Monthly Archives: February 2011

mouse-eared vacationers returning: DIS’s strong 1Q11 quarter (ended 1/1/11)

February 10, 2011 By in Current Market Thoughts, earnings conference calls, Entertainment, Industry Analysis, Lodging, Stock ideas Tags: , , , , , , , , , Leave a comment

the results

After the New York close on Wednesday February 8th , DIS reported results for its 1Q11.  Removing one-time items, earnings per share were $.68 vs.  $.47 in the year-ago quarter.  This is a 45% gain, year over year.   It handily surpassed Wall Street analysts’ estimates of $.56.  That’s why the stock was up sharply in otherwise lackluster trading on the following day.

the details

Media Networks:  operating income was $1.07 billion, up 47% year on year.  The main reason was, as usual, ESPN, fueled by booming demand for the NFL and college football.  On a like-for-like basis, ESPN’s ad revenue was up 27% year on year.  The current quarter looks to be at least as good.  “They’re just having a gangbuster revenue quarter right now and we believe that’s going to continue,” said DIS CEO Bob Iger in the earnings conference call.  Autos, retail, telcos and consumer electronics firms are all sources of advertising strength.

Studio Entertainment: operating income was up by 54% year on year, at $375 million.  Domestic DVD sales of Toy Story 3, early international release of TS3 and lower writeoffs of money-losing films (as DIS cleaned up after a since-departed management team) are the main reasons.

Consumer Products:  operating income was $312 million, a 28% increase over 1Q10 performance.  Sales of Toy Story merchandise and the inclusion of Marvel products are responsible.

Parks and resorts: This is the interesting one. Operating income was up 25% year over year, at $468 million, on a revenue gain of 8%.  The strong results come despite horrible weather–snow and extreme cold along the East Coast and in Florida, plus rain and flooding in southern California–that hurt (mostly local) patronage of both Disneyland and Disneyworld.

Normally there’s an inverse relationship between unit pricing and unit sales.  Raise prices and you sell fewer units.  You hope to end up with higher revenues and profits, but you expect to see the pricing/units tradeoff.

In the case of DIS, over the past year the company has been gradually removing the discounting it started during the recession to try to stimulate demand.  However, despite higher ticket pricing, domestic park attendance was up by 2% year on year and per guest spending was up by 8%.  Also, despite higher room rates, hotel occupancy was 85%, up 4% year on year.  Average room spending was up 4%, too.

In another sign of a recovering consumer, demand for Disney cruises is building, especially for the newly launched Disney Dream, which is almost 90% booked for the year.

We’re not back to normal yet.  Customers are booking late and are gravitating toward less pricey rooms.

As an investor, I look at this behavior as a good thing,  It means that there is still a lot to go for in terms of revenue growth in the parks and resorts business.  As this quarter’s results show, in a capital intensive business like this, even small increases in revenues will translate into large gains in operating profit.

my thoughts

I sold my DIS at around $40 within the past couple of weeks.  I used the proceeds to buy a couple of smaller mobile internet-related stocks (what can I tell you, I’m a very aggressive investor).  That’s me, however–not necessarily you.

On the plus side, DIS has strong top management, media networks are booming, the film side has had a number of spectacular successes, and the parks and resorts are in the early stages of a cyclical upturn that could go on for several years.

If all goes (even moderately) well, the company could earn, say, $2.75 per share for the year ending September 30th.  Applying a multiple of 16 to that figure yields a price of $44.  An 18 multiple, which I think is close to the high end of what’s possible, would yield a price of around $50.  It may also be that, if the stars are aligned correctly, eps comes in closer to $3 a share.  If so, the stock presumably goes higher still.

Also a plus, the company is not as well understood as I think it should be.  That’s partly due, I think, to the fact that it’s an entertainment conglomerate and therefore doesn’t fit neatly into Wall Street’s way of organizing research, by using industry specialists.  In addition, in the couple of times I’ve dealt with it, I’ve found the DIS investor relations department–whether by accident or by design–to be pretty useless.  That makes it harder to do the analysis you need to have confidence that an out-of-consensus earnings forecast could be correct.

On the other side of the ledger, while I’m a big Marvel fan, I’m not sure how successful Thor and Captain America are going to be–and they’ve got big (super-hero, in fact) boots to fill just to keep year to year film earnings comparisons positive.  Also, NFL or NBA labor problems that result in games not being played wouldn’t be good for ESPN.

When I started looking at DIS in the mid-$20 range about 18 months ago, I realized that the (bad old days of the) Eisner era had ended (except in the IR department) and that very few people realized this.  Since then, Bob Iger has been on magazine covers and lots of evidence of his work is there to see.  The stock has also gone up a lot. That has changed the risk/reward relationship.

At $40, I see 10%-20% upside in the near term and mildly market-beating performance after than.  Not a bad story.  But there is some uncertainty to ESPN, I think, and the bar has been set a lot higher for the movie business, creating risk here as well.  More importantly for me, I saw (admittedly, much more speculative) names where I thought the upside was much higher.

In the mid-$30s–assuming DIS ever were to get back there–I’d probably be a buyer again.

 

 

investor shift away from emerging equity markets is picking up steam

February 9, 2011 By in counter-trend movements, Current Market Thoughts, emerging markets, Portfolio management, Recent Market Action, Strategy Tags: , , , , , , , , Leave a comment

Recent reports from consultants like Cambridge, MA-based EPFR indicate that the large allocation shift  retail equity investors in developed countries have made in the past two years away from their home markets and toward emerging economies has begun to reverse itself.   From early January onward, individuals have been taking money out of emerging markets funds and plowing it into developed markets equities.

What does this mean?  What should we do, if anything, in response?

a look at the performance numbers

To put the current asset allocation shift into context, let’s take a look at three equity areas:

–the S&P 500, as representative of US large capitalization stocks,

–the MSCI EAFE (Europe, Australia and the Far East) index as a proxy for stocks in other developed markets, and

–the MSCI Emerging Markets index.

Just so I can get the numbers easily, I’m going to use the appropriate ETFs as proxies for the indices themselves.  All returns are in US$.  Here goes:

last 10 years

EM     +321%

EAFE     +96%

S&P     +53%

from March 2009 (the bear market bottom)

EM     +119%

S&P     +94%

EAFE     +77%

from Sept 2010

S&P     +23%

EAFE     +19%

EM     +12%

year to date

EAFE     +5.4%

S&P     +5.3%

EM     -2.2%

one month

EAFE     +7.0%

S&P     +4.2%

EM     -1.4%

What does this show us?

…several things:

–If we look at the last ten years,  US stocks have had only half the return that developed markets outside the US have enjoyed and 1/6th the performance of emerging markets equities.

–The asset allocation away from the US in 2009-2010 didn’t affect the relative performance of the S&P vs. emerging markets that much.  You have to remember that the earnings of publicly traded US companies have a healthy dose of emerging markets results in them.  Still, I think the resilience of the US in the face of investor neglect is remarkable.

–The relative performance of the S&P vs. EM begins last September.  In other words, it leads the asset allocation shift by four months.  I think this means investors are reacting to the relative performance numbers, not causing them.  That’s not so surprising.  It suggests, though, that such allocation shifts are lagging indicators, not leading ones.

flows can have asymmetrical effects

Sorry about the less-than-clear title.

There’s a wide and deep pool of investors in many developed countries.  Residents are wealthy enough to own stocks themselves.  They also typically have pension plans that invest for them.  And, of course, there are private equity funds and the big investment banks with their proprietary trading desks.  Adjustments to changing prices by all these agencies tend to mitigate the effects of money flowing in and out of the developed equity markets.

In emerging markets, in contrast, many of these stabilizing factors–notably, the existence of pension plans or of individuals able to afford the risk of owning stocks–aren’t present.  So flows of funds from developed countries in and out of emerging stock markets can have relatively large effects on prices.

my thoughts

Of course, your personal risk tolerances and your financial situation will be the primary drivers of your investment decisions.  But I don’t think the asset allocation shift is important enough to make you rethink a sound asset allocation plan.

As for myself, I expect the flow of individual investor money back into developed markets means that smaller capitalization stocks there will do a bit better than they otherwise would, and that periodic market corrections will be shorter and shallower than we have seen during 2010.

Professional emerging markets investors, facing customer withdrawals, will likely emphasize larger stocks in more liquid markets.  So “frontier” markets–which none of us have any business being in–will likely languish for a while.  

The way I read the performance figures for the past year or two (over the past 12 months, EM and the S&P are about neck and neck), a lot of discounting of the need of emerging country governments to cool down overheating economies is already reflected in stock prices.  The withdrawal of foreign “hot” money will speed the cooling down process along a bit, although the repatriation of funds may cause price weakness.  I see this as a potential buying opportunity.  Although I think it’s still too soon to act, the main message of the asset flow reversal is probably to set practical investors to thinking about when to increase emerging markets exposure.


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Washington and technology transfer

February 8, 2011 By in Balance of Payments, Dividends, economics, employment, Uncategorized Tags: , , , , , , Leave a comment

an important distinction

In an increasingly globalized world, it’s crucial for investors to keep a basic distinction in mind. It’s the difference between who owns a business and where the money-making activities are located.

for Wall Street

For a stock market investor, the more important issue is whether the company whose stock he holds is making profit gains, not whether the factory whose sales produce these increases is in the US or China.  In fact–something I think Wall Street. with its fixation on domestic economic statistics, is only beginning to grasp–half the revenues, and likely a larger share of profits and profit growth, of the S&P 500 come from outside the US.

In the longer run, of course, there will be negative consequences for the stock market in the US if unemployment remains at 9%.  Why?  This is a social problem that Washington will try to “fix”.  The Fed is already attempting to do so, with the further monetary easing dubbed QE II.  Not that any US citizen needs to be reminded, but Washington also “helped” the country by bringing us from budget surplus to deficit during the past decade, committing us to wars in Iraq and Afghanistan and creating the Fannie Mae and Freddie Mac messes.  It’s also kept corporate taxes high enough that most multinationals don’t repatriate their foreign cash, making that money unavailable for reinvestment in the US or payment of dividends to shareholders.

for Main Street

For a political policymaker, on the other hand, especially with 9%+ of the workforce unemployed, I would have thought that having new jobs located in the US is far more important than trying to make sure the employer is a domestic company.  After all, the fact that all the BMW X3s in the world are made in the US (I found this out in a Super Bowl commercial) is good for domestic employment, even if the company is incorporated in Germany.  Look, too, at the strong growth of the social networking business in the US, due in good part to investments from DST Global (Russia), Tencent (China), and DeNA and Gree (Japan).  The jobs being created are in the United States, even though the backers are abroad.

That’s not the view form the Potomac, however.

the Obama speech

Yesterday, President Obama made a speech on encouraging economic growth to the US Chamber of Commerce (full text from the Huffington Post). \ As a statement of purpose, the address could easily have been taken from an economics textbook from the 1960s.  Unfortunately for government policy, the world has changed radically since then.

What was the speech missing?  Well, it did allude to the fact that high tax rates were hurting the balance of payments by stopping the flow back home of profits earned abroad by US companies.  And it did mention trying to encourage exports.

But it assumed that an export-oriented economic strategy still makes sense.  Logistics issues aside, it ignored the fact that in today’s world, companies entering a big new foreign market may want their production base closer to their customers. Host countries definitely want that, too, to get the maximum benefit of technology transfer. Tax benefits may also come into play.

It also skipped over the fact that creating advanced manufacturing jobs in the US does nothing for the huge number of structurally unemployed, which is the pressing political/social issue of the day.  And it assumed that the US has a lot to teach the rest of the world, but has nothing to learn in return.  In other words, the idea the the US could benefit from technology transfer appears never to have entered Mr. Obama’s mind.

...a big deal?

Is this a big deal?  Right now, no.  The only real evidence of “protectionist” tendencies in Washington that I can see is last year’s congressional action to up the visa fees that Indian IT outsourcing companies have to pay to bring workers into the US.  Yes, the US will lose tax revenues, domestic IT costs will rise and the Indian firms’ (few) US workers will lose the chance to acquire skills they might use to launch competitor companies.  This is very small potatoes compared with congressional action during the 1980s.  One might also argue that such actions are no longer possible since the Democrats lost of control of the House.

On the other hand, the chances seem slim that Washington will do something constructive on the jobs front using a severely outdated picture of the way economies work.  It certainly won’t make it easy for foreign companies to set up shop here, so that US workers can be trained in new skills.

While this is not a stock market worry for today or tomorrow, someday this closed-mind attitude may catch up with us.  So it’s something to keep in the back of your mind.

 

(even) more on hedge funds

February 7, 2011 By in Academic Theories, Getting financial advice, hedge funds Tags: , , , , , Leave a comment

The Financial Analysts Journal

The Financial Analysts Journal is the flagship publication of the Institute of Chartered Financial Analysts.  The ICFA is a trade association of financial professionals that focuses on academic theories of the financial markets.  Although the FAJ has an occasional piece by a professional money manager, it contains mostly the kind of journal articles that university professors need to write for each other so they’ll get tenure.

the January/February 2011 issue

The lead article in the January/February 2011 issue is called “The ABCs of Hedge funds:  Alphas, Betas and Costs.”  The authors divide the hedge fund universe into nine different strategies and analyse the returns of each strategy over a long period of time.  They conclude that for each of the eleven years ending in 2009, every one of the strategies produced “positive alpha,” that is extra returns for investors above their benchmark indices.  These extra returns remained even after deducting management fees and after adjusting for the risks (like financial leverage) that the investors were taking.

This is a stunning result.  It’s by far the most positive assertion I’ve ever heard about the hedge fund industry.  A more usual observation would be that you would have been better off since 2003 by holding an S&P index fund than by giving your money to the typical hedge fund manager.  What’s also remarkable is that there are not just a select few outperforming managers.  According to this study, just about everybody is a hero.

What’s also a bit surprising, given the academic bent of the publication, is that this result flies in the face of the academic dictum that sustained outperformance, year after year, is impossible–and the FAJ makes no fanfare about this.

too good to be true?

Turning to the real world, my personal experience is that what the article says can’t be done.  I’ve known a few managers who’ve strung together long series of outperforming years.  Invariably, they stray from their professed styles or take hugely concentrated positions (say, 20% of the portfolio in one stock) that conventional risk measures don’t capture, to keep their strings intact.  In one (amusing) case, the manager got his clients to agree to a defective benchmark, one that 95% of the entrants in his category could consistently beat.

my opinion:  yes!

I think that what the article says is just too good to be true.  True, I’m not a hedge fund fan.  Maybe I’m jealous of the high fees hedge fund managers get to charge.  But as a group they remind me of the oil and gas tax shelter purveyors I analyzed (among other things) in my first stock market job.   Those vehicles appealed to the egos of the limited partners, who could brag that they had a tax problem, but had lots of snake oil and little investment merit.

Other than pure prejudice, the one observation I’d make about the ABCs study is that it uses returns that are voluntarily reported by the hedge funds themselves and not independently verified.  I’ve written about this practice before.  Basically, it seems hedge funds often inflate their returns when they report them to consultants.

In fact, the February 2010 issue of the CFA Digest, a very handy publication, also from the ICFA, that summarizes important academic articles, cites research published in the Journal of Finance in a piece titled “Do Hedge Fund Managers Misreport Returns?  Evidence from the Pooled Distribution.”  Short answer:  YES. The same issue cites a second article, this one from the Review of Financial Studies. It’s called “How Smart Are the Smart Guys?  A Unique View from Hedge Fund Stock Holdings?”  Its conclusion:  hedge funds outperform mutual funds in stock selection but subtract all that extra value, and more, through higher fees.

That’s more like the hedge funds we all know and …well, that we all know.  (What was the FAJ thinking?)

 

January 2011 Employment Situation report: a poor number no one believes

February 6, 2011 By in Current Market Thoughts, economics, employment Tags: , , , , , , , , , , , 3 Comments

The Employment Situation for January

The Bureau of Labor Statistics (BLS) released its January Employment Situation News report last Friday.  The headline figure, the number of new jobs added in the economy, was a disappointing +36,000.

not a great report

Why disappointing?  Two reasons, one economic and one social/political:

–The January figure follows much better results of +93,000 in November and +121,000 in December.  It would have been more comforting had January showed further progress toward macroeconomists’ hoped-for 200,000+ monthly job additions.

–On average, 100,000 people a month finish school or professional training and enter the workforce each month.  So, although it’s good that the economy created 36,000 new positions last month, the number implies the country also produced another 64,000 would-be workers who can’t find jobs.  This adds to the social pressure caused by the fact that about 14 million other Americans are already in the same situation.

the unemployment rate dropped

…to 9% from 9.4%.  That’s because, based on its monthly phone surveys, the BLS estimates the bad weather that swept over much of the country kept just under a million people from getting out to look for work.  Interestingly, the weather was not bad enough to keep people away from the malls last month.  Contrary to cautious analysts’ projections, retail sales for January were up by a surprisingly good +.7%.

the jobs number may not be as bad as it looks

First of all, there’s the weather factor.  The January figures showed big negative swings in transportation and warehousing workers (-86,600 month on month) and in temporary workers (-49,500) that may have been storm-induced.  On the other hand, the manufacturing sector was unusually strong, gaining 49,000 workers, 62,000 of them in durable goods (an area that’s especially weak during recessions and strong in recoveries).

Also, the BLS has just carried out a periodic overhaul of the analytic framework it uses to generate the employment data.  Teething pains, anyone?

In addition, if the recent past is any guide, the 36,000 figure is going to be revised up.  Each monthly figure is redone twice–as new data come in during the following month and the month after that. Recently, all the revisions have been in the plus column.  For example:

–The final November jobs figure is +93,000.  It was initially reported as +39,000  and was revised up to +71,000 in December.

–The December figure was initially reported as +103,000.  It has just been revised up to +121,000.

Wall Street isn’t worried (so far)

Investors remain bullish in the face of the weak job numbers, for several reasons:

–asset allocation shifts.  Some domestic retail investors are starting to reverse their ultra-cautious over-allocation to fixed income and beginning to buy US stocks for the first time in a couple of years.  Others, professionals included here too, having already made a lot of money in emerging markets, are taking profits there and rebuilding their US holdings.

–the expectation of favorable revisions in the jobs data, given other indicators that the US economy is building positive momentum.

–earnings results from publicly traded companies.  These are coming in very strongly, and leading indicators are signalling that more good news is in store.

–the number of people unemployed vs. the number employed.  Although there are still around 14 million people unemployed in the US, or twice the “normal” number, there are over 800,000 more people employed today than a year ago.  In a bull market, and when trying to figure out whether firms will have year over year earnings gains, the latter figure is probably more important to Wall Street.

investment implications

Asset allocation shifts, or what’s sometimes called “the weight of money,” is a transitory phenomenon.  At some point, investors become satisfied with their new portfolio structure and stop making changes.  Then, this influence–at present, favorable for stocks–disappears. So it’s not something to bet the farm on.  Nevertheless, while investors are looking for stocks to buy rather than things to sell, dips in the stocks of underachieving companies may be milder, and the positive response to good news may be more enthusiastic, than one would normally expect.  To me, this means potential trading opportunities over the next couple of months for anyone who already has a reasonably constructed portfolio.

One thing to keep an eye on:

Everyone, me included, is assuming that the BLS figures are simply wrong, that the actual job situation is better than the numbers suggest.  We’re all thinking that when the weather gets better and the BLS shakes out some of the kinks in its system the numbers will end up being in the +150,000-200,000 range.  If they’re not, that realization will likely usher in a period of stormy stock market weather.  Because it would also take away some of the sense of urgency that asset re-allocators are currently feeling, we might have an ugly month or two.