August 2008 Archives

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Improvements in Home Improvement? (LOW, HD)

The latest existing home sales report from the National Association of Realtors showed an increase of 3.1% over the previous month with sales rising to about 5 million units a year annualized. When the last twelve months of data is plotted, there's a clear bottoming pattern being formed. The report also shows home prices continuing to fall and the inventory of unsold homes increasing. That's bad news for sellers but good news for buyers since the increasing inventory should continue to put pressure on prices.

HomeSales2.png

The AP release listed on MSNBC includes this additional information, "Between 33 and 40 percent of sales activity is coming from foreclosures or other distressed properties, estimated Lawrence Yun, chief economist at the Realtors group."

If existing home sales have bottomed, it should be good news for home improvement retailers Home Depot (HD) and Lowes (LOW). The high percentage of sales coming from foreclosures should also be a positive for their business. I haven't found any data to back this up, but it's logical that on average a foreclosed home will need more repairs than an owner-to-owner purchase. Granted, logic doesn't necessarily apply to the stock market.

Both companies are profitable even in the current soft housing market. Valuations are similar with both companies trading at about 15.5 times the next 12 months earnings. Cramer did a head-to-head between HD and LOW on Wednesday's Mad Money and concluded LOW was the better bargain primarily because of better growth prospects. One key difference between the companies is the dividend. HD yields about 3.3% vs about 1.4% for LOW. Obviously, Lowe's has a much lower payout ratio so more of its earnings are available to invest in expansion.

If home sales have bottomed, LOW and HD sales traffic should start increasing, particularly with a high percentage of sales and housing inventory coming from foreclosures. Both companies should benefit from easy same-store-sales comparisons going forward. Analysts' earnings estimates for both companies have been lowered over the past 90 days. I think that's a mistake. Cramer based his opinion of the two stocks partly on his prediction that new home sales will start improving late next year. I suspect many analysts are also considering new home sales for their models. They may be overlooking stabilizing and improving existing home sales volume (not necessarily prices) providing a lift to home improvement centers.

I believe LOW is a slightly better buy than HD based on better growth prospects and a lower debt ratio. The higher dividend makes HD attractive to income investors and should provide more support to the share price if the thesis is wrong; the dividend is comfortably covered so there isn't much chance of a cut. If stabilizing home sales drive an increase in traffic, both companies should benefit.

As with most stocks in this market, I don't think there's any big hurry to jump in to these two. Moves in the housing market won't be fast and there's no harm in waiting for another home sales report or two to see if the bottoming trend is intact. A 'nibble now, add more later' approach would also make sense.

Disclosure: At time of posting, I have no position in any company mentioned.

Edited to add chart.

Comments: View Comments |  Thursday August 28, 2008  |  Stocks: , ,

Hit or Miss? Deere (DE)

In addition to serving as inspiration for one of the greatest country songs ever, you may be aware that Deere & Co. (DE) makes farm and construction machinery. Over the past two years, the stock has run from about 37 to over 90 earlier this year. It's now pulled back to 65 and change, about where it was one-year ago.

The company looks cheap, trading at 13.5 times ttm earnings and 11 times estimated 2009 earnings. Early in the first round of the Strategy Lab Open, Ken Kam asked us to explain why conventional wisdom about a stock's price is wrong in our blogs. In this case, I wasn't able to turn up a reason why the market pricing on DE is wrong.

The stock is trading at a substantial discount to the overall market, but there are several risks to explain the discount and little good news that isn't already well known.

The bull case is that the strong agricultural business will continue to translate into higher tractor and machinery sales and there is evidence to support that. In the 13 Aug conference call, DE management stated that the 8000 and 9000 series tractors have orders extending through July and Sep '09 respectively and that 70% of next year's expected combine sales have orders. The company also has invested in production capabilities and will have increased capacity for combines coming on line in 2009 and tractors in 2010. Deere's other big machinery segments, forestry and construction, are weak but profitable.

Currency translation is expected to add about $150 million, or about 7%, to '08 earnings. With the dollar strengthening, currency translation may very well turn from a positive to a negative. At a minimum, DE will be hard pressed to duplicate this year's currency gains going forward.

A stronger dollar will also benefit foreign competitors. The 19 August Wall St. Journal included an article on a joint venture between Mahindra & Mahindra of India and China's Jiangsu Yuenda Yancheng Tractor to produce tractors. Japan's Kubota (KUB) and Europe's CNH Global (CNH) would also benefit from a stronger dollar.

If US politicians end mandates and subsidies pushing ethanol, corn prices would drop as corn based ethanol production falls.

Input cost inflation will put pressure on margins. During the conference call, several analysts asked about costs and management indicated they've been able to pass most of the higher input costs along to customers.

I don't have a good handle on the farm equipment replacement cycle, but I doubt farmers rush out and buy new tractors and equipment every time there's a great year. A logical cycle would something like a big sales gain in a boom year with smaller gains in subsequent strong years. That may not be the case, but if it is, Deere has probably already seen the biggest chunk of growth in this cycle.

DE is a strong company that's been executing well. The stock seems to be fairly valued at 65 and change, but it's tough to call it a 'buy' with some of the potential headwinds on the horizon.

I normally prefer trying to pick out the best stocks in a sector rather than using an ETF, but since the driving factor behind the bull scenario is a strong and growing agricultural business, the Market Vectors Agribusiness ETF (MOO) might make more sense for an investor considering DE. Since DE makes up nearly 8% of the ETF, you still get some John Deere power in the mix.

Comments: View Comments |  Wednesday August 20, 2008

Fries with your stock? - McDonalds (MCD)

McDonald's (MCD) seemed like a good place to start catching up on research. I've had it on a watchlist for some time, Armin recommended it in a blog reply back in January, Jamie suggested it last week and today Jim Jubak mentioned it in an MSN Money column.

On 08/08/08, the company reported global comparable sales up 8.0% year over year. System wide sales were up 9.5% yoy in constant currency; 15.9% when currency exchange is factored in. System wide sales increases were particularly strong in Europe and Asia/Pacific, Middle East and Africa. In those areas, there was a big difference between system wide sales, which includes new stores, and comparable sales, which are only stores open for at least 13 months. That would reflect a substantial growth in the McDonalds' footprint in those regions.

The 23 July conference call reporting second quarter earnings painted a picture of solid business execution, growing revenues and growing earnings. Ralph Alvarez, Chief Operating Officer, stated, "Comparable sales for the quarter were up 3.4%, of which 75% came from increased guest counts." Not many businesses can boast an increase in customers in a soft economy. One of MCD focus areas is beverages and customers can expect to see a broader selection of premium drinks rolled out in 2009. Management is also looking to expand MCD in Russia - "143 million people but only 195 McDonald's restaurants today."

MCD is reasonably priced. Based on the 12 Aug close of $63.94, it trades at just under 17 times 2009 earnings estimates. That's not a screaming buy, but is a slight discount to the S&P 500 '09 PE of about 18. MCD pays a dividend yielding 2.3% and the company "has raised its dividend each and every year since paying its first dividend in 1976" according to the Investor Relations page. Music to my ears.

Risks include rising commodity costs, although based on the conference call, management seems to have the situation under control. About the only other risk I see is if business execution were to slip. Again, current management is introducing products customers want and is well positioned to continue expanding the brand.

We aren't going to discover any overlooked piece of information on a Dow 30 stock like MCD (there were 17 analysts listed on the conference call) and it isn't going to be the quick double you brag about over coffee at work. But, this is a company that's executing well with solid earnings prospects and steady growth trading at a slight discount to the overall market. The stock price jumped on the 8 Aug news release, but has pulled back some. I think the stock is a good value here in the low 60's, a market PE would take the stock to $70. The relatively low risk business model and steady growth prospects arguably justify a slight premium to the market. Like most stocks in this market, nibble and accumulate on pullbacks is a prudent strategy for building a position.

Since selling BUD after the buyout was announced, I've got room for another core dividend payer in the Marketocracy portfolio. McDonald's is definitely on the short list.

All conference call quotes from the transcript at SeekingAlpha.com. Thanks to them for a great, free service.

No position in any stock mentioned at time of posting.

Comments: View Comments |  Tuesday August 12, 2008  |  Stocks: ,

I have some work to do

Recently, Jamie asked for thoughts on how we would set up our portfolios for the next six months, corresponding to the new round of Strategy Lab. My first thought was just keep doing what I've been doing; a core of solid dividend payers and some selected growth / cyclical to spice things up a bit. But, looking a little deeper I see my Marketocracy portfolio has been under performing over the past few weeks. The reason is simple, the portfolio is heavy in energy names. I think I do a good job keeping tabs on the stocks I hold, but have slipped on building and maintaining a watchlist of names to bring in when market leadership changes and on developing a plan for shifting the stock mix to adapt to a changing economic cycle.

Since we've got six top-notch investors over in Strategy Lab, first stop is a check to see if I can steal some ideas from them.

Andrew Horowitz, the Disciplined Investor, sits in second place. Andrew's portfolio is short oil / gas (DUG) and the S&P500 (SDS), bullish on the dollar (UUP) and long a few select stocks. What caught my attention in his 7 August Journal was a comparison of recent earnings to the year-ago quarter broken down by sector. Here's what he found:

Winners
Energy +25%
Technology +15%
Health care +8%
Industrials +5%
Consumer staples +5%
Utilities +4%

Losers
Telecommunications -2 %
Materials -3%
Consumer discretionary -24%
Financials -85%

A contrarian/value approach hints that it's a good time to start turning over rocks in the financial and consumer discretionary sectors and time to be very careful in energy and tech. (that's my take, not necessarily Andrew's) Andrew is concerned that financials still have a lot of problems to work out.

John Reese,Guru Investor, is the current lab leader. John bases his picks on computer models that copy the style of some of the world's greatest investors. Two of the six guru models (Buffett and Graham) returned lists heavy in retailing names. Another area for more research. There didn't seem to be much of a sector pattern to the other four gurus, but financial, energy, industrial and consumer products were represented. I may have missed something, but there was only one tech name in the mix (Netgear).

Howard Gold, News Hound, is adding four stocks, IBM, Dolby, Qualcomm and Johnson and Johnson, to his mix of ETF's. Howard believes individual investors should stick to broad based ETF's or mutual funds for the majority of their investments. However, in his most recent journal he states, "...(although I'm amazed I'm writing this) some well-chosen individual stocks may actually be better, less risky bets than ETFs for the next few months."

Perhaps we can take a lesson from NASCAR. The teams that win championships have to do more than just show up with a fast car and great driver. They have to be prepared with plans and contingency plans to deal with track changes, caution flags, fuel mileage, damage repairs, etc. Planning ahead so they can scramble to adjust and salvage a decent finish when things go wrong is just as important as winning races. To be good investors, it's not enough to just build a solid portfolio and sit on it forever. We have to think ahead and prepare for market changes, sector shifts, technology developments, and so on. We have to be ready to adjust and then adjust again when we make mistakes. To be clear, I'm not advocating day trading or making changes on every stock drop, just that we should be prepared to make adjustments as situations change.

I don't know what, if any, changes I might need to make. But I do know I've skimped on planning and, like the title says, have some work to do. Fortunately, MSN's Strategy Lab players have already done some of the homework. I'll share what I turn up in future blogs.

Performance tracking
Jamie asked us to provide information on our performance benchmarked against the Strategy Lab. I didn't start a new M* portfolio, but here's some performance info for those interested.

Marketocracy fund performance since 31 July 07.
Motley Fool CAPS page
Marketocracy return since 1 Aug Strategy Lab 18 start: +0.68%

Comments: View Comments |  Saturday August 9, 2008

A Stroll Through the Oil Fields

Last week we got earnings reports from a number of oil companies and related suppliers. Looking over a few of those reports provides an interesting view of what's going on in the sector. ExxonMobil (XOM), Chevron (CVX), Dresser-Rand (DRC) and Graham Corp. (GHM) all reported last week and those reports combine to provide some good information.

First, the big guys. XOM and CVX both reported earnings that nicely beat the year-ago quarters, but missed analyst estimates. In both cases, earnings from the upstream (oil production) were strong, but the downstream (refining and marketing) earnings were weak (XOM) or a loss (CVX). Both companies also reported lower oil production than a year ago. For CVX the production totals would have increased, but higher prices triggered bigger production shares under some of their contracts outside the US. Both companies reported sizable increases in their exploration and capital budgets; XOM spent $7 billion, up 38% from the same quarter last year; CVX spent $5 billion, up 15.5% from the same quarter last year.

On to DRC. They supply rotating machinery used in the upstream, mid-stream (pipeline) and downstream segments of the oil and gas industry. DRC reported earnings on 30 July. Earnings handily beat analysts expectations and were up over 50% from the same quarter last year when adjusted for some one-time charges in 2007. Revenue grew and beat expectations and the backlog increased by 29% over the past year to more than $2 billion; that's nearly two-thirds of the market cap.

And finally, GHM. GHM supplies heat exchangers, ejectors and other big, heavy stuff to refineries, petrochemical, and process industries. This one is primarily a lesson to CEOs on how to increase a company's share price. Over the course of a little more than one day you:
· Report 38% year-over-year sales growth
· Report earnings that more than doubled year-over-year
· Raise gross margin predictions for the year
· Increase your dividend by 33%
· Announce a stock split

Result? Stock hits a new all-time high with a one-day 15% gain.

Conclusions: Even though the big integrated oil companies are trading at very attractive PE valuations, higher oil prices aren't helping them as much as you might expect. With high prices reducing US gasoline demand, the high crude prices are killing their downstream. XOM and CVX will continue to turn in big profits, but declining production volume along with weak refining business will make it tough for them to beat analyst estimates. I own CVX and don't plan on selling yet; I also don't plan on buying any more here. I did add some to my M* portfolio over the past couple weeks and will trim that back on any strength. No position in XOM.

On the other hand, suppliers to the oil and gas industry are benefiting from those big increases in capital and exploration budgets. It looks like oil companies will struggle to increase, or even maintain, production volume. That means strong business for equipment suppliers, drillers and other oil services. Pick your stocks or you can buy the Oil Services ETF (OIH).

Of the stocks mentioned, I think DRC is the most attractive. It was hammered over the past several weeks and then jumped after the earnings report. It still looks cheap on forward earnings, particularly with the big backlog. For those who think alternative energy will cripple the business; the production processes for most of those fuels still require pumps and compressors. During the conference call, the CEO fielded a few questions and provided some information on carbon sequestration and compressed air stored energy projects DRC is involved in, both of those stand to grow as the focus on green energy increases. I own some DRC and believe it's a good buy under $40 per share.

GHM has been shooting the lights out quarter after quarter for at least a year now, but it's getting expensive (and it may just keep on getting more expensive). I sold a little over half my position (too early) and will hang on to the remaining 'trophy shares' as long as the company keeps performing. No plans to add unless it has a big correction.

Comments: View Comments |  Wednesday August 6, 2008  |  Stocks: , , , , ,

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