50 6-m price target is based on 15x 2010E EPS ex-AOL of about $2.10, plus $2/share for AOL, a target multiple matching that for DIS. We are raising it due to higher national ad estimates and higher target multiple.
- WSJ has an article this morning titled "Comcast Could Tie Up More Cable Nationwide":
A federal appeals court ruled on Aug. 28 in favor of Comcast's and the cable industry's request for the elimination of ownership limits. No longer is any one company restricted to reaching 30% of TV subscribers. Yet as Comcast Chief Operating Officer Steve Burke said on Wednesday, while Comcast would consider an attractively priced cable purchase, "I don't think we wake up every morning saying 'how do we get bigger in cable.'"
The company best positioned to lead consolidation would be Comcast, as it already serves 23% of TV households that pay for TV, based on Comcast and Nielsen data. It could start by buying newly independent Time Warner Cable.
Would such a deal pass antitrust scrutiny, even absent the ownership cap? There is a good chance, say several antitrust lawyers. A major focus of antitrust law is whether a merger reduces competition in a way that could raise prices or otherwise hurt consumers. As cable operators generally don't compete with one another, merging wouldn't cut competition.
- Citigroup is highlighting TWX as potential target for CMCSA:
Comcast and Time Warner Cable should merge — Seven benefits: 1) Robust cost synergies, 2) Maintains investment grade rating, 3) Counters escalating content costs, 4) Simplifies wireless strategy, 5) Limits bidding war for future cable assets, 6) Extends cost advantage over telco and DBS, 7) Counters telco-DBS M&A.
Cost synergies are large — Estimate the pro forma entity would capture $1.6 billion in programming cost savings and $1.1 billion in other cost savings. Net present value of synergies around $11-12 billion, a significant portion of Time Warner Cable’s current market capitalization.
Regulatory hurdles may be low — Pro forma entity controls just 37% of pay TV market. Given nascent level of telco video subs, this may fall over time. Monopsony concerns limited by programming costs which still rose at 2-3x inflation for two largest cable firms between 2007 and 2008.
FCC concessions possible — Pro forma entity could help current administration reach potential broadband goals by enabling all homes passed for broadband – via Clearwire - and offering lower cost broadband for low-income consumers.
Maintain Buy on Comcast and Time Warner Cable — We expect both stocks to trade higher on potential announcement. As such, maintain Buy rating at $20 price target on Comcast. Maintain Buy rating on Time Warner Cable; raising price target from $35 to $45.
Action: Wow! Is it full moon or something? It just cannot be a coincidence.
CMCSA/TWX note from Citigroup was one of the first things I saw this morning and I was ready to recommend TWX on that one alone.
Then I saw Goldman's upgrade.
And a moment later WSJ article on CMCSA and other cables.
Now I'm dying to see the open already to get as many shares of TWX as possible. It is usually not a big mover so probably it will be possible to get fills around $29.. which will be a bargain. This stock will see at least $30 today.
Please ring the bell already!
Wednesday, September 9, 2009
We prefer the alternative managers to the traditional asset managers within our asset management coverage subsector. Within our total coverage, we are favorably disposed towards asset managers, though our view on the traditional asset managers is clearly more neutral following a significant outperformance since the March lows versus the market and recent underperformance as investors grow skeptical of further market gains.
Among the alternative asset managers, we prefer FIG in the private equity camp and OZM in the hedge fund camp. We are upgrading our recommendations for BX (to 2-EW from 3-UW), FIG (to 1-OW from 2-EW) and OZM (to 1-OW from 2-EW). We prefer FIG to BX because of a significant valuation discrepancy between the two, despite BX being the highest quality name in our view. That said, our DCF valuation analysis suggests greater longer-term potential upside versus our P/E-based price target methodology for BX than FIG. With respect to the hedge funds, we prefer OZM to GLG given a cleaner earnings story over the next couple of years, a better track record through the downturn and likely stronger client relationships as a result of not having thrown down gates during the redemption cycle. That said, similar to BX, a DCF analysis shows greater potential upside for GLG versus our price target, which makes sense, since 2010 earnings for GLG are still impacted by high-water marks, and thus the DCF captures the added incentive fees that will come from the firm getting back above those marks in 2011. OZM, meanwhile, is already free of those headwinds going into next year due to only having one-year high-water marks.
BX trades at a significant premium to FIG, we believe, because it operates a larger, more diversified platform with a longer-term track record. Its hedge fund business is a relative outperformer with a fund of funds business that has really set itself apart from peers, in our view, while FIG’s macro hedge fund platform saw substantial underperformance last year. BX’s private equity portfolio, which under pressure from reduced equity valuations, is less visible than FIG’s, owing to a large portion of FIG’s portfolio being in companies that have since gone public whose stock prices are off meaningfully. Further, FIG has a greater concentration of investments in companies with income-producing assets that rely on securitization markets to finance their growth, and as such, have been among the hardest hit. That said, FIG’s portfolio companies are performing fundamentally pretty well, and very little debt is coming due of any size over the next couple of years. We believe that ultimately investor confidence around FIG’s ability to realize long term value from its investments will increase, driving a narrowing of the multiples between FIG and BX. Furthermore, FIG has been raising money for distressed credit investment, particularly around real estate, an area right within the wheelhouse of the founding partners. As 2Q earnings demonstrating, these investments are already starting to generate returns as was evidenced by performance fees recognized during the quarter. Lastly, BX still has ongoing headwinds in its commercial real estate business from writedowns of property values even as it is starting to mark up its corporate private equity investments again which could be an overhang relative to FIG. To be sure, though, BX is blue chip name within the alternatives space, and a company that we expect to drive substantial long term value.
Action: While this note is overview of the whole sector, I tried to highlights the parts concerning FIG because I think it is the most interesting in trading perspective. To get a full picture one should read the whole note.
Alternative asset managers have been on a tear lately, just take a look at charts of KFN, BX and also FIG. Barclays adds some fuel to the fire with the $9 price tgt - almost 100% upside from current levels.
I expect FIG to be strong all day, going as high as $5. So it should be considered as buy below $4.75 level.
Tuesday, September 8, 2009
Broadcom announced this morning that the BCM7405 STB SoC received certification for Microsoft Mediaroom. We believe Broadcom will begin production shipments of its IPTV STBs in late Q4. Initially, we expect Broadcom to receive a 30% share of STBs at major service providers. Over time, we believe this will shift closer to the 50/50 mix that service providers like AT&T U-verse currently maintain between Motorola and Cisco STBs.
Though the certification of Broadcom's SoC was anticipated, we still view this as a major negative for Sigma Designs. We expect this to precipitate significant share loss for Sigma Designs at major service providers including British Telecom and AT&T U-verse.
Action: Not much to add. Strength of overall mkt may provide nice fills for early shorts.
We estimate Facet’s current (3Q09, post TRU-016 deal) net cash (cash on hand minus 1-3 year lease obligation) is ~$288 MM or ~$11 per share. Therefore, Biogen’s offer values Facet’s pipeline at roughly $3.50 per share or ~$95MM. Subtracting the $30MM daclizumab milestone payment Biogen would have to pay Facet for the initiation of a Phase III trial in multiple sclerosis (MS) in 1H10, Biogen is essentially offering ~$65MM. For $65MM, Biogen would own 100% of daclizumab and volociximab, ~40% of elotuzumab, 50% of TRU-016, save up to $630MM future milestone payments to FACT, be eligible for up to $680MMmilestone payments from BMS on elotuzumab and be liable for up to $177MM milestone payments to Trubion for TUR-016. We believe Biogen’s offer, inaddition to being opportunistic, is triggered by the futility analysis of daclizumab’s Phase IIb SELECT trail announced on August 3. We have learned that the futility analysis had shown that daclizumab exceeded an undisclosed efficacy threshold(most likely an efficacy that is superior to Avonex), which clearly increases thevalue of daclizumab significantly. We believe Biogen may have to increase its offer to ~$20 per share to better reflect Facet’s pipeline value.
Action: So basically Biogen Idec is trying to get FACT for pocket change.. Might have worked 6 months ago but not in this kind of market.
FACT issued PR this morning rejecting the bid as too low. I expect the shares to trade up over the next week in anticipation of higher offer. Anything below $16 should be considered as a buy.
- Baird is upgrading shares to Outperform from Neutral and raising price tgt to $30 from $16:
• Our checks increase confidence on R7128 safety. We spoke with three hepatology specialists and came away with high confidence that:
- There have been no concerning toxicities to date with R7128 in Phase 2b.
- Kidney safety monitoring in this trial is very sensitive and would pick up anythinggoing on.
- Enrollment has been rapid; we'd estimate perhaps half of the first 100 patients have already reached 12 weeks, with the rest 6+ weeks in.
No news is indeed good news. The highest level of scrutiny, conservativeness, communication, and transparency span all stakeholders in the trial. If a concerning toxicity had popped up somewhere, docs believe it would be known, which increases confidence beyond the sample captured by our checks.
Positive view in front of near-term catalyst. All eyes are on the Q4-09 DSMB review of the first 100 patients and green light to start the second cohort of 300patients. We think this could be tracking toward late October and now see attractive reward/risk here.
Exposure to subsequent data rollout should pay off. Physicians validated our belief that R7128’s exceptional four-week RVR of 85-88%, demonstrated in Phase 1b, should have positive predictive power for subsequent efficacy measures out to SVR/cure. Visibility here could begin in 2010.
Increasing target price for higher probability of success; continued upwardbias. Our target price goes to $30, reflecting a still-conservative 40% probability of success for R7128 and pushing our valuation year out to a steadier-state 2016. Meaningful upward bias exists near/intermediate term on additional safety/efficacy information for R7128.
- ThinkEquity is raising price target to $29 from $18 and reiterates Buy rating:
We visited the company and reviewed the fundamentals of the Pharmasset story. Our sense is that R-7128 trial logistics are moving forward nicely. We recognize the significance of the news that the first 100 patients in the current Phase II study have been enrolled. We theorize that some percentage of these patients have progressed beyond eight weeks. At this time, we are unaware of any serious AE issues, but it is still early. The viability of R-7128 as apan-genotype STAT-C therapy has extremely good potential, in our opinion. As such, we raise our price target to $29.
Action: I think both of these comments make great sense and are enough to keep the stock running. Expect the shares to trade above $21 today and keep climbing over the next few days.
Downgrading to Underperform: We are downgrading the shares of AIG to Underperform from Neutral, lowering our target price to $15 from $30, lowering our 2009E to -$13.98 ($2.80 for 2H09) and initiating a 2010E at $5.70.
Our Underperform rating reflects: 1) Near term monetization of value of businesses suggests little to no value for common equity, 2) book value analysis suggests mid-teens stock, 3) distressed tender of hybrids – a book value and recap opportunity, 4) normalized capital structure yields annual EPS of $1.50 to $2.50, 5) upside-down capital structure with large debt load vs. common equity, 6) ample liquidity, but near term debt maturities may increase reliance on fed line, and 7) use of government funds.
New CEO Benmosche a positive, but low probability of meaningful common equity value: The recent rally of some of the more distressed financial stocks, the arrival of new CEO Bob Benmosche, and the potential prospect of slowing the disposition of some of AIG’s businesses have all contributed to the recent large move in the AIG stock price. But we don’t expect that a 2- to 3-year process will render upside value for common equity holders, and we note the risk of further erosion of franchise value and the intention of the government to be a bridge rather than a permanent stakeholder suggests meaningful asset sales/IPOs need to occur over the coming 12-18 months.
Our $15 target price is derived from a ~1x estimated tangible book value ex. AOCI and 7x to 8x our estimate of EPS with a normalized capital structure.
Action: Be early enough and you will sometimes be offered opportunities like this. You can get shorts above $41.5 right now.
Update: wanted to get it posted quickly so didn't waste much time earlier. Yes, the futures are indicating strong start for the day but AIG will still see some early sellers on this. I'm looking for the stock to fall below $40 before 8 am.
Thursday, September 3, 2009
- Credit Suisse is downgrading HOV to Underperform from Neutral
Lowering to Underperform – improving orders, but write-downs and operating losses erode equity value. We see Hovnanian’s 9% decline in orders in 3Q as an improvement, but with 3.5% gross margins and SG&A representing 14.3% of revenue, these orders don’t create value for equity holders, especially when combined with the $106 mln of impairments in 3Q. To work out of its $1.8 bln of debt (book value is now -$3.07 per common share), Hovnanian must generate significant returns from existing assets, but we think this will be challenging given the likelihood of continued operating losses and impairments. We are maintaining our $2 target price.
$546 mln of cash provides liquidity and some time, but balance sheet restructuring still needed. We recognize that the $546 of cash provides Hovnanian with breathing room until the nearly $700 mln of debt maturities in 2013, but think that it will need to restructure its balance sheet given the lack of equity, absent a sharp rebound in home prices. In addition, we think that change-in-control provisions on Hovnanian’s debt would discourage most potential acquirers.
Future quarters likely to bring margin challenges and impairments. We anticipate further erosion of book value based on our expectation for continued operating losses and at least $100 mln of future impairments.
- JMP Securities notes that after another rough quarter, they are maintaining their Market Underperform rating and $0.50 price target (based on little to no common equity value left in the company).
Quite a run for the stock on not-very-strong fundamentals. Since closing at $0.60 in early March, shares of HOV have been on a tear: up over 600% since that time and nearly doubling YTD (against 78% and 22%, respectively, for the Homebuilder index XHB). We fail to see a positive catalyst that has either been responsible for the run-up or that could propel the stock further; it is, in our view, a combination of the success of the group as a whole combined with possible short-covering that has propelled the stock, and we feel the shares are ripe for a more severe correction than what we expect for the rest of the group. While some companies, in our opinion, are poised for a return to profitability in 2010, we feel that a positive bottom line is still at least a couple years out for Hovnanian.
The problem for HOV remains the balance-sheet-versus-margins conundrum. As of the end of the third quarter, the company now has a very high net-debt-to-cap ratio of 74% (up from 60% ast quarter) and negative common equity (though a small amount of equity still remains in the form of preferred shares). While we are not overly concerned with liquidity issues—the company continues to pay down pending maturities, including $119 million in July of notes due 2010-2017, and cash-on-hand is roughly $550 million currently—the high debt levels, equity troubles, and covenant restrictions on the company’s ability to pay down further debt are all prohibiting it from taking impairments at the necessary level. This has put serious pressure on margins, which have been some of the lowest in the industry; while decreasing pricing pressure should help, we doubt that pricing will recover quickly enough to seriously help Hovnanian over the coming couple of years. HOV’s balance sheet woes will, in our view, also limit its participation in the land-buying game for the foreseeable future, a severe competitive disadvantage against its better-capitalized rivals coming out of the present downturn.
- UBS says that focus on liquidity, over profitability, leaves them cautious. Despite the outperformance this Q, cash flow was a disappointing ($49mn), ex $180mn of outflows associated with its tender offer and revolver. Further, although the company reduced debt by ~$119mn, the lower cash balance resulted in the net debt-to-cap (adj for FAS 109) +235bps seq to 64%. In turn, we expect mgmt to remain focused on driving FCF over profitability, resulting in higher impairments and lower margins relative to its more liquid peers.
Action: Cannot feel too good shorting a $4 stock with 27% short interest, but I think the stock is due for a serious correction here.
Even if the worst is behind and we are at the beginning of next upcycle, HOV is not very well positioned to take advantage. Their focus is rather on survival and keeping the balance sheet from getting worse while competitors in better shape can take steps for future profits. And when HOV can finally start investing for future, they are a few years behind the competition and must pay up, leaving them in serious disadvantage.
Oh, and this is a best case scenario. If there is no quick improvement in real estate, HOV will keep struggling and equity holders don't have much to hope for.
I believe these results give some of the longs a reason to step out, sending the stock lower. Current $4.25 lever of pre-mkt should be good for a short as I expect the stock to fall below $4 today.