July 29, 2011
July 27, 2011
Comment on Model Portfolio activity
too shall pass. We view the Debt Ceiling sell off as a buying opportunity.
repurchased Ford Warrants at $4 down from our sale price of $5.25 a
month ago. Ford’s earnings yesterday were better than.
added Ingersoll Rand to accounts as the shares dropped 15% in the last
two days on a cautious forward statement after last Friday’s earnings report.
Plc engages in the design, manufacture, sale, and service of a portfolio of
industrial and commercial products in the United States and internationally.
The company’s Climate Solutions segment delivers refrigeration and
heating, ventilation, and air conditioning (HVAC) solutions. It offers various
products, services, and solutions to manage controlled temperature environments
for transport and stationary refrigeration markets and the commercial HVAC
markets. This segment offers its products under the Hussmann, Thermo King, and
Trane brand names. Its Residential Solutions segment offers mechanical and
electronic locks, energy-efficient HVAC systems, indoor air quality solutions,
advanced controls, portable security systems, and remote home management
products to homeowners in North America and South America. This segment offers
its products under the American Standard, Schlage, and Trane brand names. The
company’s Industrial Technologies segment provides compressed air systems,
tools, pumps, fluid handling systems, and golf and utility vehicles. This
segment offers it products under the Club Car and Ingersoll Rand brand names.
Its Security Technologies segment provides electronic and biometric access
control systems and software, locks and locksets, door closers, floor closers,
exit devices, steel doors and frames, portable security devices, decorative
hardware, and cabinet hardware, as well as time, attendance, and personnel
scheduling systems. It serves commercial and residential housing markets;
healthcare, retail, maritime, and transport industries; and educational and
governmental facilities. This segment offers it products under the CISA, LCN, Schlage,
and Von Duprin brand names. Ingersoll-Rand sells its products through
distributors, dealers, and large retailers. The company was founded in 1905 and
is based in Dublin, Ireland.
added Juniper Networks today. Juniper is off 20% today and 50% in the
last three months and we think that is enough punishment for a 5 pennies
earnings miss this quarter.
Networks, Inc. designs, develops, and sells products and services that
provide network infrastructure used for the deployment of services and
applications over a single Internet Protocol (IP) based network worldwide. The
company’s Infrastructure segment provides routing and switching products that
control and direct network traffic. Its products include IP routing and carrier
Ethernet routing portfolio, and Ethernet switching portfolio comprising
T-series, M-series, E-series, MX-series, and EX-series, as well as JCS, TX, and
TX plus products. The company’s SLT segment offers firewall virtual private
network systems and appliances, SRX services gateways, secure socket layer
virtual private network appliances, intrusion detection and prevention
appliances, the J-series router product family, and wide area network
optimization platforms. Its products protect the network and data on the
network, enhances existing bandwidth, and accelerates applications. In
addition, the company provides Junos platform comprising the Junos Space
network application platform and Junos Pulse integrated, multi-service network
client, which enables its customers to expand network software into application
space and deploy software clients to control delivery. It also offers various
other services, such as technical assistance, hardware repair and replacement
parts, unspecified software updates on a when-and-if-available basis,
professional services, and educational and support services. The company sells
its products and services through direct sales force, distributors, value-added
resellers, and original equipment manufacturer partners to wireline, wireless,
and cable operators; Internet content and application providers; businesses;
federal, state, and local governments; and research and education institutions.
Juniper Networks, Inc. was founded in 1996 and is headquartered in Sunnyvale,
Reich has an interesting take on Standard & Poor’s ratings and debt ceiling
If you think deficit-reduction
is being driven by John Boehner or Harry Reid, think again. The biggest driver
right now is Standard & Poor's.
All of America's big
credit-rating agencies -- Moody's, Fitch, and Standard & Poor's -- have
warned they might cut America's credit rating if a deal isn't reached soon to
raise the debt ceiling. This isn't surprising. A borrower that won't pay its
bills is bound to face a lower credit rating.
But Standard & Poor's has
gone a step further: It's warned
it might lower the nation's credit rating even if Democrats and Republicans
make a deal to raise the debt ceiling. Standard & Poor's insists any deal
must also contain a credible, bipartisan plan to reduce the nation's long-term
budget deficit by $4 trillion -- something neither Harry Reid's nor John
Boehner's plans do.
If Standard & Poor's
downgrades America's debt, the other two big credit-raters are likely to
follow. The result: You'll be paying higher interest on your variable-rate
mortgage, your auto loan, your credit card loans, and every other penny you
borrow. And many of the securities you own that you consider especially safe -
Treasury bills and other highly-rated bonds - will be worth less.
In other words, Standard &
Poor's is threatening that if the ten-year budget deficit isn't cut by $4
trillion in a credible and bipartisan way, you'll pay more -- even if the debt
ceiling is lifted next week.
With Republicans in the
majority in the House, there's no way to lop $4 trillion of the budget without
harming Social Security, Medicare, and Medicaid, as well as education, Pell
grants, healthcare, highways and bridges, and everything else the middle class
and poor rely on.
And you thought Republicans
were the only extortionists around.
Who is Standard & Poor's
to tell America how much debt it has to shed in order to keep its credit
Standard & Poor's didn't
exactly distinguish itself prior to Wall Street's financial meltdown in 2007.
Until the eve of the collapse it gave triple-A ratings to some of the Street's
riskiest packages of mortgage-backed securities and collateralized debt obligations.
Standard & Poor's (along
with Moody's and Fitch) bear much of the responsibility for what happened next.
Had they done their job and warned investors how much risk Wall Street was
taking on, the housing and debt bubbles wouldn't have become so large -- and
their bursts wouldn't have brought down much of the economy.
Had Standard & Poor's done
its job, you and I and other taxpayers wouldn't have had to bail out Wall
Street; millions of Americans would now be working now instead of collecting
unemployment insurance; the government wouldn't have had to inject the economy
with a massive stimulus to save millions of other jobs; and far more tax
revenue would now be pouring into the Treasury from individuals and businesses
doing better than they are now.
In other words, had Standard
& Poor's done its job, today's budget deficit would be far smaller.
And where was Standard &
Poor's (and the two others) during the George W. Bush administration -- when W.
turned a $5 trillion budget surplus bequeathed to him by Bill Clinton into a
gaping deficit? Standard & Poor didn't object to Bush's giant tax cuts for
the wealthy. Nor did it raise a warning about his huge Medicare drug benefit
(i.e., corporate welfare for Big Pharma), or his decision to fight two expensive
wars without paying for them.
Add Bush's spending splurge
and his tax cuts to the expenses brought on by Wall Street's near collapse --
and today's budget deficit would be tiny.
Put another way: If Standard
& Poor's had been doing the job it was supposed to be doing between 2000
and 2008, the federal budget wouldn't be in a crisis -- and Standard &
Poor's wouldn't be threatening the United States with a downgrade if we didn't
come up with a credible plan for lopping $4 trillion off it.
So why has Standard &
Poor's decided now's the time to crack down on the federal budget -- when it
gave free passes to Wall Street's risky securities and George W. Bush's giant
tax cuts for the wealthy, thereby contributing to the very crisis its now
demanding be addressed?
Could it have anything to
do with the fact that the Street pays Standard & Poor's bills?
July 21, 2011
Comment on Model Portfolio activity
S&P 500 held at 1330 support on Monday and the moves higher Tuesday and
today with a pause on Wednesday is positive. With the S&P 500 at 1345 at
the close today a move 1% higher move through 1355 in the next few days would
be bullish according to the tech gurus.
Intel was cautious looking forward and INTC shares were
lower this morning although earnings and sales beat. We added shares to
accounts and also added more NVDA when it sold off on INTL comments on PC
Bank beat but dropped and we took a
also picked up shares in Walgreen which was down $2 on the big merger
news in the pharmacy benefits management area. Walgreen’s contract with Express
Scripts expires at the end of the year and traders are betting that WAG will be
injured by having only one company to deal with. Our guess is that the FTC and
Walgreen’s lawyers won’t let that happen.
we repurchased Alcoa $1 lower than our sale price a few months ago.
July 19, 2011
Comment on Model Portfolio activity
added to BankAmerica when it sold off on earnings and also reestablished a
position in Goldman Sachs as it dropped on earnings. Finally we doubled the
position in XLF that we established yesterday.
July 18, 2011
Comment on Model Portfolio activity
value close of business 7/18/2011: $549,328
the future the stock positions in the Model Portfolio will be adjusted at month
end and the value posted only when we have a comment.)
sold all our Aéropostale and a portion of Yahoo and reinvested approximately
60% of the proceeds in BankAmerica. We also repurchased a portion of the SPDR
Financial at $14.54 that we sold last week at $15.08 and added to our KBE
position 5% lower than our last purchases. The financials and banks are unloved
and unwanted. There will be no recovery without them.
also repurchased at $13.85 starter number of shares of Nvdia. We sold it last
month at $17. And we added Ford Warrants at $4.40 that we sold last month at
Below is commentary on current market conditions
from a fellow who's calls have been right on the markets for the
last three years.
Continued Earnings Beats Should Provide Downside Cushion for Equities
Jeff Saut 7/18/2011
In last Monday’s missive I
wrote, “So, my sense is that the S&P 500 (SPX) will spend a few
sessions oscillating between 1320 and 1350 until the equity markets’ internal
energy is rebuilt for a move higher.” Obviously, that view fell apart on the
same day when the SPX closed below 1320 last Monday. Subsequently, there have
been three attempts to recapture the 1320 level, all to no avail; that worries
me. This year the 1320 level has proven to be an important “attractor/repellor”
level. One can see that with a quick perusal of the charts. Accordingly, last
week’s stock market action was not encouraging, at least not to me. It’s not
that I have given up on the idea that the economic backdrop is about to improve
despite last Friday’s disappointing sentiment figures -- I haven’t. Indeed, I
think a lot of things are geared to go right once the debt ceiling crisis is
resolved, which I can’t imagine will not happen. To be sure, the Japanese supply
side disruptions are abating, as witnessed by last week’s numbers. Then too,
crude oil prices have declined from~$115/bbl. to ~$97 as the world’s “mean men”
seem to be falling like dominoes. Auto production is slated to ramp by 23%+
this month and capex should surge since the 100% expensing option goes away in
2012. Of course, a resolution of the debt ceiling crisis is likely going to be
accompanied by a scaling back in governmental expenditures, which should give
entrepreneurs and businessmen the belief that deficits are being tackled. As
for the recent employment report, the June employment report is historically
fickle. What you have is students leaving jobs taken while attending school and
heading for home.
Weakness during job recoveries
has happened before. In 2004, 2005 and 2006, which were the second and third
years of prior recoveries, there were also monthly disappointments in job
growth. Moreover, there were screwy seasonal adjustments in the recent
employment data. For example, without seasonal adjustments, payrolls rose by
some 376,000. Surprisingly, the government’s seasonal adjustments reduced the
adjusted employment figures by an eye-popping 358,000. Further, the official
employment numbers are in sharp contrast with the ADP employment report.
Typically, when I am confronted with such conflicting numbers, I turn to the
charts because in this business “price” is reality. So I pose the question, “If
the employment numbers and the consumer sentiment numbers are so bad, why did
the S&P Consumer Discretionary Index and the S&P Retail Index
tag new all-time highs last week?” Surely, that’s a valid question and one
worth consideration before one dismisses the U.S. consumer as totally kaput.
Over the past three weeks I
have traveled through Europe (for two weeks) and spoken at Raymond James’
National Conference (last week). My message has been pretty consistent – I have
been relatively optimistic on the equity markets, the employment situation, and
the economy because of the explosion in corporate profits. In the real world,
profitable companies hire and unprofitable companies fire employees.
Manifestly, the way the world works is that profits explode, fostering an
inventory-rebuild cycle. With the Inventory to Sales Ratio back down to the
recession levels of 2008, it is reasonable to believe we will get some sort of
kick to the economy from an inventory rebuild. That, in turn, drives a capital
equipment cycle (capex), which should be enhanced by the aforementioned
factors. When companies spend money on capex they typically begin to hire
people and the economy improves. So why has job growth evaporated over the past
few months? I continue to think it is because of temporary factors like
Japanese auto part shortages, surging material and gasoline prices, the world’s
sovereign debt debacle, and the weird weather.
Recall, it was roughly a year
ago when I began talking about the potential for some really weird weather. At
the time people dismissed me as another Joe Granville, who lost his stock
market guru status by predicting an earthquake that would make Phoenix “beach
front” property. Nevertheless, I opined that the La Nina weather pattern,
combined with more volcanic ash in the atmosphere than anyone can ever
remember, was going to give us a very cold/wet winter with weird weather that
should foster droughts, floods, hurricanes, and tornadoes. The culprit driving
the weird weather was a huge shift in the Hadley Cell Winds (see previous
reports for an explanation), which were affected by said La Nina and volcanic
ash. Subsequently, I recommended being “long” energy stocks. While I was
laughed at by the folks in the Northeast and Midwest last summer, they are no
longer laughing. Regrettably, while the La Nina pattern is going away, it will
return this fall. Additionally, while there is little news coverage about
another Icelandic volcanic eruption that is four times worse than last year’s
Eyjafjallajokull eruption, Mount Grίmsvötn’s eruption has spewed 4x as
much ash and chemicals into the troposphere as last year’s eruption. This is
certain to cause a change to the northern hemisphere’s weather. Accordingly,
expect a busy hurricane season with damage to oil/gas production facilities in
the Gulf of Mexico. Currently, parts of the U.S. and China are being plagued by
droughts, while other regions are experiencing floods and violent storms.
Expect another very cold winter. Agricultural crop yields, especially wheat,
should be affected negatively. Interestingly, the drought has caused Norwegian
hydro-electric generation to be down by two-thirds with attendant investment
implications. Also, the Rhine River (I was just there) is so low barges are
operating well below capacity. All of this has major investment implications.
The call for this week:
Last Monday proved to be a 90% Downside Day whereby 90% of the total volume
traded came on the downside, while 90% of total points were likewise negative.
Typically, 90% Downside Days are followed by rally attempts lasting five to
seven sessions. Obviously, that wasn’t the case last week and it concerns me.
Also concerning is the fact the often-mentioned 1320 level was violated, and
despite the three separate rally attempts that were staged to recapture 1320,
it was all of no avail. This brings us to this week, where 2Q11 earnings
reports will be Wall Street’s focus. Worth noting is that of the 31 companies
that reported last week, 74% of them beat estimates. Unfortunately, 15 of those
“beating companies” rallied, while 17 declined. Still, if the number of
earnings “beats” continues, it should provide some kind of downside cushion for
equities, provided the debt ceiling “thing” is resolved. Also of note is that
there are a host of technical “timing points” due this week. Accordingly, while
we are disappointed, we have not given up on our bullish “call,” at least not
yet. That could change, however, if the SPX breaks back below 1295.
Editor's Note: The above
article was written by Raymond James Chief Investment Strategist Jeff Saut.
positions in stocks mentioned.
July 15, 2011
July 14, 2011
Comment on Model Portfolio activity
the failure of yesterday’s strong rally and the weakness of this mornings
attempted move higher we decided to sell half our positions in Hewlett Packard,
Ford, Cisco, Nokia, and GE. All the positions sold were large in relation to
accounts. The markets just aren’t acting like they have found a bottom yet. The
major measures are still positive on the year and may have to visit the
negative side before the correction runs its course.
when the pain gets too great and we reduce positions the markets rally. This time our guess is that the ‘deficit’ media circus will
continue to depress stocks prices. Negativity gets ratings and it does affect trader/investor
psyches - including our own. And the politicians can stay in the limelight for
the next two weeks by dragging negotiations out till the last minute.
July 13, 2011
Comment on Model Portfolio activity
the debt ceiling issue is settled the High Frequency Traders will control the
markets. Of course we like it when they push prices higher but….
sold The Talbots common and now only own the warrants which are worthless
unless Trudy Sullivan can figure out how to sell clothes. We have 4 years for
her to do this- unless she sells the company to get another bonus- if she can
find someone dumb enough to buy it.
also added KBE, the large bank ETF to accounts ahead of earnings by these banks
over the next two weeks. We believe the markets can’t go significantly higher
without the major banks- thus the reason for our purchase.
the sale of XLF, the Financial ETF, yesterday the cash levels in accounts are
July 12, 2011
Comment on Model Portfolio activity
sold the SPDR Financial for a scratch profit to replenish cash in accounts and
added a few shares of Nokia. If the market
bottoms here we will give up some gains but we want the cash as a cushion in
case more work on the downside occurs before the Debt ceiling is raised when
the politicians decide there has been enough pandering and grandstanding.
July 11, 2011
July 8, 2011
Comment on Model Portfolio activity
switched Medtronic to Nokia and Ford.
The major markets indexes are
down 1% this morning because the June Monthly Employment Report said only
18,000 jobs were created. 57,000 where created in the private sector and there
was a loss of jobs in the public sector.
The Wall Street gurus can’t have
it both ways. They want government to quit spending which means job losses in
the government sector- while at the same time selling stocks when the
Employment report shows a net loss of jobs because of job losses in the
The Kabuki Theater will continue
with the deficit until a deal is announced that will kick the major budget cuts
eight years down the road (it’s a ten year plan). There will be time for the
Congress to adjust spending when that time comes.
See Krugman today:
Enjoy the weekend.
July 7, 2011
Comment on Model Portfolio activity
Dictionary.com word of the day
futilitarian \fyoo-til-i-TAIR-ee-uhn\, adjective:
that human hopes are vain and unjustified.
Futilitarian is a satirical coinage from the 1820s combining
"futility" and "utilitarian."
in many politicians seeking compromise for the good of the country as opposed
to their individual needs for reelection.)
repurchased part of our Nokia position lower after the dust of last quarters
report has settled.
July 6, 2011
Comment on Model Portfolio activity
American Eagle Outfitters:
A Prime Buying Opportunity for Value Investors
Value investors like to look
for good stocks that have fallen out of fashion with the market, and there is
one such company today whose business is to remain very much in fashion.
American Eagle Outfitters (AEO) is a clothing retailer that
targets the 15-25 year old demographic of image-conscious young men and women
in the United States. They currently operate three brands: heritage American Eagle,
Aerie, which sells dormwear and intimates for women, and 77kids, a new concept
designed for children 14 and under.
Along with Aeropostale (ARO) and
Abercrombie & Fitch (ANF), American Eagle is one of the three players that
form the triumvirate of so-called "teen apparel retail" in America, a
label more apt perhaps for Aeropostale, who markets to teenagers exclusively
than the other two, who also target older and more sophisticated consumers in
Since its IPO in 1994,
American Eagle's stock has been on a tear, reaching all-time heights in the
$30s in 2007. Its story took a turn for the worse when the recession hit,
consumer discretionary spending fell, and the company's profits followed suit,
as it was forced to resort to heavy markdowns to clear its inventories. The
stock dropped like a knife and never recovered, closing last week at a price of
$12.99, a shadow of its former valuation. I believe that at this price point,
American Eagle trades at a significant discount to its underlying value, and
offers by far the best buying opportunity compared to its competitors today.
When looking for bargains in a
depressed economy, we must first make sure that a company's decline in earnings
can be attributed mostly to the cyclical downturn and not to any game-changing
deterioration in the fundamentals. I believe this to be the case with American Eagle.
By evaluating its performance
in contrast with that of its competitors, a clear pattern emerges. According to
the average price points of their assortments, the big three teen retailers are
ranked like so: Aeropostale at the bottom, with the cheapest clothes, American
Eagle sandwiched in the middle, and Abercrombie at the top, with the most
expensive threads. Since the economy's collapse in 2008, their respective
financial performances inverted in relation to their prices as the consumer
budget tightened. Abercrombie saw its same store sales decline by a whopping
28% over the next three years, American Eagle's fell 15%, and Aeropostale, as a
countercyclical performer due to its low cost assortment, saw its comparables
actually rise 23%.
More comparisons: Gap's (GPS) comps
dropped 19%, Macy's (M)
fell 5%, and Hot Topic's (HOTT)
fell 9%. As a medium to high-priced retailer, American Eagle's decline was to
be expected, and not outsized compared to the setbacks the industry as a whole
experienced during the economic downturn. Though consumers have spent less
money at its stores over the past few years, American Eagle's brand equity has
not suffered materially: user reviews at social media site viewpoints.com
awarded the American Eagle brand 4.39 out of 5
stars, and its denim business received an even higher score at 4.46. Reviews
of individual stores at yelp.com generally range from 3 to 4.5 stars for
American Eagle locations in the country's most populated cities. Its flagship
store at Times Square received 4.5 stars,
compared with 2 stars for
rival Abercrombie & Fitch's Fifth Avenue flagship.
The three apparel retailers
are similar in size as well as product offering: all three operate about a
thousand stores in the US. However, their market caps are vastly different: Aeropostale
trades for 1.4 B, American Eagle for 2.5 B, and Abercrombie for 6 B. Though it
has the lowest market cap compared to the number of stores it owns, Aeropostale
also operates much smaller stores, and on a per square foot basis, you're
getting Aeropostale's 3.7 million gross square feet of retail space for roughly
the same price as American Eagle's 6.4 million. Abercrombie is the odd man out
here: though it has slightly more selling space, clocking in at around 7.7
million square feet, its market cap is more than double American Eagle's and
more than quadruple Aeropostale's.
From the standpoint of
trailing P/E, Aeropostale trades at slightly less than 8, American Eagle at
about 16, and Abercrombie at over 33. During the course of my research, I've
found no justification for the premium investors are being asked to pay for
Abercrombie compared to American Eagle and Aeropostale, but I also don't
believe the stock to be overpriced. As a cyclical company, Abercrombie's
current earnings aren't reflective of its average expected earnings power, and
in a rational market, it should trade for a higher P/E during a trough in the
business cycle such as the one we're experiencing now. Instead of Abercrombie
being overpriced, it seems that American Eagle and Aeropostale are bargains
seemingly good value is deceptive: as a countercyclical player, it will not
benefit from an economic upturn nearly as much as its competitors (indeed, its
earnings may even fall as the economy improves and consumers start buying up).
Another concern: the company recently lost Mindy Meads, one of its co-CEOs who was
responsible for a lot of the merchandising. Not one quarter later, Aeropostale's
earnings got cut in half due to poor merchandising decisions, leaving investors
with doubts about whether or not the company can stay on top of fashion trends
without Ms. Meads. So that leaves American Eagle.
American Eagle's trailing P/E
of 16 is misleading - last year's GAAP earnings were reduced due to one-time
charges related to discontinued operations and a non-cash loss from the sale of
its investments in auction-rated securities at a discount. Smoothing out these
adjustments to account for the company's true earnings power, American Eagle
actually trades for a trailing P/E of around 13. For a cyclical company that's
been beaten down by the recession, and consequently is perfectly positioned to
benefit enormously from an economic upswing, this stock is ridiculously cheap.
Peter Lynch has said that he likes to buy cyclical stocks at high P/Es during a
down cycle and sell at low P/Es during an up cycle - American Eagle, at the
price it's trading for today, represents the rare opportunity to buy a cyclical
stock at a low P/E during a down cycle.
There's no reason for a company
to sell for so cheap unless its fundamentals have deteriorated, and American Eagle
remains a fundamentally strong company. It has a fortress balance sheet, with
over $600 million in cash (25% of its market cap) and practically no debt. The
strength of its financials is particularly impressive considering the company's
conservative accounting practices - for example, it depreciates its buildings
over 25 years instead of 30-40 years like many of its competitors, and
equipment over 5 years instead of 10 years. This may be one of the reasons why
the company's total free cash flow over the past three years is 40% higher than
their total earnings over the same time period.
American Eagle's strong
financial position gives it the freedom and resources to capitalize on its
growth opportunities, of which it has several. Though its main brand is
reaching maturity in the US and 77kids is still being run through the
preliminary trials, Aerie has proven to be a successful concept that can stand
on its own, and with only 150 stores across the country, it has a lot of space
to grow into. American Eagle is also beginning an aggressive international
expansion program, with five successful stores in Dubai, Kuwait City, and Hong
Kong and more to come.
Unlike its stores at home, its
international stores operate under a franchise model, which requires no capital
investment for the company and supplies a continuous revenue stream with much
higher margins than their domestic business. These signs all point to one
conclusion: American Eagle is poised to make a significant turnaround when
economic conditions improve, and as such, its shares are remarkably underpriced
Company insiders agree - in
the past six months, insiders have acquired more than half a million shares,
and sold only forty thousand. Two of the biggest buy orders year to date came
from director Jay Schottenstein, who bought 500,000 shares last September, and
director Michael Jesselson, who bought over 100,000 shares at around the same
time. These weren't option exercises - these two insiders spent a combined $8
million of their own money on open market purchases.
What's more interesting is
that these guys aren't your typical insiders. Schottenstein, who previously
served as CEO of American Eagle for ten consecutive years, knows much more
about the company's operations than your run-of-the-mill director. Jesselson is
a seasoned investor himself, and runs New York investment company Jesselson
Capital Corporation. All their shares, as well as shares bought by a number of
other insiders, were acquired at a price higher than the price American Eagle
is trading for today.
Charlie Munger has said that
it's important to always invert, or to look for reasons why you shouldn't buy a
stock when you're analyzing it. No investment opportunity is perfect, and
American Eagle is no exception. Its management, though more than adequate,
isn't stellar. While the company never posted a quarterly loss during the
recession, which is admirable in its own right, competitor Gap actually managed
to increase its earnings every year during the economic downturn, in the face
of declining revenues. However, Gap is the exception, not the rule, and it has
its own set of problems to deal with, though inefficient management isn't one
American Eagle's management
has since recognized the drag their bloated SG&A is taking on their bottom
line and has begun to initiate cost-cutting initiatives. Though some weight has
been shed from their operating expenses in the last few quarters, only time
will tell how effectively they can execute on this strategy in the longer term.
Another thing to watch for: management has recently indicated that they're
monitoring about 100 underperforming stores across the country and evaluating
the possibility of closing some of them down over the next five years in order
to clean up the company's operations. The impact this move will have on the
company's bottom line remains to be seen.
When performing an equity
analysis, the conservative investor should make cautiously optimistic
projections for the upside and forecast the downside as pessimistically as
possible in order to retain a margin of safety. Even under such a scenario, I
believe American Eagle Outfitters to be a prime buying opportunity for value
investors at today's prices. With an unassailable balance sheet, great brand
name, and profitable opportunities for expansion both at home and abroad, the
company is poised to witness a massive rally in its shares when the broader
economy picks up. And with a 3.4% dividend yield, investors can afford to wait
until it does.
am long AEO.
Hewlett-Packard: A Mean
Reversion Strategy for Patient Value Investors
Hewlett-Packard (HPQ) makes a
lot more sense if you temporarily tune out the market, the analysts and the
commentators and consider the phenomenon of mean reversion. Mean reversion
isn't infallible, but over any substantial period of time it's a force to be
reckoned with. In HPQ's case, the probability of mean reversion is enhanced
because management has correctly identified the company's issues and is in the
process of resolving them.
Mean Reversion - The Numbers
Projected 5 year average EPS,
using 4 years actual plus revised GAAP guidance of 4.17 for 2011, works out to
3.79, after adjusting for the fact that share counts have been decreasing at 4%
per year. Over the past five years, which include the financial crisis, HPQ has
traded at an average PE5 of 19.8, very close to the 20 that is typical for high
quality. At recent prices in the 37 area, the company is trading at a multiple
of 9.8 on that metric.
As a point of reference,
Benjamin Graham recommended that conservative investors should not pay more
than 15 X some long term average EPS, either 5 or 7 years. I've had good
results working with this rule of thumb, typically buying at or below 15X and
selling around 20X. For cyclical or lower quality companies 12 X is more appropriate.
Applying a multiple of 15 to
projected 5 year average EPS, I arrive at a mean reversion target of 15 X 3.79
= 57, by the end of 2012. From a price in the 37 area, that implies an annual
return of 33%, to which could be added a 1.3% dividend.
Issues and Opportunities
Hewlett-Packard has issues
(most value candidates have issues), however the company also has
opportunities. The analytical task is to determine whether management has
identified the issues and opportunities, developed a plan to address them, and
marshaled the resources to implement the plan.
CEO Léo Apotheker's
prescription for Hewlett-Packard has been evolving as he becomes more familiar
with its operations. His initial approach, as reflected in the letter to
shareholders (with the 2010 annual report)
was "steady as she goes." By the time of the HP Summit presentation
on 3/14/2011, he was presenting a common-sense, broad-brush approach, and
focused on the opportunities:
Build and manage cloud-based
Enable seamless transition to
Define and deliver the
connected world from the consumer to the enterprise
The FQ2 2011 earnings conference call,
preceded as it was by a leaked email to
senior management, highlighted two problems:
Some members of senior
management were not on board for the planned strategy (the reason for the
Revenues, margins and earnings
are not developing as expected.
There has since been a management shakeup,
and individuals reporting directly to Apotheker can be expected to stay on the
On the more complex issue of
revenues, margins and earnings, discussion can be interpreted to indicate that
necessary investments (to include personnel) in the Services segment were not
made. Hewlett-Packard needs to have additional resources in place to provide
what customers are asking for. This is entirely consistent with the big picture
evidence provided by examining the EDS acquisition and its aftermath.
Briefly, EDS was a sinking
ship when acquired; revenues were declining and the company operated at a loss.
Revenues for the last full year were 22 billion, but when added to HPQ's 2008
revenue of 104 billion, the result was 2010 revenue of 114 billion. HPQ was
profitable during this period, which included the financial crisis.
The EDS business was
predominantly services. It is easy to envision a meat-cleaver approach to
cost-cutting and restructuring the struggling acquisition. It is possible that
muscle and bone were cut, in addition to the fat. The discussion of "investment"
simply highlights the obvious, that resources must be available to meet
ordinarily refers to the expenditure of money to acquire assets, preferably
tangible, along the lines of capex. From a bookkeeping point of view, you
credit (decrease) cash and debit (increase) assets.
management will sometimes use the word in a different sense, where the
investment takes the form of expenditures on hiring, sales salaries, research
and development, etc. The bookkeeping is, you credit (decrease) cash and debit
(increase) expenses. This has the effect of reducing reported earnings. It's
not really all that popular on Wall Street.
The conference call includes
many instances using the word in its second, less acceptable sense:
We continue to make
investments in the business with new innovations and incremental R&D
Second, we will accelerate
portfolio investments in higher value-add services. We will deepen industry
content and form a Business Solutions Group to create more strategic value for
our customers. We will enhance our Services offerings in emerging areas, such
as cloud services and consulting, application modernization, business analytics
Total operating expenses were
$4.2 billion, up 10% year-over-year, with increases in R&D and field
selling costs, both of which are expected to enable revenue growth in coming
quarters. As we have said before, we actively monitor and evaluate all
investments against key milestones as we work to achieve our objectives and
deliver results for shareholders.
In Q3 of fiscal '11, we expect
Services margins to be 13.5% to 14% as a result of lower revenue growth in
local currency, unfavorable mix and investments we are making to further enable
Industry Growth Rate Favorable
Research firm Gartner, a
respected source of industry information and estimates, has increased their
2011 estimate for tech spending, from 5.6% to 7.1%. Hewlett-Packard is an
important force in the industry and can be expected to participate.
Apotheker is correct in his
diagnosis: Investment is required. Margins will be reduced, hopefully on a
temporary basis, until revenue ramps to cover expenses. Hewlett-Packard has the
financial resources to implement this corrective action. Internal impediments
to constructive solutions have been addressed. When the appropriate human and
technological resources are in place HPQ will participate favorably in expected
industry growth and regain lost stature.
Obviously this conclusion must
be verified by future performance. The investor can monitor presentations and
conference calls on a regular basis, looking for evidence that the appropriate
actions are being taken. Earnings, for the short term, are secondary. Remember,
these investments will be booked as expenses.
An analyst meeting is planned
for September, at which point management can be expected to have some
visibility into FY 2012.
Strategy for Investors
With a 1.3% dividend, strong
balance sheet, steady reduction of share count, and corrective action in
process of implementation; the stock is suitable for patient value investors,
based on a mean reversion strategy. As discussed earlier in the article,
corrective action needs to be monitored for implementation and efficacy. ….
…….Disclosure: I am long HPQ Jan 2012 32.0 calls, short HPQ Aug
2011 41.0 puts and HPQ Nov 2011 35.0 puts
July 5, 2011
July 1, 2011
We plan on being in business for at least the next twenty years
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Summary of Business Continuity Plan