One of my core holdings in SLO (Strategy Lab Open) and real life is Wells Fargo (WFC). With the stock price hitting new lows recently, I wanted to review that holding to see if it's time to disembark from one of my dividend stocks.

The first step in that evaluation is to review why I bought the stock in the first place. The main focus for my IRA account is to establish a team of dividend paying stocks that will generate income. WFC is part of that core, so I'm less concerned about price fluctuation than I am with the dividend prospects.

Unless you've been living under a rock, you're well aware of credit problems in the financials and the big write-downs most of these companies have been taking.

WFC hasn't been immune from these problems, but recent quarterly reports still show earnings that comfortably cover the dividend payout. Recently, Richard Bove lowered his earnings estimates and price targets for WFC. But, his price target of $29 is well above today's price and the earnings estimates for 08 and 09 comfortably cover the dividend payout.

The financial stocks that have been hammered the hardest have typically been caught in positions where they needed to raise capital, diluting current shareholders. In every case I'm aware of, an announcement to raise capital has been followed by substantially lower share prices and, frequently, dividend cuts.

I'd consider any event that jeopardizes long-term income prospects for this stock a sell signal. Most significantly, if they announce a need to raise capital, I'd sell immediately. Recent market action is very clear. If you still like the company, you'll get a chance to buy it back much lower. And most financials that have needed to raise capital have followed that up with more bad news.

To date, WFC isn't acting like a company that needs to raise capital. Significantly, they've been acquiring businesses and expanding operations. Recently, they've acquired Farmers State Bank of Fort Morgan, Colorado, Transcap Associates, and expanded operations in Oklahoma. Nothing earth shattering, but also not actions consistent with a company that thinks it will need to raise capital. So not bad for one of my dividend stocks.

I'll also be watching for the next earnings report and dividend announcement. WFC has a long track record of annual dividend hikes and the next announcement will tell whether they continue that track record. I won't necessarily sell if they don't raise, but if that were accompanied by troubling earnings..... I'm guessing there'll be a nominal dividend hike to keep the string of annual increases running.

Long term, I think WFC is well positioned to pick up business as weaker competitors either fall out or just can't take advantage of opportunities.

Bottom line, I'm nervous about holding a company in a very troubled sector. But, I still believe WFC will do what I bought it to do - crank out dividend income for a long time. Unless they announce a need to raise capital or earnings get to a point that they don't support the dividend, I'll continue to add small buys going forward, mostly just reinvesting dividends. I'll also continue to look for opportunities to trade a little around my position.

Comments: View Comments |  Wednesday June 25, 2008  |  Stocks: WFC,

After the recent non-traditional defensive pick, I wanted to look at a more traditional defensive play involving commodities trading -- food stocks.

Last week, General Mills (GIS) issued a press release raising guidance for their 4th quarter and full FY08 earnings and providing guidance for FY09. Excluding some mark-to-market gains on commodities options, GIS expects earnings of $3.52 a share for FY08 when they report this week. The company expects to earn between $3.78 and $3.83 for FY09 excluding any one-time adjustments.

At the 19 June close of $62.79, that puts GIS at a ttm PE of 17.8 excluding items and a fwd PE of between 16.6 and 16.4 on the '09 guidance. The mid-point of the guidance would be 8.1% earnings growth over this year and according to Yahoo analysts expect a 5-year earnings growth rate of 8.7%. GIS pays a quarterly dividend of 40 cents a share for a yield of a little over 2.5%.

When compared to some of their competitors, General Mills looks a little pricey at over 16 times next year's earnings. HJ Heinz (HNZ) has a slightly higher 5-yr growth estimate, but sells at 15.6 times estimated '09 earnings. Conagra (CAG) has a slightly lower 5-yr growth estimate of 8.2%, but sells at a much lower fwd PE of 13.8. Kellogg (K) has nearly the same predicted growth rate as GIS, but sells at a slight discount based of forward earnings.

For any food company, an investor needs to be very concerned about rising commodity prices. JM Smucker (SJM) reported higher yoy revenues last Thursday, but disappointing earnings because of high input prices. The stock shed over 8% on the day. With ethanol mandates increasing demand for corn and tragic flooding in the mid-west, it's hard to be bullish on any company that has grain as one of their main raw material inputs.

I didn't find any information on how much GIS has hedged their commodity cost exposure, but they must have some futures or options since they reported gains in their press release. Anyone who's spent any time in a supermarket lately can testify that food companies are passing along at least some of their costs; however, at least in Smucker's case it wasn't enough to offset rising commodity prices.

Based on this quick look, HJ Heinz looks like the best bargain in the group with Conagra a close second. None of these stocks are going to take off on a tear, but they're not likely to see a lot of downside either - defense. All of the names mentioned pay a decent dividend, so you get paid while riding the market out. General Mills' dividend and strong brands should provide some downside protection, but the stock would have to drop about 5% to be comparable to HNZ.

Comments welcome, especially if you can explain why GIS deserves a premium to HNZ.

Comments: View Comments |  Tuesday June 24, 2008  |  Stocks: CAG, GIS, HNZ, SJM,

Don Ferk, the Viking Warrior from SLO1, commented on my blog last week and asked for my opinion on Dresser Rand (DRC) vs. Graham Corp (GHM) going forward. That prompted our QOTW on another oilfield equipment supplier, Lufkin Industries (LUFK).

First Graham. GHM supplies condensers, heat exchangers and ejectors to refineries, petrochemical and other process industries. The stock has had a phenomenal run this year, moving from a ytd low of 30 at the end of January to over 68 on 13 June. I think the company will continue to do well, but the stock price may be getting near fair value at 17.4 times 2009 earnings estimates. So, Don's comment and the QOTW prompted me to take a look at DRC and LUFK to see if it might make sense to shift out of GHM into one of them.

Dresser Rand

Dresser Rand makes pumps, compressors and other rotating machinery for oil, gas, refining, petrochemical and process industries. The company has a market cap of $3.5 billion, trades at 15.4 times analysts' 2009 estimates, has 370 million in debt, 260 million in cash and an estimated 5-year growth rate of 29%. The company doesn't pay a dividend.

According to the latest earnings transcript the company has a $2.1 billion order backlog. They also have a $150 million buyback authorized; that would be over 4% of the float if exercised at Friday's closing price.

During the earnings call, the company stated that the refinery business is good. Despite US refineries scaling back expansion plans, they are upgrading to handle heavier or high sulfur crude oil. And, overseas refinery equipment orders are strong. "So, maybe there is a bit of a slowdown in the U.S. refining, but I can tell you that on a worldwide basis, there is a heck of a lot of activity." according to Mark E. Baldwin, Executive Vice President and Chief Financial Officer. Strong worldwide refinery business is consistent with statements Graham's management made during their conference call as well.

President and CEO Vincent Volpe stated, "We continue to believe that our 2008 operating income will be in the range of $285 million to $315 million."

Mr. Volpe made an interesting comment concerning R&D efforts to improve the ability of pumps to handle mixed gas and liquid flows. "So, I would say that we are ahead of the game, not behind the game and we're ahead of it with what I believe is leapfrog technology, which we've patented." I'm not sure exactly how much that benefits oil extraction, but at $130+ a barrel, anything that makes extracting crude more efficient would certainly be appealing.

In summary, very reasonable PE, strong order backlog and a customer base covering the upstream and downstream of the oil and gas industry.

Lufkin Industries

LUFK has three different business operations, oil and gas equipment and service, transmission systems for heavy machinery and marine, and truck trailers. They are shutting down the truck trailer business to focus on the other areas. The company has a market cap of $1.16 billion, trades at 13.1 times analysts' 2009 estimates, has no debt, 130 million in cash and an estimated 5-year growth rate of 10.25%. The company pays a 25-cent quarterly dividend for a yield of 1.3% based on Friday's close. LUFK has been a good performer for the CAPS Commando in the current MSN Strategy Lab.

The latest earnings transcript indicated an order backlog of $235.7 million, mostly over the next two quarters. LUFK has $3.5 million remaining in their buy back authorization. They also raised guidance for 2008 earnings to between $5.10 and $5.30 a share.

The company has seen some orders from customers who tried lower price competitor's equipment, but have been coming back to LUFK due to quality and reliability issues.

In summary a PE well below the market, decent order backlog, strong customer base and no debt.

Wrap-Up

I think all three of these companies are likely to outperform the overall market going forward, but DRC stands out. A backlog totally nearly two-thirds of the market cap provides good earnings visibility for at least the next couple of years. That compares with GHM and LUFK backlogs at about 25 and 23% of market cap respectively. Another deciding factor is DRC's much higher estimated earnings growth rate. Even though DRC trades at a slight premium to LUFK on PE, that premium seems more than warranted by the higher projected growth rate. Finally, DRC has under performed the other two stocks over the last 12-months. LUFK is up 21% over the past 12 months, GHM is up over 230% while DRC is up a little under 9%,. I didn't find a good reason for the discrepancy between LUFK and DRC, so it looks like DRC has some room to play catch-up.

I started building a SLO position in DRC on Monday and bought some in real life.

Earnings call transcript information is from Seeking Alpha. Many thanks to them for posting transcripts.

And thanks to my friend Don for the Dresser Rand lead.

Disclosure: At time of posting, I own a few shares of GHM and (now) DRC, but have no position in any other company mentioned.

Comments: View Comments |  Monday June 16, 2008  |  Stocks: DRC, GHM, LUFK,

When the economy and markets are rocky, many investors move into consumer staples and healthcare stocks on the theory that those businesses don't depend on the economic cycle. But, what if you're a bit of a contrarian who still wants some defensive holdings? Outside of consumer staples and healthcare is there anything likely to do well in a soft economy?

If a little volatility is ok, I think I've got a candidate that fills the billet. Transocean (RIG).

RIG is typically thought of as a cyclical stock, and it may be, but it currently has a full order book so the cycle will still be working for quite some time. In order to replenish reserves, oil companies will need to continue expanding their offshore operations. Valuation looks cheap with a forward PE under nine.

One of the footnotes to the most recent Fleet Status Report caught my eye. The contract for one of their rigs currently under construction has a fixed dayrate for the first three years, then the dayrate varies with the price of oil for the last two years. The variable dayrate has a floor of $400,000 per day if West Texas Intermediate is $40 per barrel or lower. Then it goes up to a ceiling rate of $500,000 per day if oil is $70 or higher. The critical piece of information there is that the high dayrates are still profitable for Transocean's customers at much lower oil prices than we have today. Even if oil drops by 50%, no one will be canceling drill rig contracts. The huge contract backlog that continues to work at much lower oil prices gives RIG some insensitivity to the economy. Unless you think oil is going back under $70/barrel again, the cash flows are there regardless of what happens in the economic cycle.

Comments: View Comments |  Wednesday June 11, 2008  |  Stocks: RIG,

GE

GE got too cheap to pass up. I've been watching it since the hammering after the last earnings report and it looks like a good value.

Not a lot of detailed analysis here. For one, there are so many pieces to GE that trying to analyze it in detail would be a full time job and then some. Aircraft engines, stationary gas turbines, locomotives, electric machinery, financials, drilling equipment, NBC, water treatment, wind power, medical equipment...it would be easier to list the businesses they're NOT in. It's tough to imagine a more diversified (or maybe deworsified) business anywhere.

GE fits the profile I target for much of my portfolio. Above average dividend yield (4%), history of dividend hikes (32 consecutive years), reasonably low payout ratio (53%) and predicted earnings growth to support future payout hikes (11%).

The widely diversified business model makes it virtually impossible for the company to fire on all cylinders, but also means something will nearly always be doing well. The last earnings report was a disappointment due mostly to poor performance in the financial business. The market has it priced a lot like a financial company, but GE has a lot of business in some of the strongest parts of the economy.

The selloff in this stock sure looks like the market put a great long-term holding out on the deep discount aisle.

Graham

My biggest winner in SLO, Graham Corp. (GHM) issued a press release on Friday outlining $10 million in international refinery equipment orders. I thought the release helps explain part of the picture driving oil prices. The orders in GHM's release are for refinery projects in South Korea, China, Malaysia and Russia. This supports the argument that oil demand is growing outside the US and is keeping upward pressure on crude prices. It also adds to Graham's already solid backlog.

Graham also got a mention in Barron's Research Reports section. Singular Research put a buy recommendation on the stock. I bet Singular's customers would have been happier if the buy rating had been issued four or five months ago so they could have been in on the quick double.

Disclosure: I own some GE and GHM.

Comments: View Comments |  Saturday June 7, 2008  |  Stocks: GE, GHM,

One of our SLO1 questions of the week was Fannie Mae and we've been asked to take another look. When the SLO1 question hit, FNM was trading in the mid-to-high 40's. Most opinions were decidedly negative (and correct) as the stock now trades at about 27.

Since Nov, FNM has cut the quarterly dividend from 50 cents to 35 cents and issued new common and preferred stock to raise about $6 billion in new capital. The dividend will be cut again to 25 cents beginning in the third quarter. According to the most recent monthly summary 1.15% of loans are seriously delinquent and that rate doesn't appear to have leveled off yet.

The most recent quarterly report is for their Q1 FY08 ending 31 March and shows losses of $2.57 per share. That was prior to the dilution from raising new capital. That was an improvement from the $3.80 per share loss from the prior quarter, however charge-offs were higher than Q4 FY07. The report states "We expect home prices to decline 7 to 9% on a national basis in 2008..." and that credit losses are expected to increase in 2009.

It's tempting to point to an implied government credit guarantee for FNM, but that only protects bond holders. While getting wiped out in a bankruptcy is highly unlikely, there's still plenty of room on the downside for the share price.

According to the Yahoo Finance page, analysts are estimating losses for the remainder of 2008, but predict FNM will earn 1.97 a share in '09. That puts the stock trading at 13.7 times 2009 earnings and a dividend yield of 3.7% based on the 25 cent a share dividend.

The stock is certainly a better buy than last fall, but you need to believe the mortgage business is going to improve substantially over the next year to make it a good deal. If you believe that, I think Washington Mutual offers more leverage (and risk) to an improving housing market. While we may have seen the worst of foreclosures and credit gridlock, I'm very skeptical of forecasts for improving mortgage markets in the near term. In their last quarterly report, WaMu was forecasting future home price declines of 13-30 percent.

Based on the forward PE, FNM is trading at a 25+% premium to my two favorite financials, Wells Fargo and JP Morgan. Both of those banks offer a much more diversified business model than FNM and I see no reason FNM should trade at a premium to them.

FNM is cheaper than it was last fall, but not much else has changed. I'd still rather own a stronger, more diversified financial or the BTO bank closed-end fund that Tom recommended a while back. FNM would need to trade at a discount to those investments to get interesting.

If I wanted to bet on an improving housing and credit market (and I don't), it would make sense to get a little more leverage (and risk) with WaMu, Citi or one of the other troubled lenders.

Disclosure: At time of posting I'm long Wells Fargo; the dividend helps ease the pain. No position in any other company mentioned.

Comments: View Comments |  Tuesday June 3, 2008  |  Stocks: C, FNM, JPM, WFC, WM,