Monday, January 31, 2011

Investopedia: A Foursome Of Pharma Earnings Suggests Business Is Still Tough

Medical progress is a tricky thing, especially since the pace of that progress follows no particular rule or trajectory. Pharmaceutical companies increasingly find that they must spend considerably more money on R&D only to develop drugs that are incrementally better than generics that have been available for two decades. Add to that fierce global competition, occasionally hostile regulator behavior and opportunistic generic drug developers laying in wait, and it is not altogether surprising to see a mixed bag as pharmaceutical companies report their fourth quarter results. 

AstraZeneca - Sharing the Wealth, But Taking Some Blows
AstraZeneca did a little better than expected, but sales were still down about 4% in the fourth quarter. The company's largest drugs had mixed performance, as Crestor sales jumped 26% and Nexium sales fell 2%. Investors should note, though, that just four drugs accounted for 57% of revenue and AstaZeneca is one of the most "concentrated" drug companies out there. (For more, see UK's Global Footprint Stocks.)

AstraZeneca has had some rough going of late including a complete response letter for Brillinta and the decision to discontinue a range of drugs including olaparib, Certriad, and Iressa. On a more positive note, the company is moving ahead with an exciting first-of-its-kind oral diabetes drug, as well as an oral rheumatoid arthritis drug that could threaten large franchises of Abbott Labs (NYSE:ABT) and Roche (Nasdaq:RHHBY). 

On a happier note, AstraZeneca is not being miserly with its wealth - the company doubled its buyback to $4 billion and pays a respectable dividend. Investors may question, though, whether that money would be better spent in the lab, as pipeline disappointments have taken more than $1 billion out of the mid-term revenue outlook.
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Investopedia: Nucor And The Steel Sector Look Toward A Better 2011

Nucor (NYSE:NUE) was the last major U.S. steel company to report earnings in this cycle, but many of the themes in the results and outlook were familiar. Mini-mill operators Nucor and Steel Dynamics (Nasdaq:STLD) and conventional steel makers AK Steel (NYSE:AKS) and U.S. Steel (NYSE:X) are clearly all different companies, but every company pointed to a tough fourth quarter, improved pricing in early 2011 and a stronger overall outlook for steel demand. Barring any odd twists in the economic situation, it looks like 2011 will be a better year all around, as better pricing seems to not only be sticking, but outpacing cost growth. 

Nucor Probably Glad to be Done With 2011
Although 2010 was by no means a disaster for Nucor, the last half of the year was a tough operating environment as the company was squeezed by so-so pricing and higher costs. For the fourth quarter total revenue dropped 7% though external shipments climbed about 15% and realized prices climbed about 14%. Scrap costs were also considerably higher in the quarter, though, climbing about 30% from last year.

Talking about the quarter and its outlook, management did point to signs of improvement in demand as well as a solid pricing environment. Though not specific to Nucor, the increase in hot-rolled prices since November lows has roughly doubled the increase in scrap costs, so that is clearly moving in the right direction for Nucor. Moreover, the company is moving ahead with a direct reduced iron plant in Louisiana - a plant that will help the company's cost structure over time, as direct reduced iron is an important ingredient in improving the quality of steel produced by mini-mills. (For more, see Steel Cycle Looks Good.)

The Look Around
As mentioned, Nucor's results were directionally in line with the rest of the U.S. steel sector for the fourth quarter. Steel Dynamics reported that shipments and pricing were soft on a sequential basis (that is, comparing the fourth quarter of 2010 to the third quarter), while up by a low-teens rate on a year-over-year comparison. Steel Dynamics also pointed to a revival in demand and a firm pricing outlook for 2011. Investors should keep in mind that both Nucor and Steel Dynamics are relatively leveraged to construction - a market that has yet shown only the barest signs of recovery. (For more, see Is Now The Time To Invest In Steel?)

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Investopedia: Riverbed Far From Dragging The Bottom

Investors in Riverbed Technology (Nasdaq:RVBD) had to be a little nervous going into Thursday night's earnings release. F5 (Nasdaq:FFIV) had already spooked the Street with its near-term demand outlook, and tech stocks were getting hammered on any perception of weakness in their earnings results. Fortunately for its investors, Riverbed came through with a good (though not great) release.

A Hot End to the Year
Riverbed definitely exited 2010 on a hot streak. Revenue rose 12% sequentially and 47% from the prior year, due in large part to ongoing demand for the company's Steelhead appliances. Product sales rose 52% for the quarter, and the company continued to gain share in the market. In fact, it looks as though Riverbed ended the year with over 40% share in the WAN optimization market. 

On the profitability side, things get a little murkier. Gross margin did improve nicely on a sequential and annual basis, and Riverbed is in the enviable position where its product gross margins are higher than service margins. The picture was not so rosy in the op-ex, where substantially higher sales and marketing expenses stripped away a lot of operating leverage. All in all, while the company did beat estimates, a better tax rate had a lot to do with it and that makes this a low-quality earnings beat. (For more, see Can Earnings Guidance Accurately Predict The Future.)

The Road Ahead
Since there is never any shortage of advocacy for small growth tech stocks, it might be more useful to first think about what could go wrong with the Riverbed story. Clearly the operating leverage story is potential worry, but one iffy quarter does not prove that Riverbed lacks leverage.

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Investopedia: Honeywell Looking Sweet

Although conglomerates do not always get the benefit of the doubt, Honeywell (NYSE:HON) is showing some of the benefits of managing a broad base of unrelated businesses. Not all of Honeywell's businesses are running hot right now, but the company has a good spread of businesses exposed to the early, middle and late phases of the economic cycle. Honeywell does not have the best growth top-line growth outlook on the Street, nor the best free cash flow margin, but investors should not be quick to ignore this name. 

The Quarter That Was
Analysts have been in a rush lately to raise their estimates on Honeywell, but the company nevertheless surpassed expectations for the fourth quarter. Revenue jumped 12% in the quarter, with organic growth clocking in at an impressive 10% clip. Within the company's segments, Honeywell's largest business (automation/control) was one of the strongest as revenue grew 15% to over $3.9 billion. Transportation was even stronger at 18% growth, while specialty materials grew 12% and aerospace brought up the rear with 6% growth.

The profit side of the income statement was a little harder to evaluate. Gross margin was quite a bit better than last year, expanding almost 340 basis points. Unfortunately, both gross margin and operating margin are impacted by various costs like "repositioning." Consequently, segment operating profit rose just 4% for the quarter, but the company's operating leverage is not as weak as that suggests. (For more, see Honeywell's 2011 Outlook.)

The Look Ahead
Honeywell has been maintaining pretty solid free cash flow production even despite a relatively mediocre environment in the commercial aerospace industry, particular the segment of the marketing targeting larger jets (where Honeywell is relatively stronger). Eventually Boeing (NYSE:BA) and EADS will figure it out, though, and companies like Honeywell, United Technologies (NYSE:UTX), Rolls Royce and General Electric (NYSE:GE) can go back to beating up on each other with the backdrop of a healthier overall environment. Given that aerospace produces the highest operating margins for the company, that is clearly something that Honeywell needs to happen.

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Saturday, January 29, 2011

FinancialEdge: What Is Great Management Worth?

In some respects, corporate management seems to be a bit like the weather - everybody talks about it and everybody agrees it's important, but nobody can ever seem to quite figure it all out. More to the point, only a momentum investor or chartist would likely even try to claim that management does not matter when assessing a stock merit's. Yet even value hounds have a hard time assigning value to management, or even proposing how such a thing could be measured. (For more, see Putting Management Under The Microscope.)

Great Management Sees the Future
In 1998, Finland's Nokia (NYSE:NOK) was the world's largest cell phone maker and Apple (Nasdaq:AAPL) was struggling to right itself just over a year into Steve Jobs' return to the company. While Apple developed breakaway winners like the iPod and the iPhone, Nokia introduced lead balloons like the N-Gage. Worse still, Nokia seemed to make the decision to play it safe and follow the market instead of looking out ahead of the curve and anticipating what customers would want. As a result, while Nokia is still the largest phone company in the world, Apple has jumped ahead both in revenue and in how much investors will pay for that revenue (Apple is over nine times larger in terms of enterprise value).

This is relatively common occurrence in business, and a major axis around which management value revolves. It is incredibly difficult to succeed by forever playing catch-up or hoping to take an already proven idea and execute it just a little bit better. The CEOs of companies like Microsoft (Nasdaq:MSFT), Intel (Nasdaq:INTC), Wal-Mart (NYSE:WMT) and Nike (NYSE:NKE) saw a future that other CEOs could not see and they positioned their companies accordingly - building billions in shareholder value along the way.

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Friday, January 28, 2011

Investopedia: Understanding Liability-Adjusted Cash Flow Yield

Investors, particularly those who call themselves value investors, place a great deal of emphasis on a company's ability to produce free cash flow and the valuation of the company's shares. Unfortunately, there are relatively few handy ratios for quickly evaluating a company by these metrics, and those that are pressed into service (like enterprise value to EBITDA) have some notable deficits.

Given the importance of both free cash flow and valuation, investors may want to consider adding liability-adjusted cash flow yield (LACFY) to their repertoire of analysis tools. LACFY offers investors an ability to quickly gauge the value of a company's stock relative to its free cash flow history and make relative valuation calls within an industry or sector, as well as a quick acid test of a company's dividend policy. Though LACFY is not perfect and does not work in all situations, it holds up well as a fast and easy evaluation metric. (For more, check out Free Cash Flow Yield: The Best Fundamental Indicator.)

Defining LACFY
 The calculation of LACFY is straightforward. Take the historical average of a company's free cash flow (that is operating cash flow minus capital expenditures) and divide that number by the sum of market capitalization, liabilities and current assets net of inventory. LACFY is basically a measure of the "cash on cash" returns that an investor could expect if he or she owned the entire company outright.

In other words:
LACFY = 10-year average free cash flow ÷ (market capitalization + total liabilities – (current assets – inventory)

This equation is simple, but it elegantly handles a few of the thornier aspects of cash flow-based methodologies. By using a multi-year average, LACFY largely neutralizes the year-to-year volatility that can come from working capital adjustments (running down inventory, for instance) or changes in cap-ex and can capture what should be a full economic cycle for a company.

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Investopedia: Meet The New Stryker

This is not your father's Stryker (NYSE:SYK) anymore. Although Stryker is still thought of first and foremost as an orthopedics company (and ortho is more than 58% of sales), the company has a sizable surgical/medical equipment business and has been using acquisitions to add more markets to its portfolio. Though Stryker is not liable to turn into a serial acquirer like Integra Life Sciences (Nasdaq:IART) used to be, or Danaher (NYSE:DHR) still is, investors should keep their eyes open to the possibility that Stryker might have a few more tricks up its sleeve and more growth potential than commonly thought. 

The Quarter Was What We Thought it Was
Stryker pre-announced its fourth-quarter results prior to a major investor conference earlier in January, so there were not many surprises in Tuesday night's report. Revenue rose 8.8% as reported (and 8.6% in constant currency), with the ortho business showing 4.5% growth. Ortho growth was helped by relative strength in hips and trauma, and hampered by weakness in spine. The MedSurg business continues to recover well, with better than 15% growth in this quarter. (For more, see Investing In Medical Equipment Companies.)

Operationally, Stryker has always been a solid performer, and this time around was no different. Gross margin increased 100 basis points (to 68.7%). Stryker ramped up its operating spending, particularly in R&D, and that took almost two and a half points out of the operating margin (after adjusting for some exceptional items). Nevertheless, adjusted earnings did grow more than 12% for the period, and the company posted year-on-year free cash flow growth once again (continuing a six-year streak). (For more, see Profitability Ratios: Introduction.)

The Road Ahead
It is still early in the reporting cycle, but Stryker's commentary on the orthopedic market was definitely more positive than that of Biomet and another large rival that recently reported earnings. With new products in the hip category, it looks like Stryker is a share-taker in the market once again, though pricing is still an issue. As an aside, though, investors who want really exciting growth in orthopedics shouldn't be looking at Stryker, Smith & Nephew (NYSE:SNN) or Zimmer (NYSE:ZMH); look instead at much smaller companies like Orthofix (Nasdaq:OFIX), Alphatec (Nasdaq:ATEC) and Nuvasive (Nasdaq:NUVA).

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Investopedia: Today's Xerox Not Just A Copy Of The Past

Institutional Wall Street is a funny place. Not only do these highly educated professionals badly misuse words like "catalyst" on a routine basis, but they cannot seem to decide what they really want. Companies are under near-constant pressure to convince the Street that they can find new sources of growth and continually transform their business to stay current with the markets. On the other hand, when a company is actually in the midst of a transformation, a lot of investors flee to the hills and wait for a "catalyst" to return.

That would seem to be the case for Xerox (NYSE:XRX) today. Although the company has gone to considerable lengths to build a process outsourcing and IT outsourcing business to counterbalance the tradition printing/copying business, Wall Street seems to still talk about them primarily as an old-line, slow-growth machinery company.

The Quarter That Was  
To some extent, Xerox is not doing itself a lot of favors in shaking up that image. Although reported revenue growth came in at 42% this quarter, organic growth was more on the order of 2%, as the company's "technology" business (that is, printers, copiers and the like) was basically flat versus last year.

More positively, there was some improvement in profitability. Gross margin came in at 33.6 for the quarter, and operating margin expanded about one full point on a pro forma basis. Better still, bookings in the service business were up 13% on a very difficult comp.

At What Pace Change?
Unfortunately, management guided earnings down a bit for the first quarter and did nothing to really encourage analysts or investors to expect a much better 2011. So even though the company has products like the iGen3 that leave it in good shape as the market moves to digital printing and is also targeting small and mid-sized businesses more than before, it is going to be a slow road to progress. 

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Investopedia: Caterpillar Still Down A Cylinder Or Two

The "stuff trade" may be about a year and a half old now, but Caterpillar (NYSE:CAT) is still making money hand over fist as a major supplier of machinery. What's more, while construction may still be flat on its back in the U.S., a lot of the developing world continues to build at a truly dizzying pace. History says this too will fade, but Caterpillar may yet have a few more quarters in the sunshine.

The Quarter That Was 
Sales jumped 62% in the December quarter, as the company saw a 69% increase in sales in its machinery and engine segment. Breaking that down even further, machinery sales were up 88%, while engine revenue increased 36%. Volume growth was a significant part of growth in both business, with higher value added almost $4 billion to the machinery total.

While sales growth was strong, the rest of the income statement was a bit more questionable. The company booked a solid improvement in gross margin, but operating margin was less impressive. True, the company did see its operating margin increase more than 750 basis points from last year's level, but the pace of margin improvement seemed less impressive in light of the volume gains. In other words, the company's incremental operating margins were somewhat disappointing. Moreover, while the company did report an impressive bottom line earnings beat, a big chunk of that came from a lower tax rate. (For more, see Analyzing Operating Margins.

The Road Ahead 
With a backlog of nearly $19 billion (double the mid-2009 levels), Caterpillar still has plenty of promising business prospects going into 2011. Mining companies like Vale (Nasdaq: VALE), Potash (NYSE:POT) and Rio Tinto (NYSE:RIO) continue to expand operations and open new mining sites, and that requires machinery. Moreover, do not forget that companies like Gafisa (NYSE:GFA), Vanke, and China Railway continue to build residential and commercial projects at a rapid pace in markets like Brazil and China.

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Thursday, January 27, 2011

Investopedia: Texas Instruments Suggests A Soft Landing In The Works

Figuring out the semiconductor industry is a little like playing one of those games where you are supposed to guess at what the image is as it is revealed a piece at a time. While Linear Technology (Nasdaq:LLTC) started the reporting cycle with a sour note, Maxim (Nasdaq:MXIM) seemed incremental better, and so too now does Texas Instruments (NYSE:TXN). If Texas Instruments is more indicative of the "real" state of the industry than Linear, perhaps the worst of the mid-cycle correction is over. 

A Mixed End to a Rebound Year
As is so often the case, the strength of Texas Instruments' quarterly results depends very much on the frame of revenue. After all, 17% year-on-year revenue growth sounds good - up to the point when it translates into a 7% decline in sequential performance. Analog is TI's biggest segment, and revenue here was up 20% annually and down 4% sequentially, while embedded processing saw a 31% annual increase and 7% sequential decrease. Wireless was comparatively boring, up 1% from last year and flat relative to the third quarter.

Profitability was not quite as positive for TI. Due at least in part to higher capacity and lower utilization, gross margin fell 150 basis points from last year. Although the company did do a solid job of holding the line on operating expenses, the decline in gross margin led operating margin to contract about 200bp on a sequential basis, while rising 170bp from last year after adjusting for a divestiture gain. (For more, see  The Bottom Line On Margins.)

Orders fell 4% from last year and 9% from the third quarter, leading to a 0.89 book-to-bill ratio. While management did say that lead times were back to normal (suggesting that the book-to-bill should have bottomed), it is worth noting that inventory did climb almost $100 million on a sequential basis and stands (on a days sales basis) at a pretty high historical level. 

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Microsemi - Will Boring-But-Good Be Good Enough?

Even though I typically invest with a multi-year horizon, I am not going to pretend that I don't notice short-term moves in my stocks or that they don't bother me. To that end, then, I'm not all that confident that the Street is going to love the results that Microsemi (Nasdaq: MSCC) just delivered.

Microsemi delivered revenue of $184.4 million, up 22% from the third quarter (and boosted by acquisitions). That's a little bit above the average guess that was out there. Although Microsemi is relatively pro-investor, they don't give a lot of info in the release, so I'll need to listen to the call to get more details on the topline performance.

Below the revenue line, Microsemi did alright with profitability Gross margin of of 53.6% (non-GAAP, of course, as this is a tech company) was likewise firmly in the midst of most analyst expectations, and the operating margin of 23% was just a few tenths of a percentage off the median. All in all, Microsemi matched the average estimate. Likewise, the company's guidance for next quarter was consistent with prior expectations.

Who knows what the market will choose to make of it? I consider it a solid quarter from a defensive and often-overlooked semiconductor company. Others may see the lack of a beat-and-raise as a sign to move on to more exciting territory (though the idea of those investors getting into MSCC in the first place is a little amusing).

I intend to write something a bit more insightful after listening to the call and mulling it over a bit. For now, though, I think I'll probably keep my fair value at $28.75, and I would continue to BUY these shares. It's not a go-go growth name like Qualcomm (Nasdaq: QCOM), Broadcom (Nasdaq: BRCM), Cavium (Nasdaq: CAVM) and so on, but it's a well-run business that is undervalued by the Street.

Disclosure: I own MSCC shares

Investopedia: Can VMware Manage Its Own Partisans?

Managing growth is hard enough, but managing the expectations of growth investors can be downright impossible. It may prove to be the toughest challenge for VMware (NYSE:VMW). While the company has a commanding share of the server virtualization market, rivals are gearing up to take some of that share away and the company's investor base is full of twitchy growth/momentum investors that may bail on the first sign of disappointment. 

A Great Finish to the Year
To the extent that it is the responsibility of public company management to manage the business, there is little to complain about with VMware. Revenue jumped 37% this quarter, handily surpassing both the average estimate and the highest published estimate. Growth was certainly helped by very strong licensing, as license revenue rose almost 39% to $422 million and again easily surpassed expectations. Not surprisingly, growth was helped by solid ELA renewals, as well as strong sales of vSphere.

VMware also once again translated revenue strength into operating leverage. Operating income grew strongly for the quarter, whether an investor chooses to look at GAAP numbers (where operating income rose 84% to $131 million) or non-GAAP (where operating income grew 57% to $248 million). (For more, see Zooming In On Operating Income.)

The Road Ahead
The first concern to address is the company's ongoing operating leverage. While the company grew revenue 23% on a sequential basis, the non-GAAP operating income grew a bit less than 22%. So where is the incremental operating leverage? Moreover, the management's commentary on the call suggested that there was not likely to be much further operating leverage in 2011. That makes it a fair question to ask whether the company is going to max out at around 30% in non-GAAP operating margin.

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Investopedia: Abbott's Next Act

Abbott (NYSE:ABT) showed its mettle during the Great Recession and was one of the relatively few larger healthcare companies to post solid ongoing results. Unfortunately, Wall Street gives little time for basking in past successes before turning to the question of how high levels of performance can be continued or exceeded. On that score, Abbott would seem to have some work to do. 

A Solid End to the Year 
Abbott's fourth-quarter results came in basically as expected. Revenue rose more than 13%, as pharmaceutical sales jumped almost 23% and vascular sales rose nearly 14%. Diagnostics was less impressive yet still positive (up 4%), while nutrition was flat. Looking at three key businesses, Humira sales were up 13% (to nearly $1.9 billion), Tricor/Trilipix sales were up more than 19% (to almost $500 million) and stent sales were up almost 20% to over $500 million. (For more, see 6 Important Earnings Announcements.)

Abbott's profitability was a bit more mixed, particularly given the need for some adjustments to the numbers. Gross margin did jump more than two full points from last year, but operating margin shrank a bit as the company ramped up its R&D spending.

Looking for the New "New Thing" 
Although Abbott is often praised as a top-notch healthcare enterprise, the reality is that the company depends upon Humira for a large chunk of its profits. That's a problem, as Pfizer (NYSE:PFE) and Rigel (Nasdaq:RIGL)/AstraZeneca (NYSE:AZN) have promising alternatives in the clinic that have seemed to produce solid efficacy with a more convenient oral administration. While the current FDA aversion to the new may shield Humira to some extent, eventually competition (or generics) will hit the market and erode this profit center.

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Wednesday, January 26, 2011

Investopedia: An Off-The-Board Bidder For Smurfit-Stone

The idea that Smurfit-Stone Container (Nasdaq:SSCC) was not going to stay public for too much longer was not all that controversial. After all, the company was a leading manufacturer of containerboard (#2 in the United States), well positioned relative to virgin fiber resources, and not in possession of a terribly dynamic restructuring-oriented management. Consequently, it would not have been surprising to see a company like Temple-Inland (NYSE:TIN) or Koch Industries' Georgia-Pacific step in and acquire Smurfit to better compete with International Paper (NYSE:IP). 

Well, Rock-Tenn (NYSE:RKT) had other ideas. In what is virtually a merger of equals, Rock-Tenn came in with a cash and stock bid for Smurfit-Stone that creates a rather interesting new company in the space and would seem to offer a compelling match of strengths.

The Deal
Rock-Tenn hopes to acquire Smurfit-Stone in a $3.5 billion bid composed of $17.50 in cash and 0.30605 shares of Rock-Tenn for each share of Smurfit-Stone. That gives Smurfit shareholders a 27% premium to Friday's price. At a bit more than 6 times trailing EBTIDA (annualizing Smurfit's last quarter), the deal premium is lower than what IP paid three years ago for Weyerhauser's (NYSE:WY) containerboard assets, but does not seem radically out of line with typical industry valuations (Rock-Tenn itself trades at 6.4x trailing EBITDA).

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Investopedia: Novartis Building Itself Into One-Stop Shop

Monday's announcement that Novartis (NYSE:NVS) will acquire Genoptix (Nasdaq:GXDX) offers an interesting lesson in how quickly things can change in the medical technology market. It was not so long ago that Genoptix was a hot idea and analysts treated it as an example of how the practice and business of medicine was changing. At that same time, Novartis was seen as a sluggish pharmaceutical company and a lagging part of the old guard. 

More recently, though, Genoptix appeared to have hit a wall in its near-term growth and management seemed to have a nearly empty bag of tricks to change that. Novartis, though, has remade the investment community's vision of the company, with more credit being given to its attractive pipeline and growing generics business. To that end, Monday's deal gives Genoptix shareholders a decent exit strategy, while giving Novartis yet another growth option for the future. (For more, see The Latest Greatest Corporate Mergers And Acquisitions.)

The Terms of the Deal 
Novartis announced that it will acquire Genoptix for $25 in cash, a 27% premium to Friday's price, but still a relative bargain on an EV/revenue or EV/EBITDA basis. Even acknowledging the low apparent valuation ratios on the deal, the terms were in line with the recent General Electric (NYSE:GE) acquisition of Clarient (a similar business) and reasonable relative to Genoptix's own near-term growth outlook. (For more, see Investment Valuation Ratios: Enterprise Value Multiple.)

What Novartis Is Getting 
Genoptix is a specialized lab services provider that targets community-based oncologists and hematologists with its specialized diagnostic services in leukemias and lymphomas. In very simple terms, an oncologist will send a patient sample to Genoptix, who will perform a variety of advanced tests on it to determine whether the sample is cancerous (and if so, what type).

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FinancialEdge: Do Americans Get A Discount On Everything?

Though some readers may remember the days when the British pound was the global reserve currency of choice, that position has been held by the United States dollar for quite a while now. One question, though, is the extent to which the U.S. economy and its participants benefit from that status. While there are certain undeniable advantages to having the world adopt your currency as the reserve currency of choice, Americans do not necessarily enjoy the windfall profits and advantages that some outside of the United States suggest. (Learn how the Bretton Woods system got the ball rolling for world trade. See Global Trade And The Currency Market.)

Paying a Little Less for Commodities?As the preeminent global reserve currency, many international commodities are priced and traded in dollars - including oil and gold. That means that foreign buyers have to exchange their euros, yen or yuan to dollars before buying those commodities, and that represents an added cost that Americans do not have to pay. Although currency exchange rates can be significant at the small scale (a small company doing business overseas, or an individual traveler exchanging money), they are not nearly so significant any more for large international concerns and the added cost is relatively minor.

There is a less-appreciated source of profits that America does enjoy, though. America profits from the issuance of its currency to nonresidents, something referred to as seigniorage. In other words, the U.S. quite literally gets paid for its currency. That is perhaps not so surprising to those who've traveled overseas and encountered merchants happy to take U.S. dollars outright (and sometimes at better exchange rates than the "official" rates) or seen TV footage of narco-busts with piles and piles of U.S. currency sitting in trucks or warehouses around the world. Even though the estimated profits from this are modest (perhaps $10 billion), it is almost literally free money, and an extra $32 per head in national income does not hurt.

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Investopedia: DuPont Nets Out To Lukewarm

The good news about DuPont (NYSE:DD) is that it is not just some commodity chemical player, forever at the mercy of cycles it cannot control. No, DuPont is a highly-diversified player in a wide variety of businesses, many of which are either counter-cyclical to each other or not especially cyclical at all. Well, in point of fact that is actually both good news and bad news - for while DuPont has enough diversification to smooth out some of the worst of the cyclical swings, it also has enough diversification to tone down even hot segments to an overall level of lukewarm. 

A Good Enough Finish to the Year
Even DuPont's fourth quarter earnings were an exercise in good news and bad news. To the good, the company reported that sales climbed 15% to about $7.4 billion - a fine performance that surpassed even the highest estimates. Growth was fueled in part by double-digit volume growth, and the company saw strength in the U.S., Asia and Latin America.

Unfortunately, the company did not do nearly so well on its profitability. The company did okay at the gross margin level, but operating income was a little disappointing. Moreover, while the company did beat the average estimate by 18 cents, 15 cents of that came from an unexpectedly low tax rate. Consequently, a much better top-line performance delivered only three extra pennies of earnings. Not exactly an exciting result.

Looking at the segments, some of the trouble becomes more apparent. Revenue in the sector was up a solid 13%, but the company actually worsened its operating loss from a year ago. Although the company did see very solid operating leverage in electronics and communications and performance chemicals, businesses like Performance Coatings and Safety/Protection weren't so exciting. Some of the trouble was due to input costs, ironic in a sense given that DuPont is so often grouped with those basic input producers.

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Another Solid Quarter From First Cash

Little by little, pawn shop operator First Cash Financial (Nasdaq: FCFS) has morphed into one of my foreign holdings. Oh, the company is still headquartered in the U.S. and has substantial operations here, but more than half of the company's revenue now comes from Mexico, the majority of the store base is in Mexico, and the future of the company's growth is in Mexico as well. So, for all intents and purposes, it may be more reasonable to think of First Cash as a Mexican financial services growth stock with some U.S. operations that are in slow-growth maturity.

Good Results
Overall revenue grew 17% in the fourth quarter, with pawn merchandise revenue growth of 14%, pawn service fee revenue growth of 30%, and short-term/payday loan fee growth of 16%. Profitability was also solid, as gross margins expanded almost 300bp from last year and operating income grew 34%.

As mentioned, more than half of revenue came from Mexico, where year-on-year growth amounted to 24% on a constant currency basis. By comparison, U.S. revenue growth was a much more modest 5%, as jewelry scrap sales declined by a double-digit percentage.

Topping off a good quarter, First Cash management gave very positive guidance for 2011. Keep in mind, though, that this has traditionally been an “underpromise/over-deliver” type of management, so the real results could be even better.

Looking South For The Future
I frankly like how the company has positioned itself for the future. Pawn lending is not really a growth industry in the U.S. and self-appointed public guardians keep trying to kill the payday lending business. Luckily for First Cash, only about one-tenth of the company's revenue is exposed to U.S. payday lending, and I expect that will continue to decline with time.

In addition, Mexico looks like an increasingly attractive opportunity. Mexico is significantly “under-banked” relative to the U.S., which means that Mexicans have to turn to alternative financing options like First Cash more often than they would in a country like the U.S. True, that will change in time, and Mexican officials may eventually start taking action to rein in non-bank lenders like First Cash, but that is likely to be way in the future.

As proof that I'm never satisfied, I would like to hear more from the company about future growth prospects. There is much further to go in Mexico, I grant, but how about starting to lay the groundwork for the next market and the next opportunity? I really do not know that much about local lending/pawn laws, but perhaps First Cash could have similar opportunities in Spanish-speaking Latin America (Colombia, Peru, Chile, Argentina, et al) and/or Brazil. Or how about Eastern Europe? Sure, it sounds ambitious to have a small company like First Cash operate on multiple continents, but sooner or later Wall Street will demand to know how the company can maintain mid-teens growth in the future.

The Bottom Line
With this earnings release, I've lowered my free cash flow margin expectations; not because of underperformance per se, but a better understanding of the business on my part. I'm still looking for improvement, though, as well as low-teens revenue growth out for a few years. All in all, I end up with a price target of almost $36 on these shares. That does not leave them as the cheapest shares I own, but it is enough to hang on or buy in today given the prospect of earnings outperformance and steady high-quality growth.

I would BUY First Cash Financial shares.
Disclosure: I own shares of First Cash Financial.

Tuesday, January 25, 2011

Investopedia: Can Maxim Outgrow Its Cycle?

Looking at calendar fourth quarter results so far, there is definitely a little cause for concern about the cyclical slowdown. That puts Maxim Integrated Products (Nasdaq:MXIM) investors in the midst of a bit of a quandary - will product wins in popular consumer products like smartphones, TVs and tablets be enough to overpower cyclical pressures, or is the company just going to go through the same trouble a little later? 

The Quarter That Was
Maxim reported a pretty solid fiscal second quarter. Revenue was down 2% on a sequential basis, but up 29% from last year and a bit ahead of the published average analyst guess. Communications was a standout (up sequentially by 3%), while computers were notably weak - especially notebooks. Profitability was not bad either. GAAP gross margin did improve a bit on a sequential basis, but operating income did fall even after excluding some unusual items. (For more, see The Chips Are Down.)

There were a few concerning items in the details, though. The company reported that bookings dropped 15% on a sequential basis and the book-to-bill was 0.85. Lead times continue to fall and stood at 12 weeks - off a bit from the company's peak of 14, but still ahead of the "normal" level of 8-9 weeks. That is a definite risk factor for the stock - as customers can more easily get the chips they need (and get them on time), they do not need to over-order or carry larger inventories. That in turn leads to order cancellations and revenue stress.

The Road Ahead
Order times are not the only concern for Maxim investors to consider. Texas Instruments (NYSE:TXN) is building a large 300mm fab (which FBR's analyst Craig Berger has called the "Death Star") and that could produce some supply-driven pressure on the sector. Arguably Maxim would be more vulnerable than Linear Technology (Nasdaq:LLTC) and Analog Devices (NYSE:ADI) but it is hardly good news for any supplier other than TI. (For related reading, see Linear's Ups And Downs.)

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Investopedia: Schlumberger Sets A Fast Pace

The world's largest energy services and equipment company Schlumberger (NYSE:SLB) has started the calendar fourth quarter earnings reporting cycle by setting a tough pace. Not only did the company report very strong revenue growth relative to expectations, but profitability was solid and guidance was rather encouraging. 

The Quarter That Was 
On a reported basis, the fourth quarter was clearly a period of strong demand for Schlumberger's services. Revenue rose 32% sequentially and 58% annually and topped $9 billion. Even stripping out the acquisition of Smith, the year-on-year growth was about 15%. Profitability was likewise strong, with EBITDA growing 28% sequentially and 47% annually. Once again, even without the inclusion of Smith, the year-on-year growth in EBITDA and operating income would have been quite strong.

North America was clearly an area of strength for the company, as revenue jumped 27% sequentially - including a 24% increasing land revenue on top of 4% growth in rig counts. Operating income was likewise very strong (up 76% sequentially), even as the federal government's ban on Gulf of Mexico activity impacted earnings.

Around the rest of the world results were less scintillating. Revenue was up a bit in the Eastern Hemisphere category, while declining a bit in Latin America due largely to the Mexican market. (For more, see Oil Services Sector Powered By North America.)

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Investopedia: Med-Tech Choice Is Simply Intuitive

Although 2010 was a lousy year for medical technology stocks, patient investors know that the buyers will return in time. When they do, high-growth companies like Intuitive Surgical (Nasdaq:ISRG) will surely be on the shopping list. For while there are legitimate concerns about how long this company can sustain double-digit system growth, it is much harder to argue away the rising procedure counts and incredible free cash flow conversion performance.

A Strong Finish to the Year 
Intuitive capped 2010 with another estimate-beating performance. Revenue rose 21%, exceeding even the high estimate, as instrument and accessory sales jumped 33%. System sales grew 10%, while service revenue rose 27% for the same period. Revenue growth in instruments was supported by a 35% increase in DaVinci-assisted procedures and a back-of-the-envelope calculation suggests that procedure counts per machine per week rose about 8% to around 3.7.  (For more, see A Checklist For Successful Medical Technology Investment.)

While there was almost nothing to quibble with in the top line numbers, the company's operating leverage was not quite up to the same standard. Gross margin rose about 30 basis points from the year-ago level, a somewhat surprising lack of leverage given the larger contribution of instruments and accessories. The company also posted a sizable increase in SG&A and R&D (though few investors really begrudge higher R&D spending for growth med-tech names), and that limited operating income growth to 20% and resulted in a slight decline in operating margin.

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Investopedia: McDonald's Seems A Bit Overcooked

Quality is all well and good, but at some point price always has to matter. That, then, is the issue with McDonald's (NYSE:MCD) shares today - there is really no quibbling over the quality of the company, but have investors already baked in more than enough optimism? 

The Quarter that Was
The fourth quarter was really not a performance that McDonald's management is going to tack onto the board as a prototype. Revenue grew 4% (5% in constant currency) and met estimates, and full-quarter comp growth of 5% was not all that bad. More problematic, though, is the trend in those comps. December comps were a bit soft, rising 3.7% versus 4.8% in November. U.S. comps slipped below 3% in December, while Europe went negative. Although the company pointed towards weather as a key issue in the U.S. and Europe numbers, and management is still looking for 4 to 5% growth in 2011, institutional investors can be a twitchy and unforgiving lot.

Going down the earnings statement, the company appeared to have a relatively lower-quality quarter. Operating income grew 2% as reported (or 3% in constant currency) and the company clearly lost some of its operating leverage. What's more, while the company met estimates for the period, it got a boost from more favorable taxes and would have missed the quarter otherwise. (For more, See Zooming In On Operating Income.)

The Road Ahead
For a company of its size, McDonald's has done an impressive job of growing its free cash flow over the past five or six years. Moreover, the company has navigated the recession better than many other restaurant operators. Some of that is due to new store hours and menu items (particularly the value meal options), while some of it is also due to the quality-value trade-off that customers see in McDonald's menu (nutritionists may hate it, but customers like it).

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Maybe The End Of The Line With JNJ

This earnings report may be the straw that breaks the camel's back between me and Johnson & Johnson (NYSE: JNJ). It has been a while since JNJ has really impressed me, and I find that I often end up telling myself "don't worry, it'll get better ... after all, it's JNJ". Well, sometimes once-great companies don't rebound and just continue to fade.

A Quick Run Through The Numbers
JNJ reported that revenue fell more than 5% this quarter, missing the average estimate and actually coming in below the lowest published estimate. Consumer was the worst performer of all, as sales fell 15%. Within that, woundcare was down 16% and OTC was absolutely crushed (sales down almost 31%) by the never-ending series of recalls. Pharmaceutical sales were down almost 5% and there were almost no signs of life in the segment, with only Prezista showing any meaningful growth.

Devices were ironically the best story this quarter, as sales rose 0.2%. Cordis (drug-coated stents) was weak yet again though, and sales fell 10%. Orthopedic sales (DePuy) were also down (2%), and so was diabetes (down 2%). Ethicon was up 4% and diagnostics grew 7%.

Oddly enough, gross margins were stable this quarter and that's pretty good considering that the company should have seen operational de-leveraging. Moreover, operating margin actually expanded by 1.5%, but almost half of that was from lower R&D spending. I do NOT like to see health care companies cutting their R&D budgets, but even moreso when their current revenue trajectory and near-term pipeline are uninspiring.  At the bottom line, earnings were down 12%

This And That
It annoys me that JNJ does not provide a cash flow statement with its earnings. If other equally large and diverse conglomerates can do so, what is their excuse? I frankly find it dismissive and disrespectful to investors, but I don't expect that they will change. Nevertheless, it means I cannot immediately re-run a DCF analysis on JNJ shares, but I cannot imagine it will be better than my last run-through.

I also take issue with the company's strategy. JNJ overpaid for Crucell; vaccines can be a great business, but Crucell is not going to help the company much in the short-term. And if JNJ did make a bid for Smith & Nephew (NYSE: SNN), it's just another sign (to me, at least)  that JNJ cannot compete on the basis of its own internal R&D efforts. What next, a bidding war for Beckman Coulter (NYSE: BEC)? And then there's the whole mess in Consumer ... though I believe management has actually started handling that better and that's on the way to resolution.

The Bottom Line
On the basis of my last valuation run, JNJ shares are worth about $71.50 - about 15% higher than where the stock will open today. If JNJ were executing well and giving my confidence in management's abilities and direction, I wouldn't mind that relatively low appreciation potential.

But JNJ is *NOT* executing well, and I cannot see any immediately obvious reasons to think that will change anytime soon. Consequently, I think I will be selling these shares. I'd frankly rather pay up for Abbott (NYSE: ABT) or Becton Dickinson (NYSE: BDX) than own JNJ, and if I was going to own a troubled health care company that needed some TLC, why not own Roche (Nasdaq: RHHBY) instead? Obviously, I'm annoyed as I write this, so I need to let the emotion fade a bit and then decide how to proceed. At this point, though, I'm thinking it's time to move on from JNJ.

At this point, I would probably SELL (though not short) JNJ shares.

Disclosure: I own shares of JNJ

More Grinding For 3M

Reading over some of recent earnings write-ups, I realize that I'm often complaining that Wall Street isn't giving a lot of my portfolio companies what I consider to be a fair shake. But given that I deliberately seek out the unloved, misunderstood, and undervalued, what else should I expect?

Consequently, while it seems that analysts and institutions aren't going to go out of their way to love 3M (NYSE: MMM), that is just part of my investment thesis. While 3M's fourth quarter results were not super, they were okay and the impressive free cash flow production here has me content to hang on a while longer.

Quick Review Of The Quarter
3M had a fourth quarter that was good enough for a fundie like me, but probably not good enough to impress the Street. Revenue rose 9.6% (8.6% organic) to just over $6.7 billion; enough to beat the consensaguess by about $100 million, but a fair bit short of the high estimate. Although Health Care and Safety did okay from a top line perspective, a lot of other segments (Industrial, Consumer/Office, Display, and Electro/Comm) were a bit softer than I'd like.

Unfortunately, it got a little worse on the margin side. For reasons that weren't completely obvious from the press release, the margins in the Display business were disappointing, and that certainly weighed down the total performance. Given that Display is a lucrative business (but one where competition has been expected for some time now), that could be a problem going forward.

All in all, 3M's operating margins were a bit disappointing and the company's bottom-line EPS performance was a little better than expected, but nothing to get excited about. On a happier note, the company did a fair bit better than I expected for full-year free cash flow, and that matters to me a great deal more than a quarterly margin or EPS number.

Bottom Line
While I'm discouraged by the performance in Display, strength in Health Care is good to see. I would have liked to have seen 3Mbump up its organic revenue growth estimate for the year, but I suppose it is better to under-promise at this point rather than disappoint the Street.

3M has a valuable health care franchise (with real strength in dental, infection prevention, and wound care), as well as strong positions in segments like adhesives, abrasives, paint/finish/filler, optical films, and personal safety gear. True, the company competes against well-heeled foes like Johnson & Johnson (NYSE: JNJ), Danaher (NYSE: DHR), Covidien (NYSE: COV), Kimberly Clark (NYSE: KMB), DuPont (NYSE: DD), BASF (Nasdaq: BASFY), Avery Dennison (NYSE: AVY), Tyco (NYSE: TYC) and many others, I think 3M is more than holding its own in most of these markets.

A have a fair value estimate of $106 on 3M shares now, so I'm holding what I have and would consider buying more on a dip.

I would BUY 3M shares.

Disclosure: I own shares of 3M and JNJ

Sunday, January 23, 2011

Trying To Figure Out A Valuation On Active Power

Active Power (Nasdaq: ACPW) is an odd little company. Debuting as a public company amidst the final gasps of the tech bubble, the stock traded above $70 before the market abandoned risky and unproven energy-tech ideas and investor disillusionment pushed the stock below $0.30. Sometimes, though, there can be real opportunity in cherry-picking small companies with interesting proprietary technology that have been through the fires of mass investor abandonment and emerged alive. Such is my interest in Active Power.

What They Do
Active Power is in the business of manufacturing flywheel-based uninterrupted power supply systems. While traditional UPS options have an efficiency level in the low 90's (under optimal conditions), Active Power boasts an efficiency level of 98% for its flywheels. Better still, priced at only about 10% more than traditional lead acid battery-based systems, it is not as though Active Power is demanding that would-be customers pay up dramatically for new technology.

It should also be noted that flywheel approaches are not really new or unproven. The problem is that prior iterations just didn't deliver much in the way of performance or reliability advantages and could be a little ... well, "finnicky". Active Power, then, has not invented a new concept but rather significantly improved an existing idea.

The High Price Of Failure
These kinds of UPS are not meant to replace a diesel generator at a hospital or somesuch. No, these systems are meant for high-level applications where any interruption can be bad news. To offer one example, there was a story that came out a little while ago about how a power problem at a Toshiba factory ruined about 20% of the flash memory chips the plant was intending to ship in Jan/Feb of 2011. What caused this mess? A voltage drop that lasted all of 0.07 seconds. Yes, 0.07 seconds.

Good Partners
Anyway ... Active Power targets data centers and other sorts of markets where price sensitivity is not so critical, but where absolute performance and reliability must be in place. The company has Caterpillar (NYSE: CAT) (a major player in diesel generators) on board as a partner and CAT markets Active Power flywheel systems under their own name. Active Power also has Hewlett-Packard (NYSE: HPQ) and Oracle (Nasdaq: ORCL) on board as IT partners, and boasts customers like the software giant SAS.

So What Is Active Power Worth?
Okay, now back to the point of this whole post - what is Active Power worth? I'm a hard core cash flow guy, so I had to build a model of what ACPW's earnings and cash flow might look like out through 2020. Along the way I took some shortcuts and made some assumptions, but here are the basics.

I'm looking for the company to go from $64 million in revenue in 2010 to $140 million in 2014 and $310 million in 2020. That's a 10-yr CAGR of 17%.

I'm looking for the gross margin to go from 28% in '10 to 41% in '14 and 46% in '20.

For operating margin, I model (7%) in 2010, 18% in 2014, and 20% in 2020 - 20%, by the way, is 25% better than the current S&P 500 average and well ahead of where companies like Eaton (NYSE: ETN) and Emerson (NYSE: EMR) are today.

I estimated a 30% tax rate starting in 2013.

For depreciation and cap-ex, I assumed that the company will use an asset-light model that will not require a lot of capital investment. Consequently, I pegged D&A at about 3% of sales and cap-ex at 2% of sales.

The bottom line, then, was to produce a FCF-sales margin of 13% in 2014 and 15% in 2020 - both pretty high margins by the standards of industrial companies. Assigning a 12% discount rate to the free cash flow and using the current share count gives me a price target of ... $2.69, or about 14% higher than today's price.

So, Active Power may be undervalued, but not hugely undervalued.

Just for kicks, I decided to re-run the numbers if Active Power was able to double my 2020 revenue estimate (so, ending at $600 million instead of $310 million). That sends the DCF-based price target rocketing up to $11.11, but would also mean that Active Power had 10% of the estimated $6.1 billion market for UPS (though that's today's market size, not 2020's).

Of course, any one of my numbers could also be adjusted or modified, including the gross margin, sales & marketing spend, R&D investment, tax rate, and so on. Likewise, I probably underestimated the company's tax loss benefits.

In any case, I'm not sure whether to really recommend Active Power shares at today's price, but if the company can grow revenue at a 25% CAGR for 10 years (and do so profitably), there could definitely be a lot of value here. Then again, how many companies manage a decade of 25% compound annual revenue growth? At a minimum, it's at least worth a bit more due diligence.

Oh, and by all means, if there are readers out there interested in or knowledgable about Active Power and its prospects, feel free to chime in with any comments on my model assumptions.

The Curious Case Of Brazil And Turkey

I do not spend all that much time talking about economics, monetary policy, and the like, but I am making an exception to talk about an interesting “compare and contrast” situation in the emerging markets. Specifically, I find it very interesting to see the unusual monetary policy being pursued by Turkey vis a vis other large emerging economies like Brazil.

High Growth, Lower Rates
Turkey is currently enjoying some of the best growth in Europe, coming in at about 8% for 2010. In most cases, that sort of growth would have policymakers nervous about inflation and looking to hike rates to cool things off. After all, that's what's going on in countries like Poland, Hungary, China, and Brazil right now.

Turkey is handling things quite a bit differently though, and lowering rates. Last week, Turkey's central bank cut rates by 25bp (to 6.25%) after cutting them 50bp back in December. At the same time, the country is raising banks' reserve requirements.

The idea here, then, is to deter yield-shoppers and limit the inflow of speculative/investment capital. Unfortunately, world markets do not usually react well to the unorthodox or the unexpected, and Turkey's actions are both – Turkey's central bank has been pretty cagey and this last rate move took the market by surprise. Moreover, a lot of economists and commentators believe that Turkey will botch this delicate balancing act and that the tougher reserve requirements won't offset the stimulation of lower rates and that this will this ramp up credit growth and stoke inflation.

What might be helping embolden Turkey's officials is the fact that inflation is very low by Turkish standards – about 6.4% in December. On the flip side, the ballooning current account deficit is a real concern, standing as it does at over 7.5% for the last period I could find data. Given that higher rates do not always produce their desired consequences, it is a credible (if very unorthodox) approach for Turkey to try.

That said, this unorthodox policy is certainly not helping Turkey's financial sector and major banks like Garanti (Nasdaq: TKGBY), Akbank (Nasdaq: AKBTY), and Yapi. All of those stocks have taken a smacking lately, as has the stock of Turkcell (NYSE: TKC). If Turkey's central bank is ultimately proven right, this could be a great buying opportunity in one of my favorite markets. If this “low rate in the face of high growth” policy backfires, though, it could take years to sort out the damage.

Brazil Going The Conventional Route
While Turkey is trying something new, Brazil is sticking to the old pattern. Brazil recently bumped its interest rate up 50bp to 11.25%, due in no small part to concerns about inflation. While Turkey has had bouts of high inflation before, it doesn't have the same history of some truly rampant hyper-inflation periods like Brazil does. Consequently, it is hard for me to imagine Brazil's central bank ever being cavalier about the risks of inflation. Unlike Turkey, Brazil also has much less to worry about in terms of its current account balance and the impact of capital inflows.

Not surprisingly, though, this round of tightening hasn't been great news for Brazilian bank stocks like Itau (Nasdaq: ITAU) or Banco Bradesco (NYSE: BBD). On the other hand, it has made virtually no difference for major exporters like Embraer (NYSE: ERJ) and Vale (Nasdaq: VALE). And then you have the broader market ETFs like the iShares Brazil Index (NYSE: EWZ) and Market Vectors Brazil Small-Cap ETF (NYSE: BRF) – with a mix of exporters and more domestically-oriented stocks, these have traded lower, but not to the same extent as the financials.

It will be interesting to see how these two countries' policies play out. Clearly there are very different circumstances for each economy – Brazil is highly leveraged to China's development and appetite for raw materials, while Turkey is keenly exposed to Europe's health and demand for lower-cost manufactured imports. Nevertheless, Brazil runs the risk of choking off growth at time when it really needs to be using the windfall of commodity exports to develop a more balanced and sustainable economy. On the other hand, Turkey is not endangering its growth, but may well be risking its future stability.

The Bottom Line
I do not want to sound too cavalier about things, but on some level I dismiss monetary movements as “rates go up, rates go down … and the markets march on”. It's not wise to ignore a country's economic conditions or present fiscal/monetary policies, but you also cannot lose the forest for the trees. Should investors buy Brazilian financial stocks in the face of higher rates or Turkey financials in the face of market disapproval and uncertainty? Maybe not. By the same token, long-term value investors know that stocks often turn before the news changes and these stocks will probably stabilize and start rebounding ahead of any official “all clear” in interest rates.

More to the point, Turkey and Brazil are two places I really want to be for the long haul.

So, how cute should an investor be? After all, banks like Itau, Garanti, and Yapi are now trading at pretty attractive valuations. Sure, there is the risk that the stocks could go down another 10-20% with investor worries about monetary policies. But tell me when, exactly, there isn't *some* risk that could push down the price of an emerging market stock by a similar amount.

All things considered, I'd probably rather own exporters, but that's not always so easily done. The most liquid stocks (and those most likely to trade as ADRs) are usually domestic-focused companies like banks, utilities, and telecoms. It's a little easier with Brazil, with stocks like Embraer, Brazil Foods (Nasdaq: BRFS), and Vale, but there are fewer options with Turkey beyond ETFs, index funds, mutual funds, and a few stocks like Anadolu Efes.

The bottom line, then, is that I'd be looking to start buying. Maybe world markets are at a near-term top and maybe we're all due for a pullback. That's just part of the risk of investing. Given the turbulence and concerns over monetary policy, though, I'd probably take a multi-stage approach – looking to buy maybe one-third of my position in the next few weeks, another third a few weeks later, and the final third in a few months.

What should investors buy? I would take a very serious look at the three banks – Akbank, Garanti, and Yapi (the first two are reasonably liquid ADRs). I would also dig deeper and look into names like Anadolu, Tofas, Koc Holdings and so on. In fact, I hope to be back in a week or so with some additional Turkish names, hopefully with available ADRs. For Brazil, I'm talking my book, but I'd seriously consider Brazil Foods, as well perhaps as Cosan (NYSE: CZZ), Vale, Itau, Petrobras (NYSE: PBR), and Hypermarcas.

Disclosure: I own shares of Turkcell and Brazil Foods

Friday, January 21, 2011

FinancialEdge: 5 Signs Of A Market-Beating Stock

Apart from those investors committed to indexing strategies, everybody is on the hunt for market-beating stocks. After all, if you do not expect a stock to beat the market, why take the risk that goes with individual stock selection? While investors should always be suspicious of any advice claiming to offer easy strategies to spot market-beating stocks, long-term high performers do seem to share certain traits. (For related reading, also take a look at How To Make A Winning Long-Term Stock Pick.)

A Short-Term Warning
Before talking about how to spot market-beating stocks, a word of caution is in order. The motivating principle of this column is to find stocks that beat the market for the long term. In the short term (18 months or less), almost anything can "work" and outperformance is based largely on investor enthusiasm and stock market momentum.

Unfortunately, that system does not hold up so well over time - last year's winners tend to be next year's losers as the enthusiasm fades, momentum investors move on and high valuations are no longer ignored by the market. Consider the words of Warren Buffett who has said (perhaps quoting his mentor Ben Graham) that, "in the short-run the market is a voting machine; in the long run, it's a weighing machine." With that in mind, here are the hallmarks of a market-beating stock.

1. Excess Economic Profits
Ultimately, the companies that win over the long term are the companies that follow a deceptively simple formula. These companies earn economic profits in excess of their cost of capital. To some extent, though, this is a tautology that is not all that helpful. After all, companies do not report their economic profits (they report accounting profits, as determined by GAAP rules) and no two analysts will ever agree completely on the proper calculation of the cost of capital.

2. Strong Returns on Invested Capital (ROIC)
Return on invested capital is a pretty handy substitute for separating out those companies that are earning the sort of returns that lead to long-term success. Return on capital divides some measure of the company's profitability (net income, EBITDA, NOPAT, et al) by the company's capital base (debt and equity).

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FinancialEdge: The Unseen Taxes That You Pay Everyday

The old joke says that nothing is certain in life but death and taxes, and medical science has done a lot to forestall the former. Although nobody enjoys paying taxes, most people probably do not realize how they permeate our daily lives. Simply put, one way or another, we pay taxes on almost anything and everything we do.

To illustrate how the tax burden can be spread around, consider the "tax trail" on a few common daily items (For help with filing your taxes, check out 6 Sources For Free Tax Help.)

The taxes on a gallon of gas start as soon as the oil comes out of the well. Although negotiated contracts, sweetheart deals, kickbacks and cross-cutting legislative actions can dramatically muddy the waters when it comes to assessing an "average" royalty in many countries, the fact is that companies like Exxon Mobil (NYSE:XOM) and BP (NYSE:BP) owe the landowner and/or the state money whenever they remove oil and natural gas. In the United States for instance, companies pay a royalty of 12.5% on oil taken from onshore Federal lands, and that is an addition to so-called "bonus bids" that are paid upfront.

If that oil travels through a pipeline to reach a refinery (and much of it does), there's more taxation there - states and municipalities will charge property tax on the pipelines, and some also charge tax based on the volume of oil or gas sent through the pipeline. What's more, pipeline tariffs are often restricted by law, which is in effect a tax as well.

Once the oil gets to the refinery, there's still more taxation that figures into the final pump price. Although excise tax is collected at different times and at different levels, the federal tax on gasoline amounts to a little over $0.18 per gallon, with states tacking on more tax (ranging from $0.07 to $0.30 per gallon depending upon the state). Don't forget, too, that many states tack on their regular sales tax every time you buy gasoline.

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Investopedia: F5 - Suddenly Valuation Matters Again

One of the really tricky aspects of growth stock investing is that overvalued stocks can easily continue to outperform the market and become even more overvalued so long as the company produces enough growth to excite the "valuations don't matter" crowd. The problem, though, is that sooner or later valuations always matter, and that day of reckoning can be painful. 

That would appear to be the case with F5 Networks (Nasdaq:FFIV). F5 is a great company and a leading provider of network traffic management products and services. What's more, the company's earnings/guidance miss was not all that bad. And yet, the stock has recently endured a sharp selloff as investors suddenly question the wisdom of paying more than 12 times trailing revenue for a company whose torrid growth may be cooling.

The Quarter That Was
As suggested, F5's fiscal first quarter was really not that bad. Revenue rose 6% sequentially and almost 41% year-on-year, with product revenue leading the way with 44% growth over last year. Gross margin improved (and stand at an extremely impressive 82.6% level), while operating income grew 7% sequentially (69% YOY) and operating margin improved to over 38 percent. (For more, see Zooming In On Net Operating Income.)

Now the bad news. This quarter broke a streak of six beat-and-raise quarters. Book-to-bill for the quarter was below one. Worst of all, the company gave guidance for the next quarter that suggests sequential revenue growth of 2-4% and a midpoint 1% below the prior consensus.

The Road Ahead
Again, for a normal company these results would not be bad. But F5 is not a normal company or a normal stock. F5, along with Riverbed (Nasdaq:RVBD) and Blue Coat (Nasdaq:BCSI) has been basking in a "cloud premium" for at least the last six months - so much so, in fact, that the average analyst price target on F5 shares has more than doubled from its July level. That's a lot of optimism for any company to redeem.

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