Category Archives: Stock ideas

Whole Foods (WFM) and Millennials

May 11, 2015 By in earnings conference calls, Recent Market Action, Retail, Stock ideas, supermarkets Tags: , , , , , , , 1 Comment

What should we make of the announcement by WFM that it’s launching a new chain of supermarkets–smaller stores, selling less expensive merchandise, targeted to Millennials?

preliminaries

I was an early investor in WFM.  My family shops there on occasion.  But I haven’t followed the company for years.

Over almost any period during the past decade, the traditional supermarket chain Kroger (KR) would have been a better investment.

The stock’s strong performance from the depths of the recession comes in part from its starting point–a loss of over 3/4 of its stock market value and the need for a $425 million cash injection from private equity firm Green Equity Investors.

my thoughts

new brand–As I once heard a hotel marketing executive say, “You don’t start selling chocolate ice cream until the market for vanilla is saturated.”  Put a different way, if there’s still growth in the tried and true, it’s a waste of time to segment the market.  Therefore, the move to a second brand signals, at least in the minds of the managers who are doing this (and who presumably know their company the best), the end to growth in the first.

less expensive food–Pricing and brand image are intertwined.  Paying a high price for goods can confer status both on the product and the buyer.  Lowering prices can do the opposite.  It seems to me that WFM judges it can’t lower prices further in its Whole Foods stores without risking the brand’s premium image.  It may also be that WFM thinks it needs the pricing to pay for the big stores/prime locations it already has.  That would be worse.

smaller stores–This is less obvious.  The straightforward conclusion is that WFM has exhausted all the US locations where the demographics justify a big store.  My impression is that this happened years ago, however, when WFM began to decrease the square footage of its new stores.  On the other hand, it may also be that in their search for “authenticity,” Millennials react badly to big stores.

Millennials–Millennials and Baby Boomers are each about a quarter of the population.  Boomers have about twice the income of Millennials.  But as Boomers fade into retirement, their incomes will drop.  Millennials, in contrast, are just entering their prime working years, when salaries will rise significantly.  So targeting Millennials makes sense.

 

It’s not surprising that WFM shares dropped on the news.   It signals the end of the road for the proven brand and a venture into the unknown for which no details have been provided.  Why announce this now in the first place?

What Amazon (AMZN) said about its web services Thursday night

April 28, 2015 By in Amazon, cloud services, earnings conference calls, Industry Analysis, internet, software, Stock ideas, Technology Tags: , , , , , , Leave a comment

AMZN shares rose by 15% last Friday, after the company gave its first income statement details about Amazon Web Services (AWS), its cloud business.  In its quarterly reporting from now on, AMZN will break out three business segments:  US sales, International Sales and AWS.

IN the late Thursday earnings release, Jeff Bezos said that AWS is growing fast and “in fact, it’s accelerating.”

the data

operating income

–during calendar 2013, AWS had segment operating income of $673 million, according to the GAAP accounting rules used in financial accounting.  That was 35.3% of AMZN’s total segment income.

—for 2014, AMS had segment operating income of $660 million, or 36.5% of the total

–in 1Q15, AMS had segment income of $265 million, 37.5% of the corporate total

cash flow

–on GAAP principles, AWS had cash flow of $2.4 billion last year.

capital spending

–AWS represents over a third of AMZN’s plant and equipment of $17 billion.  With $4.3 billion in plant additions in 2014, AWS was almost half the company’s total capital spending.  Of the $4.3 billion in new plant, $3 billion was acquired using capital leases–meaning a kind of financing which looks like a loan but which allows AWS to buy the stuff cheaply at the end of the lease.

plant life

–if we divide last year’s depreciation into the average of 2013 and 2014 plant, we get an average plant life of 4 1/2 years.

–return on capital

–last year AWS earned $660 million, using capital of $4.6 billion, meaning a return of 14%.

what to make of this

It’s hard to make a lot out of two years’ data, especially in such a fast-moving and capital-intensive business as AWS’s.

The GAAP numbers look good. Nevertheless, AWS is cash-flow negative, which isn’t troubling if we’re certain that the company will continue to earn a significant return on the capital it is pouring into AWS.  Also, although there’s no way to tell for sure, it seems to me likely that on its IRS books, AWS is losing money.  How so?   …tax breaks for technology investment, including depreciation that’s heavily front-loaded (vs. spread out evenly over the assumed life of the equipment, as GAAP calls for).

Certainly, if Wall Street’s view has been that AWS is bleeding red GAAP ink, the reality is hugely better.  As time goes on, we’ll be better able to judge how insatiable AWS’s need for capital is–or whether, as one would hope, AWS will turn cash flow positive .  My guess is that before then, AWS will be more than half AMZN’s profits, as well.  So holders will have to figure out whether or not it’s an uptick to hold shares in an internet infrastructure business that happens to retail stuff online, too.

 

 

3Q15 earnings for Microsoft (MSFT)

April 27, 2015 By in cloud services, earnings conference calls, Industry Analysis, internet, software, Stock ideas Tags: , , , , , , , 1 Comment

the report

After the closing bell last Thursday, MSFT reported earnings for its third fiscal quarter (its fiscal year ends in June).  The company had revenue of $21.7 billion for the March period and earnings per share of $.62.  This compares with Wall Street consensus estimates of $.51/share.

Cloud-related businesses were very strong, Windows-related less weak than expected–although the coming launch of Windows 10 at mid-year is already keeping a lid on Windows performance, as potential buyers wait for the newer version.

 

MSFT shares opened Friday trading up by 5%+ from the Thursday close and tacked on another 5% or so be 4pm.

 

Yes, the quarter was good.  And management made it clear, even through its brand of jargon-laden corporate speak, that its move to the cloud can enable a radical expansion of its business, not simply a shifting of revenues from one pocket to another.

the Amazon influence

However, I think the unusually sharp rise in MSFT shares on Friday is more due to Amazon (AMZN) than to MSFT.

AMZN also reported after the close on Thursday.  For the first time, it broke out its Amazon Web Services as a separate business line.  Most Wall Street observers had apparently assumed that AWS, a cloud industry leader, made little or no profit for the company.  I’m not sure why they thought this.  The only thing I can come up with is that AMZN as a whole lost money for the first eight years of its existence as a public company–and analysts argued that AWS would be déjà vu all over again.

Turns out, though, that despite AMZN’s notoriously conservative accounting, the line of business breakout shows AWS making a ton of money.  AMZN shares opened Friday up by 12.5% from Thursday’s close, and drifted higher during the day.

It seems to me that MSFT rose mostly in sympathy with AMZN.

what to do about the stock

The move to the cloud has a bunch of pluses for MSFT:

–the company’s services can be used on many platforms–servers, PCs, smartphones, tablets

–it is launching new multimedia, multi-platform services

–it can provide truncated versions of sophisticated corporate services to small businesses and individuals

–the rental model for services will generate higher income than sales, and

–MSFT can reshape its image from being a PC-centric company of the past to being a cloud-based company of the future.

 

My sense is that Wall Street still views MSFT through PC glasses.  Change in perception represents substantial upside for the stock, in my view.  Still, the outsized upward move in the stock has got to tempt holders–myself included–to take some profits now, with the idea of replacing the stock being sold at lower prices.

1Q15 results for Intel (INTC)

April 16, 2015 By in earnings conference calls, internet, semiconductor manufacturing, Stock ideas, Technology Tags: , , , , Leave a comment

the results

INTC reported 1Q15 earnings after the close on Tuesday.   Results were flattish year-on-year, matching analysts’ forecasts.  This was unsurprising, given  INTC had preannounced 1Q15 was not going as well as expected.  The company thinks some, but not much, relief from the current doldrums will appear in the second half.

The culprit has been the traditional PC business.  Small-and medium-sized firms haven’t been converting their old Windows XP desktops to newer machines.  Maybe they’ve decided to wait for Windows 10, or they don’t want to update their (pirated?) Office programs or they just figure they’ll use XP until something breaks.  Whatever the reason they’re not buying.

This hurts INTC in two related ways:  OEMs don’t have to reorder parts   …and they run down their inventory levels to match weaker demand.  INTC thinks the second process was pretty much over by the end of March.

Notebooks and tablets were up, though, and the server-related businesses are going great guns.

picky stuff

INTC now thinks its full-year tax rate will be 25%, not the 27% previously forecast.  This suggests the current mix of business is more Asia, less US than the company previously thought.

INTC is cutting capital expenditure plans.  Weaker PC demand means less need for older factories, which can be refit for more cutting-edge use.  Hence, less need to build from scratch.

Tablet demand was up 45% yoy in 1Q15.  This is good news and bad.  Good that someone wants the chips, bad in that INTC is essentially paying users to take them.  Nothing new here.  However, INTC had expected to begin to show profits on them by yearend.  That apparently is not going to happen.  INTC was likely planning to get out of the hole both by raising prices and by driving down unit manufacturing costs.  My guess is that the first isn’t happening yet.  (My view is that whatever it takes to get INTC parts into the hands of manufacturers is the correct strategy.  Ideally, the prior CEO would have understood the movement away from big clunky tethered PCs and reacted years ago.  But that’s water under the bridge.)

the big change (in my view)

INTC has changed the way it is presenting results to investors, effective with 1Q15.  It is folding the loss-making Mobile and Communications Group into the former PC Client Group, now dubbed Client Computing Group.

Some of this is just optics–the MCG lost about $1 billion a quarter during 2014, mostly trying to jumpstart the tablet business.  So we won’t see the red ink any more.

At the same time, through the magic of subtracting mobile losses from PC profits, the server business  becomes the largest single earner INTC has.

conclusions

In a sense, INTC is saying it wants to be known as an internet infrastructure company that happens to make PCs, rather than as a PC firm that happens to make servers.

Who wouldn’t!, a cynic might comment.

I think  the move is more than that, however.  It may also signal a change in behavior.  The new line of business table neatly divides the company into a growth segment–servers, embedded internet-of-things chips, 3-D flash…–and a mature cash cow, Client Computing.

If so, the first will be run as a profit center and measured by growth, the second more or less a cost center and measured by contribution margin (the reason I wrote about this topic yesterday).

During the conference call (as usual, I read the Seeking Alpha transcript) INTC said the servers etc. are accounting for 60% of the company’s profits right now.  If we assume that these businesses can continue to grow at 20% annually and that CCG stays flat, then servers etc. would be 75% of INTC’s profits–and expanding in scale–in 2018.

This would presumably result in a higher PE multiple at come point, as well as higher earnings.  The question I’m currently pondering is whether this prospect makes INTC more attractive than a tech-oriented ETF.

 

merger talks off between Intel (INTC) and Altera (ALTR)

April 9, 2015 By in Current Market Thoughts, mergers and acquisitions, semiconductor manufacturing, software, Stock ideas, stock market, Technology Tags: , , , 1 Comment

CNBC is reporting that INTC has broken off takeover talks with ALTR .  ALTR has supposedly rejected an offer of $50+ per share.

If ALTR’s value were not in its software engineers, that is, intellectual property that drives out of the parking lot every evening, we’d expect that the situation would develop along two parallel lines:

1.  figuring (correctly, in my view) that shareholders who are not part of ALTR’s top management would jump at the chance to sell their stock to INTC for $50, INTC might consider a hostile bid (that is, one not endorsed by ALTR’s CEO), and

2.  ALTR would decline on the news, but remain above its new-leak level as Wall Street would expect, at worst, another suitor to emerge sooner or later.

 

I don’t think the first will happen in this case.  INTC doesn’t want buildings, land and equipment.  It wants researchers–who might either decamp to work for competitors or even form their own independent software firm if they felt they were being forced against their wills to work for INTC.   Management likely wouldn’t stand in anyone’s way.  Therefore, making a hostile bid risks ending up with an empty shell.

On the other hand, I don’t expect another suitor.  It seems to me that INTC is uniquely able to use ALTR’s intellectual property to create new value  …and I found myself struggling to justify a bid price, even with INTC as the buyer, over $40 a share.

 

Still, ALTR may not simply drop back to the mid-$30 range.

If we assume that INTC knows what it’s doing, then it thinks that an INTC/ALTR partnership would have transformative value that would make ALTR worth something like double the pre-bid market price (otherwise, why bid $50+? …the other alternative, which I’ve ruled out in the first clause of this paragraph, is that INTC is either foolish or desperate).

INTC sought to capture most of the upside by buying ALTR.  That hasn’t worked.  Presumably, when emotions clear and heads cool, INTC will try to work out a different arrangement (joint venture?) in which ALTR will retain its independence and take a larger amount of any upside for itself.

If this is correct, a big selloff in ALTR over the coming weeks might offer an interesting opportunity to buy.