Tag Archives: yield

thoughts on BP

June 16, 2010 By in Current Market Thoughts, Recent Market Action, Stock ideas Tags: , , , , , , , , Leave a comment

The market for BP’s stock is made or broken in the UK, where the majority of its shareholders reside.  The London Stock Exchange itself is chock full of mature, slow-growing, dividend paying companies with exposure to a wide variety of different geographical areas outside the domestic arena.  There isn’t much tech and not much growth retailing.  In other words, BP is much more a mainstream stock for UK investors than it is for the US.

Britain is thinking cricket, the US is thinking something else. Despite its penchant for listing fly-by-night companies rising from the ruins of the old USSR and its harboring of the worst US financial malefactors, the UK’s expectation for its corporations, including BP, is that they will go beyond the letter of the law to do what is fair and honorable.   The US, on the other hand, seems quite concerned that BP will pay out all its cash as dividends and then present an empty shell to the bankruptcy court.

UK investors, both individual and institutional, are much more dividend oriented than their US counterparts–which shouldn’t come as much of a shock if you accept my description above of what the London market has on offer.  What this means, though, is that the US government suggestion that BP either refrain from paying a dividend or place it in escrow is a far more serious threat to the stock than an American might think.

There’s a lot of bond in the big oils.  That’s what a veteran oil analyst told me when I began to follow the industry in the late Seventies. It wasn’t true during the oil shocks of that period, nor has it been the case during the recent upward spikes in the price of crude.  But I think it is so again today.  As a result, the dividend is one of any oil equity’s main attractions.

Investors will look not only at the current payout (a sky-high 10.7% in BP’s case), but also at the prospects for growth in earnings and cash flow, and at the percentage of profits (very high for BP) now being distributed  to shareholders.  On most of these measures, BP looks sub-par.  And the yield itself, because it is so far above the norm for the big integrateds–around 4%–should be read as an indication by the market that the payout will be cut.

BP looks very cheap, on a price to book (less than 1) or price earnings (below 5) basis.  As a foreign firm, BP does not make the extensive disclosure of the value of its reserves that the SEC requires of US listed companies (BP trades in the US as an American Depository Receipt–basically a bank IOU backed by shares of BP held in its vaults).  So price to book is probably the best measure of value.  However…

The stock has become a political football. President Obama has been stung by his negative standing in polls of voters who put him in office to be an agent of change, only to find him wilting before a political establishment they perceive as thoroughly corrupt and want him to fix.  He has decided (mistakenly, I think) to show he is “tough enough” by kicking around a foreign oil company–which doesn’t address the real issue, but risks offending almost no domestic interest.  Unluckily for it, BP is his target.

The current oil spill is not BP’s only recent misstep. The firm had a disastrous joint venture in Russia, for example.  It experiencing a major refinery fire in Texas that cost 15 lives.  The US Chemical Safety Board attributed this worst industrial accident in the country in fifteen years to overzealous cost-cutting.  In the case of the oil spill, press reports again suggest that BP was cutting safety corners to get drilling back on schedule.

Good wells are always better than anyone expects; bad wells are always worse than anyone thinks. A pearl of wisdom from a long-time petroleum executive I dealt with years ago.  I’ve found it to be true not only in the oil business but a good rule for companies and stocks in general.  Whether some companies are just plain unlucky, whether some management flaw is deeply imbedded in a corporate culture or whether some mistaken way of doing things is broadcast throughout a company by the top brass is irrelevant to an investor.  The bottom line for me is that when things go bad, they tend to proceed far beyond what one would typically believe possible.

Several brokerage house oil analysts have come out in recent days to say that the market has severely overreacted to the bad oil spill news and that BP is very cheap.  The stock has lost almost $100 billion in market value since the oil leak news first became public and has underperformed both XOM and CVX by more than 40% over that span.  BP trades at a discount to book value, XOM at 2x book and CVX at 1.5X.  This may be lay-up for value investors.  As a growth investor, the stock still scares me.

tax rate, earnings per share, dividends and cash…: (II)

April 28, 2010 By in Current Market Thoughts, emerging markets, Industry Analysis, internet, Stock ideas, Technology, Wireless Tags: , , , , , , , , , , , , , , 1 Comment

lots of cash

A few days ago the Financial Times ran an article pointing out the huge amounts of cash that IT companies have been piling up over the past year.  According to the newspaper, the top ten public firms in technology have added $65 billion to their cash holdings since the market bottom last March.  Together they have about a quarter-trillion dollars on their balance sheets.  The FT points to the lack of anticipated merger and acquisition activity (anti-trust?) as one reason for the accumulation, and suggests that the industry will soon begin to buy back shares to reduce the size of their holdings.

Not all the big ten are as flush as the FT makes them seem, however.  EMC, IBM and ORCL have long-term debt that pretty much offsets the cash they have.  DELL, and to a lesser extent, AMZN, are negative working capital companies.  That is, they collect money from their customers before they have to pay their suppliers.  So they enjoy a kind of “float,” the same way that a restaurant or a hotel does.  There is at least some risk to the cash that appears on the balance sheet for this reason.  If the business slows, the cash begins to disappear as suppliers are paid.

Nevertheless, there are a number of tech firms with staggering amounts of cash and little or no debt.  They include:  AAPL, GOOG, INTC, MSFT and QCOM.

an important question:  where is the money?

As I suggested in yesterday’s post, at least some of the cash is overseas.  How much, no outside observer knows.

Oddly, as I was researching the 2004 amnesty that allowed firms to repatriate money to the US without paying much tax, I found an article that suggests that six years ago, some of the companies themselves, despite their financial control software, didn’t know where the money was, either.  And some had to postpone repatriation while they upgraded their treasury departments to create a mechanism to start the process and handle the incoming money.

Would companies like another amnesty?  An academic study that I also cited yesterday suggests they would.  Professors from Duke, Michigan and Washington conducted an internet survey on this topic.  Two-thirds of respondents said they would like a repeat of the 2004 amnesty.  The median amount anticipated to be repatriated was half of current foreign cash holdings.  Most of the money sent to headquarters would come from cash balances, though some would come from added foreign borrowing. (In the next few days, I’ll post on the limits to the confidence one can have in surveying in today’s world, and in internet surveying in particular.)

Other academic research suggests that the requirement to pay income tax on repatriated earnings does motivate companies to keep large foreign balances, and even to invest the funds in projects that will not be as lucrative as competing investments in the US.

stock buybacks

I’m not a big fan.  Maybe it’s age, but I’d prefer dividend increases.  It may be more tax efficient to buy back stock.  My objection, though, is I think every company has a compensation plan that features a policy of shifting a set percentage, say, 1% a year (but a lot more for small, fast-growing firms), of the ownership of the enterprise away from its shareholders and to its management.  I’m not sure the ordinary shareholder realizes this.  And it seems to me that most stock buyback plans retire just enough stock to offset dilution from stock options–thereby keeping this part of the compensation process from becoming evident through an ever-increasing share count.

looking at the numbers

The table below lists the big tech companies with the largest amounts of net cash (= cash and marketable securities minus long-term debt).  Although, as I mentioned above, there’s no good way to tell the location of a company’s cash, the lower the tax rate the more foreign earnings–and, I think, the larger the amount of cash parked abroad.  Note that I didn’t factor in long-term investment securities.  (You have to draw the line somewhere, and I decided I wasn’t comfortable deciding about the liquidity of firms’ non-current investments.)  You may want to do this differently, and the company financials are easily available on the Edgar site.

I also show the dividend yield, if any.  The following column shows dividend payments as a percentage of free cash flow ( = cash flow minus capital spending needs).  It gives mostly “negative” information.  That is, if the percentage is high, the company has little scope to increase the dividend, or even support the current payout in bad times.  A low percentage would be a good thing for dividend seekers, if we knew the location of the cash–i.e., whether the cash is available to be paid out.

The next-to-last column shows the stock’s pe based on consensus estimates of earnings to be reported in calendar 2010.  The final column shows what the pe would be if all the foreign-generated cash were to be repatriated and tax paid in the US.

—–stock price–cash/share—–tax rate——-divd—–divd/fcf—–pe—-pe”normal”tax

AAPL      $262            $27           27%        none         n/a           19x             21x

CSCO      $27.01        $4.20        19%         none        n/a           19x             24x

GOOG      $529           $78          22%         none        n/a            21x            25x

INTC        $23.35        $2.50        30%         2.9%      35%         12.6x         13.6x

MSFT      $30.84        $3.70       26%         1.7%       33%            14x            16x

QCOM     $37.92        $7.15        17%         2.0%      38%           18x            23x

my observations

1.  The absolute amounts of cash are huge.  They were astoundingly high percentages of the firms’ stock market capitalizations at the market bottom.  But they no longer are big enough to be a primary feature of the stocks as investments, in my opinion.

2.  The group divides into two camps:  fast growers–AAPL and GOOG; and more mature companies–INTC, MSFT and QCOM.    QCOM is somewhat of an anomaly.  The other stocks declare their growth characteristics through their pes and the presence/absence of a dividend.  QCOM hasn’t expanded much during the last half-decade and pays a dividend, yet has a higher pe than either INTC or MSFT.  This is probably due to its smaller size and its focus on mobile.

3.  GOOG seems to still be a more expensive stock than AAPL, despite the year-to-date outperformance of the latter over the former by about 40 percentage points.  AAPL’s pe is lower and its growth rate higher.  GOOG’s lower tax rate suggests more earning power outside the US, but also the potential issue (perhaps non-issue to everyone except me) of tapping overseas cash.

4.  The INTC/MSFT comparison is also interesting.  They are the two stalwarts of the “Wintel alliance” of the pc era, one the hardware genius, the other the software guru.  The market worries that time has passed both firms by.

INTC has a higher dividend yield and a lower pe, which I think expresses the market’s logical preference for a software company over its more capital-intensive hardware analogue.  Wall Street also believes, I think, that MSFT has an easier migration path away from the pc to more compact internet-centric devices than INTC, which has an obvious rival in ARM Holdings plc.  On the other hand, (I think) INTC has a much stronger management than MSFT.

INTC is paying a higher portion of its free cash flow in dividends than MSFT is, but the difference is slight.  INTC also has a much higher tax rate, indicating higher potential to tap offshore cash.

I don’t own either.  If I had to buy one, I’d pick INTC–but I would also watch very closely developments with the company’s Atom chip line and how it is faring against ARM offerings.

Intel’s March 2010 quarter–another good one

April 15, 2010 By in Current Market Thoughts, earnings conference calls, Industry Analysis, Stock ideas, Technology Tags: , , , , , , , , Leave a comment

March quarter earnings

INTC reported march quarter results after the close on Tuesday.  The company earned $.43 a share on record revenues for a first quarter of $10.3 billion.  Sales were down 3% quarter on quarter from the $10.6 billion posted during the December 2009 period, or about a third of the typical seasonal decline.  Nevertheless, laptop-related revenues were at a quarterly all-time high.

The company said demand was “incredible” and raised its guidance for the rest of the year.

Two parts

I’m going to write this post in two sections.  The first will deal with INTC comments that bear on the state of the world economy or the overall technology industry.  The second will deal with INTC-specfic issues.

Part one:  general

–During the quarter, INTC saw the first indications of a pickup in corporate buying of PCs.  For some time, companies have been swapping out older servers for newer, faster, lower operating cost models.  But now they’re starting to replace aging desktops (average age: 5 years) and laptops (4 years).

This isn’t a mass replacement, at least not yet.  That won’t come, if it does, until corporations have done enough testing of Windows 7 that they feel comfortable substituting it for the aging XP operating system that most are still using.  But it does indicate that corporations feel they have more money to spend.

–INTC is also seeing the first signs of life in “transactional volumes,” that is, sales through distributors to small- and medium-sized businesses.

–Demand was strongest for INTC’s newest 32 nanometer chips.  Despite a faster-than-expected rampup of 32nm factories, INTC couldn’t keep up with client orders.

–INTC itself feels good enough that it will be doing net hiring for the first time in five years.

–I think the regional breakdown of sales for the quarter is very revealing.

——————% of total sales       q on q sales change

Asia ex Japan           57%                            -1%

Japan                          11%                          +10%

Americas                     18%                           -9%

Europe                         14%                            -8%

Given INTC’s dominant position in the logic chip business, this chart shows how radically this business depends on Asian demand.  The Americas and Europe now comprise less than a third of the total.  The Pacific was actually up in slaes for the quarter, which typically shows a seasonal decline of 9% vs. Q4.

INTC expects the corporate tax rate to rise as the year progresses, implying that it expects sales from higher tax-rate places like the US to begin to accelerate.

netbooks/tablets

netbooks

With a 19% quarter on quarter drop, sales of Atom chips for netbooks experienced an unusually sharp decline–although that might not be the right word for such a new computer market segment.

INTC says that it sees netbooks as a purely individual consumer phenomenon.  There is no corporate market.  It now comprises about 20% of laptop sales, a figure INTC expects will remain steady.

I see the sales falloff as coming from a combination of several factors:  new firms entering the market, a desire by all participants not to miss the big yearend selling season, and uncertainty about the true size of demand.   Now that we have a better handle on the last item, netbook producers are adjusting their production plans but will presumably begin reordering during the second quarter.

tablets

INTC sees the tablet market as being today where the netbook market was two years ago.  It thinks demand for tablets won’t cut into traditional laptop demand but will, like netbooks, be additive.  The company says lots of Atom-based tablets are going to be introduced shortly, using both Android and Windows 7 operating systems.

Part two:  INTC itself

INTC is surprising itself with the speed and efficiency of its changeover from producing chips with a spacing of 45 nanometers between lines to the newer-smaller-faster 32 nm.  At the same time, customers who want to be the first on the block with cutting-edge PC speed are willing to pay high prices for the privilege.

On top of that, while 2009 was the year of the consumer’s return to buying PCs (China in the first half, Europe and the US in the second), 2010 is giving every indication of being the year when corporates finally upgrade their PCs that in IT years (2.5x dog years?)  are fast approaching decrepitude.

The first factor means higher than expected operating margins; the second means higher revenues.  The two combined are the force behind INTC’s surprisingly good earnings performance in the March quarter.

There’s no reason to think performance won’t get better as the year progresses.  If corporations decide to adopt Windows 7 during the second half–a bit faster than might be typical, but XP is getting long in the tooth (no one adopted Vista)–2010 could be a truly memorable year.  If not, the earnings party will continue well into 2011.

One probably shouldn’t get too carried away with speculation about how good earnings might be in 2010.  Prior to this report, the Wall Street  consensus was that INTC would earn about $1.65 a share this year.  When the latest round of revisions are in, that figure will probably be a lot closer to $1.80.  $2 a share might even be in striking distance, given that INTC’s highly automated factories have a lot of operating leverage.  But that would likely require a 20%+ increase in unit sales.  And, offsetting some of the resulting gross margin gain, the company has already indicated that it will spend $600 million more than planned on R&D and marketing.  That figure would doubtless increase if revenues do.

What really strikes me is how much free cash INTC is currently throwing off.  The company had $16.4 billion of cash and near-cash assets at the end of last year.  It added $2.4 billion to that total in the first quarter.  Absent another dividend increase or an acquisition, INTC is on track to exit the year with a total of $27-$28 billion on the balance sheet.  Even after repaying the company’s $2 billion in long-term debt, that would amount to 20% of INTC’s market capitalization.

As I wrote after INTC’s last quarterly earnings report, the present company management seems to understand that the company is mature and is managing it appropriately.  One should expect a continuation of the steady dividend increases that have been approved by the board since 2003.  Trading at a pe discount to the market and a dividend yield preference as well, INTC seems to me to be part of a group that would include MSFT and WMT (I own this one) that should be very attractive to Baby Boomers.

When the fed funds rate starts rising: how high? what does this do to stocks?

April 1, 2010 By in Constructing a Portfolio, Current Market Thoughts, Portfolio management, Recent Market Action, Shaping a portfolio for 2010, Strategy Tags: , , , , , , , , , , , , 5 Comments

The economy is healing

We know the US economy has turned the corner.  At some point, activity will be strong enough that the Fed will begin to raise short-term interest rates from their intensive-care-unit level of today.  (Yes, the Fed has already begun to raise the discount rate, but this has been to force the major banks back into the commercial paper market instead of dealing solely with the government.)

what happens when the fed funds rate rises?

Even though the initial move may be months off, when is less important than how high the rate is likely to go and the effect the move will have on stocks and bonds.  It’s not too soon to begin thinking about any of this.

two parts to this post

–The first will be what financial theory, such as it is, says about what should happen.

–The second will be an examination of the historical record of fed funds rate increases over the past twenty-five years.

Theory

fed funds rate behavior

One of the Fed’s jobs is to help carry out our highest-level national economic objective:  maximum sustainable growth with low and stable inflation.  “low and stable” means nothing much higher than 2%.

This gives us our first benchmark.  Under normal conditions the fed funds rate, the price of overnight interbank deposits, will be slightly positive in real terms–about .5%-1.0% higher than the target inflation rate.

If the economy is running too hot, the Fed temporarily raises the rate, both to telegraph its concern and to raise the cost of borrowing, thus slowing the economy back down.  When the economy is down in the dumps, on the other hand, the Fed drops the rate below inflation to try to pep activity back up.

Today, the rate is at about .25%, meaning the economy has been in a train wreck and is barely breathing.

Where is normal, then?  Assuming inflation is under control, that is, 2% or less (and I think it is), the fed funds rate should be somewhere around 2.5%-3.0%.  That means that one the Fed starts upping the rate, it won’t stop until it has tacked on 200 basis points, and possibly as many as 250.

Long rates won’t rise by as much, since this isn’t bond investors’ first rodeo and thus to some degree have already priced in some of the short-term interest rise.  The extent of the yield curve flattening (meaning a smaller rise in long rates than in short) remains to be seen, but the ten- and thirty-year bond yields could easily rise by 100 bp.

the effect on stocks

Strictly speaking, there is no independent demand either for stocks or for bonds.  This is because, to a great extent, the two asset classes are substitutes for one another.  There is demand for the more  general class of long-lived investment securities, which includes both stocks and bonds.

Why is this distinction important?  If stocks and bonds are more or less substitutes, then anything that changes the price of bonds also tends to change, in the same direction, the price of stocks, and vice versa.

As interest rates go up, the price of bonds goes down.  So rising interest rates should exert downward pressure on stocks as well.

For government bonds, that’s the end of the story.  Not so for stocks, however.

The Fed only  raises interest rates when economic activity–and thus corporate profits–are expanding as well.  Rising profits tend to put upward pressure on stock prices, offsetting part or all of the negative force of rising interest rates.  One can at least imagine circumstances where interest rates are rising slowly enough, or profits are growing fast enough, that stock prices are either stable or have a rising bias.

bond-stock equilibrium

One can also look at what the equilibrium relationship between stocks and bonds should be.  This is usually done by comparing the interest yield on government bonds with the earnings yield on stocks.  The earnings yield is typically calculated as the annual earnings per share of an index like the S&P 500 divided by the price of the index.  It’s the inverse of the PE ratio.

If we assume that the 2010 earnings per share for the S&P 500 will be 85 and the index level is a bit below 1200, then the earnings yield is about 7.0%, which equates to a price earnings ratio of 1/.07, or 14.

Let’s say that as a result of the rise in fed funds to 2.75%, the ten-year bond yield increases to 5.0%.

The “right” proportion between a unit of yield in the bond market and in the stock market is a function of investor preferences and changes as they do.

If investors were indifferent to whether the earnings came from stocks or bonds (a big if, but more or less the relationship that has prevailed over the past twenty years), equilibrium would occur when the interest yield and the earnings yield were equal.   A 5% long bond would imply a 20 times price earnings ratio (a 5% earnings yield) on the stock market.

Whatever the exact right number for today’s world may be, one can observe that a unit of earnings is available today much more cheaply than has historically been the case in the stock market vs. the bond market.

To sum up:  increasing earnings give stocks some defensive power against rising fed funds and long-bond interest rates.  Also, relative to one another, stocks are priced much more cheaply than government bonds–again arguably giving them some protection against rising rates/lower bond prices.

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