On Wed morning, McDonald's (MCD) reported per share earnings of $1.05, enough for something off the Dollar Menu with change back. Analysts were expecting $0.98. For the first nine months of 2008, MCD has earned $2.89 per share putting them on track to exceed analysts' full year 2008 estimates.

Comparable sales and operating income were up in all global regions even after adjusting European and Asia, Pacific, Middle East and Africa sales for currency exchange rates.

In the press release, CEO Jim Skinner stated, "... October sales trends remain strong and I am optimistic about McDonald's outlook."

During the conference call, Mr. Skinner indicated the specialty coffee program is on track in the US, stating, "about 3,800 restaurants are serving McCafe coffees and we expect to begin introducing the rest of our combined beverage business products, smoothies, frappes, and bottled drinks in mid-2009." There had been some reports of franchises having difficulty obtaining financing for the modifications, but the company says financing has been available.

For the value minded, it sounded like the Dollar Menu will stay, although there may be some minor changes to keep it profitable.

In Europe, comparable sales increased 8.2% in spite of, or maybe because of, a weak economy. McDonald's will be adding more extended hours for their European stores. Extended hours comparable sales are growing faster than other parts of the day.

Asia, Pacific, Middle East and Africa comparable sales were up 7.8% in the quarter. The company is focusing on breakfast sales here. In China, breakfast accounts for only 7% of sales compared with 20% in Hong Kong and Singapore. The Japanese equivalent of the Dollar Menu, the 100 Yen Menu, is helping drive traffic and sales in Japan.

Despite higher commodity costs, margins expanded in Europe and Asia, Pacific, Middle East, and Africa. US margins decreased slightly, attributed to higher commodity costs. For the full year in the US, McDonald's expects the 'grocery bill' inflation to be 7%.

Regarding credit, CFO Peter Bensen stated, "Our $1.3 billion revolving line of credit has sufficient term remaining and is unused and we secured attractive long-term financing in the first quarter to prefund debt that was retired in the third quarter and we have no additional significant maturities until late 2009."

Currency translation had been a net positive for MCD, but with the strengthening dollar it is expected to be negative for the 4th quarter. However, Mr. Bensen noted that the strengthening dollar has had a partially offsetting positive impact with lower oil and commodity prices.

In summary, MCD is growing revenues and earnings in a tough economy and they're doing it in around the world. The company has beat analysts' earnings estimates each of the last four quarters. The dividend was recently raised to $0.50 per share per quarter, yielding 3.77% based on Friday's close. For reference, that's a higher rate than a 10-year Treasury.

Over the past three months, the stock has traded as high as $67 per share and as low as $45.79. Friday's close of $53.06 is a little below the mid-point of that range.

This is one of the stocks I've been nibbling at lately. It's a tough market, but for those who want to put some money to work, MCD is worth a look.

All earnings call quotes from the transcript at Seeking Alpha.

Comments: View Comments |  Saturday October 25, 2008  |  Stocks: MCD,

Wells Fargo (WFC) reported 3rd Quarter 2008 results today in a press release and recorded message. The bank reported earnings of $0.49 a share, ahead of analyst expectations but 23% lower than a year ago and 7.5% lower than the previous quarter. The results included a 13 cent per share write down for investments in FNM, FRE and LEH and 10 cents per share going toward increased loan loss reserves. If the impact from the non-recurring security losses is excluded, earnings were only 2 cents per share below the same quarter last year.

$2.5 billion was applied to credit loss provisions against $2 billion of loan write-offs. Total loan loss provisions increased by $500 million to $8 billion or 1.95% of total loans.

Tier 1 capital increased from the previous quarter to 8.58%. The $25 billion of preferred stock that will be issued to the US Treasury will increase the Tier 1 capital ratio by nearly 0.5%.

Loan charge-off rates were mixed news. Consumer loans drove the loan losses, but after correcting for the change in charge-off policy from 120 to 180 days from the 2nd quarter, charge-off rate growth has moderated. Home equity loans are the primary loss driver. Commercial loan losses were down slightly from the 2nd quarter.

In loans 90 days or more past due but still accruing, the opposite was true. Both consumer and commercial past due loans increased, but the percentage jump in commercial loans was larger than for consumer.

A piece of good news for WFC is a substantial increase in deposits. CFO Howard Atkins stated, "Core deposits reached a record $334 billion at quarter end, up 10 percent from a year ago. Inflows of checking and interest bearing deposits accelerated sharply as the quarter progressed, across all customer segments - consumer, wealth management, middle market, large corporate and correspondent banking customers all contributed to the strong deposit inflows and increases in net new deposit accounts." The increase spiked later in the quarter, roughly coinciding with a flight to quality as bank failures made the headlines.

The merger with Wachovia is expected to close by the end of 2008. The acquisition is expected to be accretive to earnings in the first year excluding integration costs, write-downs, transaction charges and credit reserve build. The deal should be accretive to earnings by the third year without any adjustments. WFC is still planning on proceeding with the $20 billion capital raise announced in conjunction with the acquisition announcement.

The earnings report is a mix of good and bad. Continued deterioration in the loan portfolio is troubling. The ability to increase loss reserves faster than recording write-downs while still earning enough to easily cover the dividend is a positive. Troubles in the banking sector appear to be driving deposit growth and new customers for WFC, a definite positive. And, regardless of the political ramifications, WFC should be able to leverage the $25 billion of relatively cheap government capital into earnings going forward.

JP Morgan (JPM) also reported a small profit this morning, beating analyst's estimates. But, for an investor looking for one of the big 5 4 banks that has consistently earned more than enough to cover the dividend payout through the credit crisis, WFC is the only one left.

The stock price has held up very well over the big sell off the past few weeks. With all the market volatility we've seen, I suspect a patient investor may be able to pick up shares under $30. WFC can also be effectively purchased at a discount by paying attention to the arb spread and buying WB for those willing to accept the risk of the deal falling apart. WB at today's close converts to $30.43 for WFC, an 8.7% discount.

Comments: View Comments |  Wednesday October 15, 2008  |  Stocks: wfc,

Treasury Sec. Paulson's initial plan to buy troubled assets from banks has morphed in to an equity injection. The initial $250 billion TARP funding will be used to purchase preferred equity in banks with half of it going to nine of the largest banks in the country.

For this post, I'm going to try to set aside my opinion of the gov't plan and take a closer look at what it means for investors in the companies that will participate in the program.

First, how is the program going to work? I like to get source documents when possible since the media can be less than reliable. Treasury has issued an announcement and a public term sheet outlining the plan details.

Summarizing:

- Treasury may purchase senior preferred stock in qualifying banks (basically US based institutions). Maximum purchase amount is lesser of $25 billion or 3% of risk weighted assets.

- Banks must apply by 14 Nov and deals are expected to be completed by the end of 2008.

- The preferred pays a 5% dividend for the first 5 years and then jumps to 9%.

- The issuing bank can buy the preferred back after three years. They can buy it back earlier provided they raise at least 25% of the amount sold to Treasury in an offering of common or preferred.

- Preferred dividends must be paid before the bank can pay dividends on the common.

- The bank has to get permission from Treasury to raise the dividend or repurchase shares for three years, unless they've bought the preferred back from Treasury.

- Executive compensation restrictions.

- Warrants get issued with the preferred in an amount equal to 15% of the preferred sale. Strike price and valuation for determining the 15% are based on a 20-day trailing average from the date of agreement. The bank can buy the warrants back at fair market value if they've bought the preferred back. The number of warrants can be reduced by raising capital.

- The preferred stock doesn't give the government any voting rights or board representation. If the bank falls behind on the dividend payments, the gov't is entitled to board seats.

That's about as de-gibberished as I can make it.

From news reports I've read, there will be nine banks participating initially with the program being opened to smaller institutions soon. The participating banks and reported amounts are: $25 billion each - JP Morgan (JPM), Citigroup (C), Wells Fargo (WFC), and Bank of American (BAC) combined with Merrill Lynch (MER). $10 billion each - Goldman Sachs (GS) and Morgan Stanley (MS). $2-3 billion each - State Street (STT) and Bank of New York Mellon (BK). The Treasury statement indicates all participation is voluntary, but early news reports indicated some of the banks were pressured into agreeing. These nine banks get about half the initial $250 billion, leaving another $125 billion for the smaller banks.

In addition to the preferred stock purchases, the gov't will be guaranteeing bank debt and expanding deposit insurance coverage through the FDIC.

To help make sense out of this, I walked it through with WFC. That's a good choice because they had announced they were going to raise capital in conjunction with the Wachovia acquisition and because I'm a shareholder.

The $25 billion of preferred is pretty simple; WFC gets $25 billion of new Tier 1 capital at a cost of 5% or $1.25 billion per year. Tier 1 means they can leverage it up by about 10 to 1 if they want. The 5% preferred dividend is lot better deal than the 10% GE and GS had to pay Berkshire Hathaway (BRK) and I don't think WFC should have much trouble earning better than 5% on this new capital. Current return on equity is running a little over 15%. 9% is a much tougher threshold if they can't buy it back before the rate jumps in five years.

WFC also needs to issue warrants. 15% of the $25 billion is $3.75 billion. Counting back from today the 20-day trailing average comes to $33.98 per share. That would be a little over 110 million new shares or about 3.3% dilution. But, exercising the warrants would bring in the additional $3.75 billion of fresh capital.

Overall, this looks pretty good for WFC. I haven't seen any news releases, but expect they'll try to go ahead with the capital raise planned as part of the Wachovia deal to get the option to buy the preferred back. However, the gov't money will probably set a ceiling for the terms of any new offering and they may not be in any hurry to buy the Treasury preferred back. It will be interesting to see if that offering goes forward, how it's structured, how much they raise, and whether or not they buy back the gov't preferred. The current dividend yield on WFC common is just under 5%, so the only real advantage to bringing in private money is to take some of the warrants out. If they raised $25 billion, half the warrants come back.

The biggest downside to shareholders I see is possible limits on dividend increases or share buybacks. We're at the mercy of gov't regulators there and have to hope WFC management can make a good case if business conditions warrant a dividend hike or buyback program. Or just do a capital raise for a little over $6 billion and buy the preferred back from Treasury.

Treasury could have pushed for higher rates and better terms on the warrants, but that would have made subsequent capital raises more challenging and might have done more harm than good in getting capital into the credit markets. It also would have discouraged the stronger banks from playing. As it is, the gov't is borrowing 5-year money at 2.5 - 3% and earning 5% plus upside potential on the warrants. Not great, but probably a better deal for the taxpayer than paying a premium for mortgage paper and hoping it goes up in value.

Comments: View Comments |  Tuesday October 14, 2008  |  Stocks: wfc,

On Friday, GE reported their FY 2008 3rd Quarter Earnings. Links for the press release, conference call transcript and presentation. GE's diverse business model makes their earnings report a useful bellwether for the overall economy. Finance, traditional and alternative energy, media, transportation, aviation, military, medical equipment, water treatment - GE does a bit of everything and their earnings report should be a very good indication of what's working and what's not.

On 25 September, GE released lower earnings guidance. They followed that on 1 October with an announced capital raise issuing $3 billion of preferred stock and warrants for $3 billion of common stock exercisable at $22.25 to Berkshire Hathaway along with a $12 billion public common stock offering priced at $22.25. The preferred stock issued to Berkshire Hathaway pays 10% and is redeemable after three years at a 10% premium.

As a shareholder, I was hoping GE would shed some light on why they felt they needed to raise capital. They did explain the reasons behind it, but not why they did it in a placement with BRK rather than a rights offering or other approach. SVP, Vice Chairman and CFO Keith Sherin stated, "We had a liquidity plan that said we were going to get our bank lines plus our cash equal to our CP [commercial paper] by the end of the year. After our earnings call last week -- or the preannouncement, we said that may not be fast enough and we went right to work on -- well, how do you accelerate that? That's why we did the equity offering. We have accelerated today our bank lines plus our committed cash are greater than our CP." Essentially, GE bought an insurance policy against a credit market lock-up. A prudent move even if it was an expensive insurance policy.

Given all the talk about credit markets tightening, I thought this statement by Mr. Sherin was very interesting, "...the debt markets have been volatile, but we are still funding ourselves without any issues. If you look at CP, in fourth quarter '07 the average cost of our commercial paper program where we had higher balances was about 5%. In the third quarter of '08 the average cost was 2.5%; and that is the same average cost for the last couple of weeks." According to this statement, GE is not only able to borrow in the commercial paper market, they're doing it at a lower cost than a year ago. Make your own conclusions about the severity of the credit crisis we keep hearing so much about.

GE has reduced outstanding CP to $88 billion and plans to reduce it below $80 billion by the end of the year. With the recent capital raise, cash plus bank lines exceed outstanding commercial paper. They're also investigating the recent Federal Reserve announcement of a commercial paper facility as an additional back-up funding source.

The knock on GE has been fears about the financial side of the business. During the 25 Sep guidance release, GE indicated they expected to earn about $2 billion from financial services and GE met that lowered target.

The presentation provides some additional color on the assets behind GE Capital Finance. There are $413 billion of commercial assets and $209 billion of consumer assets with broad diversification across type of asset and geography. 59% of commercial and 79% of consumer assets are outside the US. There are no SIVs, CDOs or CDS exposure on the books. Delinquencies and non-earning assets are up and do not appear to be leveling off. However, GE has been increasing loss provisions faster than write-offs for four consecutive quarters. There were $451 million of loan losses this quarter and $762 million was added to loss reserves. From the transcript, it sounded like total loss provisions are expected to be $6.6 billion by the end of the year, but the statement wasn't clear.

GE includes a chart of historical loan losses in the earnings call presentation. The estimated loss for 2008 is 1.2%. The highest loss rate shown was during the 1990 - 91 recession at 2.0%. GE believes they have a higher quality, more diversified loan portfolio than they did in '90-'91 and that they won't see that level of losses this time. It would have been interesting to see the chart run back to the late 1970's. GE lists a globally oriented portfolio, smaller average loan size, and a 70% average loan to value on real estate as some of the advantages today's portfolio has over '90-'91.

Outside of the finance business, things look pretty good. Energy infrastructure (energy, oil/gas) had a 32% increase in revenue and 31% increase in profit compared to the year ago quarter. Technology infrastructure (aviation, healthcare, transportation) had revenues up 9%, profit up 2%. NBC Universal revenues were up 35%, profits up 10% largely on strong results from Olympics coverage.

Summary/Opinions

The advantage of GE's diversified business model is that something will always be working. The disadvantage is that something will always be struggling. Even with the weakness in the financial business, it still accounted for nearly 45% of GE profits this quarter. The quarterly earnings of 45 cents per share don't leave a lot of cushion to cover the 31 cent quarterly dividend. Management was confident the dividend was safe, but we've heard that from other companies before.

The $3 billion of preferred stock sold to BRK represents a $300 million or 3 cent per share annual expense GE didn't have before. Since the new capital is intended to raise cash for defense against a tight commercial paper market, there won't be any new income associated with that money. Similarly, $12 billion of new shares will also be entitled to dividend payments that will total $670 million per year at the current rate.

Mr. Buffet's warrants and the new offering put a smart money price of $22.25 on GE shares. Investors interested in adding GE should look for a significant discount to that price to make buys.

TARP and the new Fed commercial paper facility may offer some advantages to GE going forward, but there's no way to quantify that possibility.

I believe shareholders would have been better off with a dividend cut to preserve capital over the preferred issue to BRK. Cutting the dividend from .31 to .23 per quarter would have saved more than the $3 billion over the course of one year. A one-quarter dividend suspension would also have saved more than $3 billion. In either case, shareholders would have taken a short term hit to income, but wouldn't be saddled with the annual bleed from the preferred.

The company is taking prudent steps to maintain a high credit rating and protect against tight credit markets. But further weakness in their loan portfolios or a fall off in the industrial businesses would make it very difficult to maintain the dividend.

As a shareholder, I feel like it's too late to sell and too early to buy more. If the price jumps much above the $22.25 smart money target, I'll probably lighten up and look to buy back at a lower price. A drop below $18 would be low enough to look attractive even with a possible dividend cut. Those buying GE today will probably be happy five years from now. Those who wait for a better price or average in will be even happier.

Anyone buying because Warren Buffet bought needs to recognize they aren't getting the same deal Warren was able to negotiate. If Berkshire has any regrets and would like to sell a slice of that preferred with warrants at cost, let me know.

Questions I wish analysts had asked:
Why did you do the placement with BRK over other capital raising alternatives?
What other options did you consider?
How much is currently set aside for loan loss reserves?
You list a 70% average loan to value for your real estate loan portfolio. Is that based on values at origination or current values?

I'll shoot an e-mail to investor relations and share the answer when I get it.

Comments: View Comments |  Sunday October 12, 2008  |  Stocks: ge,

Yesterday I heard someone on a CNBC show mention that the yield on the Dow Jones Industrial Average was higher than 10-year treasuries. Decided to check and it's true. At today's closing, a portfolio equally weighted across the thirty DJIA stocks would have a dividend yield of 3.77% compared to the 10-year at 3.63%. I used the dividends for the DJIA stocks as reported on Yahoo, except the payout for Bank of America (BAC) was adjusted to account for their recent announcement halving the dividend.

The individual dividend yields range from a high of 8.89% for Citigroup (C) to a low of 0.8% for Hewlett Packard (HPQ). Thirteen of the thirty stocks have higher yields than the 10-year. Some of those high yielders are in troubled industries or may have difficulty maintaining the payout. However, a number of the stocks topping the payout for 10-year treasuries aren't in the financial business, are profitable and have solid businesses. Examples include McDonalds (MCD), Kraft (KFT), Home Depot (HD), DuPont (DD), Alcoa (AA), and Merck (MRK). For those willing to venture into banks that have mostly stayed out of trouble, JP Morgan (JPM) tops the 10-year. Chevron (CVX), Caterpillar (CAT), 3M (MMM) and Intel (INTC) are within a quarter point of the 10-year. You may not agree with the 'solid business' comment for all these names, but the point is there are companies in a number of sectors with very attractive yields. Many of them have the wonderful habit of raising the dividend year after year after year.

I also did a quick scan of cash and debt levels for many of the DJIA 30. An investor who wants to protect against the risk of credit tightening has several DJIA companies to choose from that have more cash than debt. That insulates them from needing to tap the credit markets and in some cases they could extend credit to their customers if needed to keep operations moving. Names include HPQ, ExxonMobil (XOM), CVX, Microsoft (MSFT), MRK, and INTC. Johnson and Johnson (JNJ) just misses being net cash positive. I had expected MSFT to top the net cash rankings, but it was a distant second among the DJIA stocks to XOM. Note to XOM CEO Rex Tillerson - $30 billion net cash? Buy a company, raise the dividend, put some of that cash to work!

I suspect a number of factors other than tight credit markets are pulling the stock market lower. Business news reports have covered hedge funds selling to meet redemptions. Retail investors have probably been scared into redeeming mutual fund shares. Both of those scenarios force fund managers to sell regardless of the market price driving indexes lower and scaring more investors into redeeming. Many buyers are probably sitting on the sidelines waiting for some sign that the worst is over and for clarity about government interventions. I have no clue when the worst will be over, but there are some good bargains out there for income investors.

The Dow Jones is certainly not the only place to look for good dividend yields. They're out there and it's a good time to start looking at what Mr. Market has put out on the clearance aisle.

Disclosure: At time of posting, I'm long MCD and CVX, but have no position in any other company mentioned.

Comments: View Comments |  Wednesday October 8, 2008

In response to public concerns over the losses that taxpayer's may sustain under the Emergency Economic Stabilization Act, the government is pleased to announce a new financial instrument to protect the taxpayer.

Many financial experts have predicted the Federal Government will actually turn a profit purchasing distressed mortgage related securities and reselling them when markets have stabilized. However, many Americans are rightfully concerned about the risks inherent in purchasing these securities in a government-run program.

To help build confidence in the program and assure profitability, the Treasury, with the full support of Congressional leaders and the President, has decided to enter into profit insurance contracts modeled after popular credit default swaps.

These new financial instruments will be known as Responsible Insurance Policies On Federal Funds or RIP OFF.

Comments: View Comments |  Saturday October 4, 2008