Monthly Archives: January 2014

a US holiday shopping post-mortem

January 17, 2014 By in Industry Analysis, internet, Portfolio management, Recent Market Action, Retail, Stock ideas Tags: , , , , , , , Leave a comment

Information is trickling in about how the holiday shopping season in the US went.  What jumps out at me (not necessarily exactly what was said) so far is:

–overall retail sales were up by 3.8% year-on-year.  To my mind that’s great, not the disappointment (vs. expectations of +3.9%) it’s being pitched as.  The reason:  the comparison is between the shortest possible holiday season, in 2013, and the longest possible in 2012.

–extended store hours didn’t appear to do much for sales.  It increased costs, though.

–the weak got weaker (think:  Best Buy, Sears, JC Penney).  Sears and Penney are both closing stores.

–Macy’s is laying off 2,500 in-store workers and hiring an equal number to work on its on-line offering

–mall traffic (not sales necessarily, but the number of visits by potential customers) is down by 50% from three years ago

–on-line sales were up by 9.3% yoy

my take

I’ve begun to believe that generational change–a passing of the baton from the Baby Boom to Millennials–will be an important stock market theme in the US for years to come.  I think the just-passed holiday season is evidence in favor of this idea.  (By the way, I heard the other day–but haven’t checked the source–that the single most important attribute to current car buyers is the technology in the car, not styling or engine power.  If I heard correctly, another piece of evidence.)

I’ve always thought that the greatest risk to equity portfolio managers performance  is that as they become more successful and wealthier, they gradually lose touch with the way normal people live their lives.  As that happens, they become less able to see the economic currents that ultimately influence stock prices.  Celebrity hedge fund managers are particularly vulnerable, in my view–but that may just be my prejudice.

Why is this important?    …because you and I will see this change going on long before the professionals do.  So we’ll be able to find the names and position our portfolios to benefit in advance of the wave of buying that will come as the light bulb comes on for gated-community pros.

 

 

 

Apple (AAPL) today

January 16, 2014 By in from growth to value: the life cycle, growth vs value, Recent Market Action, Stock ideas, Technology, Wireless Tags: , , , , Leave a comment

the stock vs. the company

the company

As a company, Apple has in most respects followed the typical pattern for businesses of high-flying growth stocks.

The company stabilized itself as a computer maker, after a brief flirtation with bankruptcy, with the return of Steve Jobs as CEO.  It took a chance on making the iPod, which a geeky DJ apparently brought to it.  That produced a series of big profit increases that lasted several years and doubled this size of the company.  Just as the iPod wave was cresting, Apple reinvented itself again, as the iPhone company.  Another huge profit surge followed, which crested as the global market for expensive smartphones matured.

Yes, Apple has reinvented itself again as the iPad company, but each blockbuster must be progressively larger to move the profit needle for a firm whose income has grown exponentially over the past decade.  The iPad doesn’t have enough oomph to do so.  Heartless as it may seem, Apple has gone ex-growth.

Look at IBM, or Oracle, or Cisco, or Wal-Mart  …or, on a smaller scale, the Cheesecake Factory or Chicos or PF Chang.  Same pattern.

the stock

What has been strange about Apple has been the behavior of its stock.  Typically, as a company’s earnings begin to accelerate, the price-earnings multiple begins to expand as well.  So the positive effect of the earnings growth is magnified.  When (or just before) earnings growth beings to disappoint, as it sooner or later will the PE begins to contract.–and the stock plunges.  Timing this shift is the key issue for growth investors.

Not so much with AAPL.  Its PE peaked in 2008, four years prior to the peak in earnings (which were, by the way, almost 8x the 2008 level).  The multiple contraction has been pretty continuous, moving from 30x ( and 1.8x the market multiple) in 2008 to 12.3x (and a .7x relative multiple) for 2013.

an investment thesis

Growth investors, who are searching for the next AAPL, have abandoned ship andgone elsewhere, leaving the field to their value counterparts.

For value investors, I think the key question revolves around the PE.  When growth stocks fall from grace, the multiple typically contracts severely–and over a long period of time.  The decline ends in an overreaction on the downside.

Looking at AAPL,nine months of stock price pain (late 2012 – mid-2013) would be unusually short period of time.  But, then, the AAPL multiple has already been contracting for five years.

Although I’m not a value investor (read: although I’m no good at making these judgments), my sense is that the AAPL PE is too low.  I don’t feel an overpowering urge to buy the stock.  But 10% earnings growth + one point of multiple expansion this year doesn’t sound so bad, either.

 

 

 

natural resource production companies: accounting quirks to watch for

January 15, 2014 By in Energy, Gold, Industry Analysis, Mining Tags: , , , , , , 1 Comment

mining

Mining is mostly about how a company develops resources that have already been discovered, sometimes very long ago.

1.  Metals orebodies can vary considerably from one part ot the next in the proportion of valuable minerals they hold.  Standard practice is to mine the highest-grade ore when prices are low, and the lowest-grade when prices are high.

Not a lot of operating leverage this way.  But the idea is to enable the mine to stay open even during the inevitable cyclical downturns.  Doing the opposite, which will likely boost the stock price in good times, can lead to disaster during the bad.  There’s no easy way for an outsider to tell, except by the reputation of company management.  In the case of gold, we may find out who’s been prudent and who’s been reckless when the 2013 financials are published.

2.  Same thing with site preparation.  Standard, and prudent, practice is to routinely spend money on things like removing overburden (layers of dirt covering the ore) in places where the company is not mining today, but plans to in the near future.  This activity can be quite expensive.  But it’s necessary.  On the other hand, a firm can make short-term profits look considerably better by not doing so.

oil and gas

Oil and gas is much more involved with finding new deposits, and how to account for those costs, than metals mining.

1.  Companies have two ways to account for the costs of buying mineral rights and doing exploratory drilling.  They are:

–successful efforts, where, as the name suggests, only successful fields are put on the balance sheet and gradually written of as oil and gas is produced.  The costs of unproductive areas are written off as expense as soon as they’re incurred.

–full cost, where all exploration costs, both for productive and non-productive projects, are capitalized and written off against production.

Successful efforts is more conservative, but normally results in lower earnings.

2.  Accumulated costs are written off pro rata as each unit of oil or gas is produced.  The amount expensed against the revenue from each unit is its proportionate share of the total cost of finding and developing all oil and gas (it’s a little more complicated than this, but this is basically what you need to know).  That proportion, in turn, is calculated based on periodic estimates by petroleum geologists’ of the total size of reserves.

Big oil companies use their own geologists; smaller ones hire outside consultants.  The important point is that this estimate–and therefore the amount of cost written off per unit produced–can vary a lot, depending on the particular consultant hired.  It may also depend on the tone, conservative or aggressive, company management sets.

Just as important, as I mentioned yesterday, oil and gas price changes can alter the size of total reserves.  The cost of recovery doesn’t change, but the amounts of hydrocarbons that can be brought to the surface at a profit can be.  Lower selling prices can raise the per unit amount expensed;  higher selling prices can lower the unit amount.  Potentially, lots of operating leverage–that’s completely out of management’s control.

3.  A minor clarification of #2:  subject to some limits, the company decides how to group reserves and associated costs into different “cost pools” for figuring out depreciation and depletion.  Artful grouping of these pools can help disguise an extended run of bad drilling luck.  Not usually a worry, except with small firms with limited history.

4.  As with any other capital construction project, when oil and gas companies explore and develop with borrowed money, they can capitalize (that is, put on the balance sheet rather than expense immediately) the interest expense on that borrowing.  The interest expanse becomes part of the general costs that are written off against oil and gas production.  For smaller companies with an ambitious drilling program, this can sometimes create the peculiar (and potentially disastrous) result that it shows positive earnings while it is suffering cash outflows.  This is because interest is being paid to creditors but these payments basically don’t show up on the income statement.  Check the cash flow statement!!

 

 

 

natural resource production companies: proved reserves

January 14, 2014 By in Energy, Gold, Industry Analysis, Mining Tags: , , , , , Leave a comment

Early in my career I interviewed for a job with a company that had brought in a new chief investment officer to revamp its research department–a job I (luckily, as it turns out) didn’t get.  In the interview, the CIO said he thought that any competent analyst could figure out most industrial or service companies, but that there were three areas that demanded special expertise, They were:  financials, technology and natural resources.

Personally, I’d take technology off the list, leaving financials and natural  resource companies as the real specialist endeavors.  I’ve coped with financials by either avoiding them entirely, buying plain vanilla commercial banks in emerging markets, or by mirroring the index (so they neither help nor hurt performance).  As it turns out, I spent about eight years concentrating on natural resource companies at the start of my career (true, during the last century).  Rightly or wrongly, I feel comfortable with them.

Two thing make natural resource production companies unusual:

–their revenues depend on the price of the mineral commodities they mine, which can be very volatile, and

–their stock market value most often depends on the amount and value of their proved reserves, something that only appears tangentially in the firms’ financial statements.  Companies routinely disclose at least some information about their reserves, but it’s in supplemental disclosure that you have to find elsewhere in the annual.

proved reserves

Proved reserves are deposits of minerals that can be recovered:

–at a profit,

–with today’s technology, and

–at currently prevailing prices.

Almost always, natural resource companies have more stuff in the ground than they report as proved reserves.  Two possible reasons:  the minerals genuinely aren’t recoverable at a profit, given today’s technology and pricing; or (commonly with small companies) the firm hasn’t wanted to spend the money to get hard geological evidence of the extent of their holdings.

why this is important

1.  When prices go up, two good things typically happen to natural resource companies:  the value of each unit of reserves rises and the volume of reserves rises as well.  The opposite happens when prices fall.

Most people don’t realize the volume part.  That will be particularly important this year when gold mining companies report their reserves.

2.  When technology changes–as is currently the case with the development of horizontal drilling and hydraulic fracturing in  shale–acreage that previously seemed worthless may suddenly become a big source of profits.

In the case of natural gas in the US, this is a two-edged sword.  The amount of new gas production that fracking has spawned is so great that it has lowered the domestic gas selling price.  This means that some high-cost operations that were previously economically viable are no longer so–thereby moving those reserves out of the proved category for the companies affected.  For particularly maladroit drillers, where the value of the reserves found is barely higher than their finding costs (i.e., where the stock market appeal is purely the bet that prices will rise steadily), fracking can be a death knell.

More tomorrow.

 

 

will EU stock strength continue?

January 13, 2014 By in China, Current Market Thoughts, economics, EU financial crisis, Portfolio management, Stock ideas, Strategy Tags: , , , , , , Leave a comment

EU outperformance

Since the middle of last July, the S&P 500 is up by 8.7%.  Over the same time span, large-cap EU stocks have risen by almost 14% in € terms–and the € has risen by almost 5% against the $–meaning close to a 20% return for dollar-oriented investors.

Will this relative strength continue?

I think so.

Here’s why:

favorable circumstances

–the EU has finally put the worst of the Great Recession behind it and is beginning to recover

–the US continues to expand, but its alleleration will be lower than the EU’s

–the new Chinese administration is undertaking two necessary economic reforms, both of which will slow near-term economic growth and (I think) create uncertainty.  (The two: wresting control of banks from local/regional governments, and shifting away from low value-added export-oriented manufacturing.)  /so Pacific Basin growth will likely be less dynamic this year than usual, as well

either/or

So far, good news about the EU has expressed itself in both currency appreciation and in a rise in local currency stock prices.  My guess is that the € won’t weaken, but that most of the currency gain has already happened.  I expect the strongest areas of the EU market will continue to be early business cycle domestic-oriented areas, however.  The extent of underperformance by multinationals listed in the EU will probably be a function of the strength of the €.

a cyclical phenomenon

Eurosclerosis is the word coined to characterize the pre-EU European economy.  It meant sub-scale firms, excessive regulation, intra-European protective barriers, rigid labor, high unemployment and an aging population.

The launch of the € has resulted in transparent (and lower) pricing throughout the EU, M&A to create world-scale firms, and the elimination of intra-EU customs/tariff barriers.

But the union is still stuck with rigid labor, an aging population and vigorous defenders of their national economies in France and Italy, two of the three largest countries in the EU.  So eurosclerosis isn’t behind us.  We’ve got eurosclerosis 2.0 instead.

In other words, playing the EU is a business cycle idea, made more interesting by lack of oomph in North America and in the Pacific.  But we can’t forget to sell–probably some time late this year.