Monthly Archives: March 2011

No one wants to buy Barnes and Noble?

March 25, 2011 By in Books, e-readers, Industry Analysis, Publishing, Retail Tags: , , , , , Leave a comment

That’s what the Bloomberg news service said the other day, citing interviews with five (count ’em, five) unnamed sources knowledgeable about the auction of the company that’s now underway.  It appears potential buyers–at least seven, according to Bloomberg–have all lost interest as they have had an opportunity to study the company and its financials more deeply.

What could be their concerns?

Well, for one thing, BKS is a big-box retailer with a lot of real estate under lease that it has to pay for.  And big-box retailers are all trying to shed floor space as fast as they can.   They are suddenly realizing that this floor space has been rendered much less valuable by the rapid growth of online sales.

For another, BKS sells books, a merchandise category that is showing little, if any, growth.  In fact, the company most similar to BKS, Borders, has just gone into bankruptcy, illustrating the parlous state of the industry.  Potentially more relevant, Chapter 11 will likely allow Borders to free itself of many financial burdens and to streamline operations very quickly, presumably turning it into a much more formidable competitor as it reemerges from bankruptcy.

Finally, BKS is a force in internet sales, both of physical books and of e-volumes readable on the firm’s proprietary e-reader, the Nook.  While this puts BKS in a strong competitive position vs. Borders (which has neither kind of online presence), it also puts the company directly into the sights of two larger, much better capitalized, aggressive digital competitors in AMZN and AAPL.

That’s not good.

For one thing, a recent survey by the Boston Consulting Group suggests that, although digital is the future of publishing, most people want to buy tablets, not e-readers.  Score one for AAPL.  For another, the accord that the publishing industry forced on AMZN about a year ago compelled the e-tailing giant to stop competing on price in the digital book industry.  That didn’t mean competition in digital books ceased, as I think the publishers thought.  It just meant AMZN had to shift the focue of competition to another arena, namely, the price/performance of the e-reader.  At the moment, BKS’ color Nook may be in the lead.  But AMZN has much more R&D money to toss around than BKS.  Score one for AMZN.

Given my description, why would anyone even consider bidding for BKS?  A growth investor like me wouldn’t, even though I was a very big holder of BKS fifteen years or so ago.  But deep value investors are another breed entirely, with a very different–and somewhat counterintuitive–investment philosophy.

I look for healthy companies where I think the consensus has seriously underestimated their growth rate.  Deep value investors, on the other hand, look for mediocre companies, or worse, where they think the consensus has seriously overreacted to the bad news that’s in plain sight.  They hope to find assets worth 100 that they can buy for 30 and sell for, say, 60.  This is a tough business, where you’ve got to be very sharp to survive.  But it’s also one where the chance to acquire a company fitting my description above would have such investors rubbing their hands in anticipation.

To my mind, the surprise isn’t that value investors have started to investigate.  It’s that they’ve apparently all lost interest.  This implies they’ve found something in doing their due diligence that wouldn’t be obvious from the SEC filings and that makes them think the situation is riskier than they had imagined it would be.

What would such a risk be?  In my experience, deep value investors are most comfortable with mature businesses.  They tend to like basic industries (like cement or pulp and paper) and simple manufacturing, where the world changes slowly.  They also tend not to like, or to do well with, technology.

So I think their new-found worries come in the digital side of BKS …that once they peeked under the hood they concluded that BKS is in a more fragile condition there than they had estimated.  My guess is that the bone of contention is the cost/market position of the Nook, not the state of actual e-book sales.  The auction is supposed to be over in a couple of weeks.  We may learn more then.

I’ve updated Current Market Tactics

March 24, 2011 By in Analyzing performance, Current Market Thoughts, Fixing mistakes, Portfolio management, Technical Analysis, Trading, Why measure performance? Tags: , , , , , , , , , , , Leave a comment

I’ve just updated Current Market Tactics.   If you’re on the blog, you can also click the tab at the top of the page.

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more on the Tokyo Electric Power nuclear plants in Fukushima

March 23, 2011 By in Asian economic development, Current Market Thoughts, economics, Japanese development Tags: , , , , , , , Leave a comment

In my post on March 15th, I suggested that as the story of the failure of the Tokyo Electric Power (TEPCO) nuclear plants in Fukushima unfolds, there was a good chance we would find out that faulty construction or substandard maintenance, deliberately disguised from public view, would be revealed.  I didn’t expect, however, that it would happen so quickly.

Yesterday’s New York Times contains an article titled “Japan Extended Reactor’s Life, Despite Warnings.” It makes the following points:

1.  The #1 TEPCO reactor at Fukushima had reached the end of its useful life (it’s a GE plant that was installed in 1971), but was approved by government regulators last month for another ten years of operation.  This was done despite design deficiencies that have been corrected in later models and worries about the backup diesel power generators.

2.  Shortly after regulators granted the extension, TEPCO said it had failed to properly inspect the cooling systems at all of the six Fukushima reactors.

3.  At the same time as they were approving the extension, regulators were criticizing TEPCO’s failure to properly inspect or maintain all the reactors.

4.  In a 2003 scandal, it came out that TEPCO had falsified reactor safety inspection reports over a sixteen year period in order to avoid spending money on repairs.

5.  The article suggests, correctly, in my view, that the failure to enforce regulations stems in part from the Japanese practice of amakudari, meaning “descent from heaven.”  Jobs in the Japanese government bureaucracy offer very high prestige but relatively low pay.  Customarily, at the end of long careers, senior bureaucrats “descend” to high-paying positions in one of the companies whose industry they formerly regulated.  In the case of utilities, the best of such jobs wold be with TEPCO.

Since a job with TEPCO may well be your future “pension plan,” a regulator has got to be conflicted about how strictly to enforce the rules.  Also, it may be difficult to refuse the request of your former boss–who has retired to be come in effect a lobbyist for TEPCO–when he asks for a lenient interpretation of a regulation.

I’m sure this won’t be the last we’ll hear on this topic.

TIF: 4Q10, Japan, fiscal 2011 earnings outlook

March 22, 2011 By in China, Current Market Thoughts, earnings conference calls, Hong Kong, Industry Analysis, Japanese development, Luxury goods, Retail, Stock ideas Tags: , , , , , , , Leave a comment

the results

TIF reported fiscal 4Q10 (ended Jan 31, 2011) earnings before the market opening in New York yesterday.  Profits came in at $1.44 per diluted share, ex non-recurring items.  This compared favorably with analysts’ estimates of $1.39.

Full year results were $2.93.  That was better than the range of $2.83-$2.88 the company had guided to when it announced 2010 holiday sales in January.  Actuals were also almost 20% ahead of the range of $2.45-$2.50, that TIF management’s initial guidance for fiscal 2010, issued a year ago.

company guidance for 2011

On the earnings call, the company gave its first indication of prospects for fiscal 2011, a year in which TIF again expects significant growth.  Prior to the earthquake in Japan, a country that accounted for 18% of sales in 2010, TIF was planning to guide to eps of $3.35-$3.45 on sales growth of 15%-19%.

For the current quarter, 1Q11, the company had expected eps of $.62 per share, on flat sales in Japan. It is estimating that the negative effects of the earthquake on its business will mean a year on year decline of overall Japanese sales of 15% for the quarter–and a reduction of total corporate eps by $.05.  Given that its stores in northern Japan were closed last week and only opened this past weekend, TIF has only very limited information to project from.  As a result, it is, for the moment at least, retaining its pre-earthquake assumption of same store sales for the remainder of the year as being flat with 2010.

Analysts have penciled in $.55 for the April quarter.  Estimates range from $3.10 to $3.43 (a stupidly over-precise number, in my view) for the full fiscal year.

Japan

For decades Japan was the El Dorado of luxury goods markets.   Intense consumption of luxury goods by half the population and the willingness of buyers to pay prices 20%-40% higher than makers could change in their home markets are the reasons why.  Sales suddenly stopped in their tracks as recession hit in 2008, however–and haven’t bounced back.   Everyone has theories; no one knows for sure why. But this appears to be a permanent change in the market.

As a result, the game in Japan has changed for Western luxury goods manufacturers from one of aggressive expansion to one of maximizing profits and extracting capital if possible.  In today’s Japanese market the negative effects of the earthquake may require a temporary change in emphasis but not a change in (a very defensive) strategy.

TIF’s business in Japan can be divided into general areas:  Kanto (the Tokyo area) and points north; and the Kansai region around Osaka, farther south.  The former, which accounts for maybe 60% of TIF’s Japanese business, has been affected by the earthquake; the latter has not.

How should we interpret TIF’s forecast of a 15% decline in Japanese sales for 1Q11?  Let’s assume that the falloff comes completely from the north.  TIF says that Japan had been comping positive during the quarter until the earthquake.  Say that’s half the quarter.  For sales to be down by 15% for the entire quarter, sales have got to be down 30% for the second half of the period.  If that comes solely from Kanto and Tohoku, their sales must be down by 30%/.6 = 50%.  This strikes me as an excessively gloomy estimate.

This drastic falloff clips $.05 per share from earnings, according to TIF.  We’ll see whether down 15% is an accurate estimate or not.  But no matter what, TIF understands its own internal profit dynamics much better than anyone on the outside. So the relationship:  down 15% in sales = down $.05/share, is probably a very reliable one.

If conditions in Japan remain depressed for the remainder of fiscal 2011, TIF’s earnings will be $.35 lower than the company envisioned before the earthquake struck.  It’s possible in a very faddish place like Japan that a sympathetic abstinence from luxury goods spending affects everyone in northern Japan–whether touched by the earthquake or not–and lasts for a year. (In the early 1990s, for example, it was chic to be poor.  So bars that offered cow intestines (tripe) to eat sprouted up, enjoyed a year of success and just as quickly disappeared).  Anywhere else, that would be much too pessimistic.  I’d be tempted to have the sales figures fade back to normal (meaning same store sales growth of zero) in a linear fashion through yearend instead.  If so, the hit to fiscal 2011 eps would be around $.20.

factoring Japan into the TIF price

Whether the right number is $.40 or $.20 or $.60, the more important question is how an investor should factor this into the TIF stock price.  It seems to me that if the earnings loss from Japan is truly a one-time event, the proper way to account for it is to subtract $.40, or $.20, or $.60 from the stock price.  Knocking $8 off the share quote, which is what the Wall Street reaction has been, is in effect assuming that TIF’s business in Japan is permanently impaired and the lower earnings level will be a fact of life from now on.

I think that’s just wrong.

the rest of TIF’s business is booming

Asia ex Japan and Europe, which together make up about 30% of TIF’s sales, will likely be up by 25% or so.

Sales to distributors for Russia and the Middle East will probably be higher than that.

The US, which in all likelihood will be less than half of the company’s total for the first time ever, will rise by 10% or so.

The only sign of weakness in the world ex Japan is in lower-priced (under $500) items in the US.  For “macroeconomic” reasons, sales of silver jewelry are barely increasing.  I think this means that affluent customers who had traded down to silver during the recession have traded back up to higher-priced items.  (In fact, sales of diamonds–and especially TIF’s newly-introduced line of yellow diamonds–are very strong, as are fine and fashion gold.)  Less affluent customers, in contrast, reined in their silver purchases during the downturn and have not yet resumed buying at their normal rate.

the stock

TIF management is guiding to earnings of around $3.40 for this year, ex the Japan earthquake effect.  That’s probably too conservative.  Let’s say that $3.75 is a more realistic guess.  The negative effect of the Japan earthquake may have taken away that upside. But if the loss of Japanese business is indeed temporary, 2012 earnings per share growth is likely to be enormous–organic growth + Japan bounceback.  EPS is likely to be in the $4.50 range.

If we apply a 20x multiple to the $3.40 number for 2011, we arrive at a target price of $68 for this year.  If we apply 25x, which is arguably more appropriate for a global firm growing as quickly and steadily as TIF, we get $85.  At the current price of around $60, the multiple the market is assigning is 17.5x.

If we were to look out a year, a 20x multiple on $4.50 would be $90.

What do these calculations mean?  I interpret them as saying that in the current price the market is assuming the worst probable outcome for sales in Japan this year (the reality might be worse, but I don’t think the chances of that happening are high).  The market seems to also be saying that TIF’s Japanese franchise is permanently impaired.

This says to me that TIF’s stock has limited downside.  And, it’s possible that TIF could be trading as much as 50% higher a year from now, assuming a reasonable overall stock market and that business in Japan bounces back to its pre-earthquake level by 2012.

musings on 2012

March 21, 2011 By in Current Market Thoughts, Inventory Cycle, Recent Market Action, Strategy Tags: , , , , , , , , , , Leave a comment

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2012?!?

Yes, you’re reading the year correctly–2012.

Why so soon?  Two reasons:

First, stock markets around the world seem to me to be laser-focused on the here-and-now.  As a general rule, any successful investor has to have a perverse streak–the fact that everyone is doing one thing is prima facie a reason to set out in a different direction.  Besides, focusing exclusively on today and tomorrow is playing the day traders’ game.  Great for passing the day, great for your broker–bad for your portfolio.  The edge, if there is any (the evidence is that day traders in the aggregate lose money), in this game is with the guy who has the most advanced trading software or the itchiest trigger finger or, in today’s world, is co-located with the marketmaker.

That’s not me.  I don’t think it should be you either.  We should be working smarter, not harder.

2.  Some people are beginning to argue that what we are now experiencing is not a simple correction in an ongoing bull market, but rather the first signs of a fundamental change in the direction of the market to the downside.

Their argument starts with two suppositions:

–turmoil in the Middle East will intensify, resulting in significantly higher oil prices.  This, in turn, will create a substantial headwind to world economic growth;

–the earthquake/tsunami/ nuclear power plant disaster in Japan will tip that country into recession (it wouldn’t take much, since Japan is barely growing). That, by itself, will have a negative effect on world growth.   In addition, supply chain disruption caused by damage to manufacturing plants in Japan will create added problems for industry internationally.

Together, the argument goes, these two forces are enough to cause a fragile world economy to slide back into recession.  Down world economy implies down world markets.

Could this be right?

my thoughts

it’s normally too soon to be worried…

Typically, the market begins to turn to earnings prospects for the following year in June or July of the current one.  Until summer, the market usually concentrates on the details of this year’s profit performance and doesn’t worry much about anything farther into the future.

…but these aren’t normal times…

2010, of course, was by no means normal.  Last year, investors refused to look any more than a month or two ahead until September or October.  Only when the positive evidence from corporate earnings reports became overwhelming did the market grudgingly begin to concede the possibility that 2011 might be an up year for company profits.

Once stocks began to move up, however, they didn’t stop until they had discounted everything positive that might happen in 2011.  Very unusual behavior, but the reason I had been expecting a correction.  It’s just too soon, for any market–but especially for one that has been so skittish, to begin to discount possible 2012 earnings gains.

The bears might cheerfully concede that that’s how the downturn began a month ago.  But, they would claim, the Middle East + Japan have turned a correction into something fundamentally different.

…so maybe a long glance ahead makes some sense

Another factor to consider:  we’ve just passed the second anniversary of the start of the bull market.  This is just an early warning indicator of the maturity of the advance. Some bull markets, like the one that began in 1992, have lasted far longer than two or three years.  But we can’t rule out the possibility of a market downturn in the easy way we could have in 2010.

So, contrary to the way things usually, maybe–just to be safe–it makes sense to take a guess at what 2012 might be like.

my yearend 2010 view

My base case for 2011 made at the end of last year:

–earnings of $100 for the S&P 500, which might be a little aggressive,

–a multiple of 14x, maybe 15x if we’re lucky,

= an index target of 1400-1500 for the S&P.

a rough guess for 1012?:

–eps growth of 10%-15%, as economies gradually return to normal and short-term interest rates begin to rise,

–a multiple of 13x-14x on those earnings,

= a target of 1430-1610 on the S&P.

If those guesses were anywhere near the mark, it would imply that 1012 would be an up year, but with the market rising less than 10%.

what’s changed since then?

How do Japan and the Middle East change these figures?  I don’t feel comfortable putting down precise numbers for either.  But I think it’s safe to say that the entire negative effect, both in Japan and elsewhere, of the earthquake will occur in 2011.  This means 2012 will benefit not only from the absence (we hope) of a comparable negative event, but also from the positive stimulus coming from reconstruction efforts around Sendai,.

Similarly, the negative effect of higher oil prices, provided they stay within a reasonable distance of the present level, will be felt throughout most of 2011.  Absent comparable increases again in 2012, the negative effects will fall out of year over year comparisons by next March.

Consumer pain will be felt most intensely in the US, where low energy taxes mean that the percentage increase in prices will be larger than elsewhere and where consumers use mind-boggling amounts of petroleum products.  But, on the other hand, the US consumer is showing surprising strength, and is in the best position today to withstand the negative effect of more expensive oil.

my conclusion

I find that these thoughts are pushing me toward a conclusion that’s different from what I’d expected. Japan may clip a percent or so off S&P 500 earnings growth this year, but will add a similar amount next.  Higher oil prices may shave another, say, 2%, from S&P earnings growth in 2011 but have little effect on the 2012 tally.

In other words, the Middle East and Japan will end up making the growth rate of 2012 earnings over 2011 results higher than it otherwise would have been.  An S&P level above 1400 may therefore prove hard to surpass in 2011, but one of 1550–a 10% gain–looks easier to achieve in 2012.  By slowing down and stretching out the pace of economic recovery, Japan and the Middle East may make it more probable that the rebound stretches well into 2012.