Friday, July 31, 2009

Compass Minerals Leaps Up On Upgrade

Compass Minerals closed up 5.22% today, on the strength of an upgrade from J.P Morgan. That was the same stock I analyzed night before last. I concluded that it was a speculative low P/E growth stock that could be attractive if the winter weather co-operates and farmers become more prosperous.

It would take a bit of brass on my part to say that I influenced that report. It would also be somewhat improbable, as professional-level research reports usually aren't whipped up over a day and a night. This summary of it shows an attention to the details of the company and its markets that I can't really muster.

So, even if I did have an influence, I have to concede that I was definitely bettered by analysts' standards.

On the other hand, I can brag about my timing. That's one advantage to being in the amateur league: I can put 'em out quicker.

Disclosure: Despite its speculative nature, I did put Compass in the actively-managed Marketocracy mock fund I run. I'm one of those who think that the winter weather will be bad and earnings on the farm will be good.

Daily Wrapup For July 31st

[Note: Corrected oil price and associated commentary.]

July is one of those months whose end coincides with the end of a week. It was a good month for the stock market, and the past five months have been great ones. Reuters put out an item entitled "S&P 500 sees best 5-month streak since 1938." Today didn't make for very much of a capper for what was a good month, though. Two of the three major averages barely eked out a gain, and the NASDAQ was down 0.29%. It wasn't a bad day, however: except for a brief blip around 10 AM ET, the Dow and the S&P 500 both were in upside territory. So was the NASDAQ except for the last twenty minutes or so. Oil was well up on the day, breaking the short-term correlation between it and the major averages. Gold also gained: at about 11:45 AM, in a matter of minutes, it leaped up more than $15. Evidently, word has spread about the healing economy; so have speculations about what will follow.

The lowest-quintile cut-off for the Low P/E Bin barely budged today, but it did move upwards from yesterday's 10.92 to today's 10.93. The S&P dividend yield dropped marginally to 2.73%. After ETFs and stocks with less than 500M market cap were dropped out, as well as those with yields of 10% or greater, the Bin was left with ninety-one stocks for a gain of two. Here are today's changes in the Bin, as dash-listed below:

- Financial Federal Corporation
- The Laclede Group, Inc.
- PartnerRe Ltd.
- Pitney Bowes Inc.


- Tenaris S.A.
- Norfolk Southern Corp.

Financial Federal got back in the Bin through plain old P/E compression: it dropped 0.64% today. PartnerRe is a newcomer to the Bin, which got in because its yield became slightly higher than the Bin's cut-off. Laclede came back in because its latest quarterly earnings didn't impress; it dropped 1.81%.

The last Arrival, Pitney Bowes, got in the bin through a "slight disappointment." Although the company declared its regular dividend, and reported quarterly earnings that were 9.5% below the same quarter's from a year earlier, it lowered its full-year '09 guidance to well below the Street consensus. That consensus was for $2.46; the guidance was for $2.09 to $2.29. Consequently, the stock got hammered today. It opened down 10% from yesterday's close, and sunk further to close at $20.65 for a decline of 12.13%. Given the guidance and the plummet, it looks like Pitney will be in the Bin for a long time.

The two Arrivals both got out through P/E expansion. Norfolk Southern left because its 12-month trailing earnings dropped to the point where its P/E went above the cut-off. Tenaris got out for a more unambiguously cheery reason: it gained 3.48%, which put its P/E above the Bin's cut-off. There was no news to explain Tenaris' rise.

Another gainer, though, did have some news to explain why. Fairfax Financial rose 5.01% today on the strength of earnings that were both better than expected and way above the same quarter's last year. The stock was stuck in a range since early June, spanning from about $243 to $260, but broke that range almost two weeks ago. Today's it closed at $304.63. Fairfax's P/E is actually quite low, evidently because the market thinks its recent good fortune will not be sustained. (Also, Fairfax's earnings are quite volatile. It's reported two annual losses in the last ten years, for 2001 and 2005, which were both marked by a major disaster.) So far, however, an EPS downtrend in Fairfax has not made itself evident.

That's all for today's Wrapup. Thanks for reading, and enjoy the first weekend of August.

Thursday, July 30, 2009

Daily Wrapup For July 30th

The three major averages got off to a quick start after opening only with a slight gain. By 10 AM ET, all three were up well above a 1%; shortly afterwards, the S&P 500 made it above 2%. Unlike in recent days, there was no last-minute push upwards; instead, the averages fell until their gains for the day straddled 1%. Reports ascribed the leap-up to continuing good news on the earnings front; this one suggests that a string of Street-beating reports shows an economy on the mend. It also points to an unexpected drop in continuing unemployment claims. Another factor was a surprise leap in oil prices: light sweet crude closed up $3.66, or 5.7% on the day. That gain more than reversed yesterday's loss.

The lowest-quintile P/E cut-off also rose today, to 10.92. As a consequence of the S&P's 1.19% rise, the yield on the index dropped to 2.74%. Once ETFs were gotten rid of, along with stocks with market caps of less than 500M or yields of greater than 10%, the Low P/E Bin was left with eighty-nine stocks: one fewer than yesterday. Here are the changes in the Bin, as dash-listed below:

- Anglo American plc
- Hugoton Royalty Trust

- BP plc
- Cal-Maine Foods, Inc.
- CVB Financial Corp.

Both Arrivals are Bin veterans that have returned from a short exile. Anglo-American is back in because its own yield rose above the S&P yield cut-off. Hugoton's back because its market cap rose to more than 500M.

The Departures used to be Bin mainstays too. BP got out because an earnings drop pushed its P/E to well above the lowest-quintile cut-off. Cal-Maine was pushed out for a different reason: its yield fell well below the S&P cut-off. CVB could be said to have graduated from the Bin, if its Departure proves not to be temporary. Its run-up continued today, to the tune of 6.31% in regular trading; its P/E got pushed well above the respective cut-off. What a difference an earnings report can make: the last time CVB was cut out, it was because the company's market cap fell below 500M. During that time, it made a 52-week low. Only Sunoco managed to do so too in the time the Bin's been in existence, and the latter stayed in the Bin while doing so.

Speaking of earnings, Bin stock Carpenter Technology Corporation announced an awful quarter. Its 2Q '09 EPS was -34 cents/share, and its loss from continuing operations was 48 cents per share. Both were much worse than the expected loss of 28 cents per share. Revenues fell 58% year-over-year. Management made some positive comments about the rest of the year and 2010, which brought some relief. These earnings were released before the bell: as of market's open, Carpenter stock was down 67 cents from yesterday's close.

Then, something funny happened on the way to damnation. Within minutes of the open, Carpenter shot right up. By 10 AM ET, it was riding a gain of $1.47, or 8.50%. Although the stock drifted downwards through the late morning and afternoon, to close with a gain of 4.40% in regular trading, the stock's reversal right after the open was stunning. It could have been caused by the mollifying guidance, it could have been the declaration of a regular dividend in spite of the loss. Given recent market action, the latter explanation is the more likely one. Nevertheless, Carpenter's reversal today stands as a mute example when Mr. Market's erratic gyrations call for the word "overdiscounted" to be used.

That's all for today's Wrapup. Thanks for reading, and may your surprises all be understandable ones.

Disclosure: The actively-managed Marketocracy mock fund I run has CVB in it; it does not have Carpenter Technologies.

Compass Minerals: A Low P/E Bin Oddity

The general market may have been down yesterday, but Compass Minerals was not. It rose 5.99%, although that gain was shaved with a 1.00% decline in after-hours trading. The company reported 2Q '09 earnings after the bell two days ago that were well above 2Q '08's. That report provided the catalyst for Compass' shares to shoot up yesterday.

Compass Minerals is a miner of rock salt and sulfate of potash, and it buys other products that are compatible with its main lines of business. It's only been a public company since 2003, and a complete set of available financials for it goes back to 2002. During the time it's been a public company, its EPS growth (as measured by logarithmic regression) has been an eye-opening 30.93%. These results have been skewed somewhat by 2008 earnings that were nearly double 2007's. Still, the first two quarters of 2009 show further EPS growth taking place.

Compass' latest 10Q report, for 2Q '09, shows something rather odd for today's revenue-nervous Street. Its revenues decreased 2% in 2Q '09 as compared with 2Q '08, and revenues in the first half of '09 have sunk 14% as compared with the first half of '08. Given today's fashions, this drop should cause concern. However, its gross margin has increased during those timeframes. 2Q '09's gross margin is 11 points above 2Q '08's. The same 11-point jump took place between the first half of '09 with respect to the first half of '08. And this, in a market where Compass' sulfate of potash sales are down because of price concerns amongst its agricultural customers.

Those who are used to seeing a current ratio 'supplemented' by a standby line of credit will find a pleasant surprise in Compass' balance sheet. As of June 30th, Compass' current ratio was 3.21. Using a strict form of the quick ratio, in which all current assets save cash and accounts receivable are excluded, Compass has a number of 1.17. This, from a company whose inventories are likely not to plummet in price as a result of fashion changes. Compass' working capital is equal to more than half of its long-term debt.

There's one easily-found trouble spot in its balance sheet. Compass' debt-equity ratio, including short-term and current long-term debt, is 3.42 times shareholder's equity. This ratio is so high in large part because Compass' shareholder's equity has been negative from 2002 to 2007*. Its long-term return on equity figure is meaningless as a result, and its more recent return on equity figures are misleadingly high. The fact that it has a lot more debt than equity is a concern, as a debt equity of 1 to 1 is the high point of safety.

This weak point can be balanced with the debt-to-working-capital ratio, which is a much lower 1.90. The earliest due date on its long-term debt is 2012. although 80.8% of its debt ($395.2 million) is due in that year.

The last annual spurt-up in EPS before 2008's was 2004's 33.9% gain over 2003's. This gain reversed in 2005, when earnings got knocked down to below 2003's level. In 2006, though, EPS shot back up to over 2004's. This can be taken as a sign that derailed EPS growth will not be permanent, or as a sign that Compass' EPS is quite volatile. 2005's started out below 2004's right from the first quarter; 2009's first two quarters are both above 2008's. Nevertheless, there is a chance that the last two quarters of '09 will not be above '08s. A relatively mild winter could knock down EPS in the fourth quarter, for example.

Another weak point on its balance sheet, from a value-investing perspective, is its book value. Excluding intangible assets, Compass' equity per share is a mere $3.47. Its close in last evening's after-hours trading was $51.51. At that price, Compass is selling at 14.8 times book value.

It's a very high overage, and the reason is the same as for the high debt-equity ratio and misleadingly high near-term return on equity ratios. Compass started off as a public company with a large shareholder's deficit*, for whatever reason**, which has made for its weakness in two standard value investor's ratios.

On the other hand, its dividend is relatively safe. Compass currently yields 2.73%, and the dividend has increased in every year it's been a public company. From 2005 to 2007, its free cash flow was less than double its dividend-payout expenditure. In 2008, though, free cash flow was more than four times' dividend expenditure. For the first half of 2009, free cash flow was about 2.5 times dividend disbursements. Compass has not had a long record of free cash flow being well above dividend disbursements, which makes for another cautionary sign for a value investor. On the other hand, its recent record does show a nice margin of safety.

There's another, more earnings-related, weak point in Compass' most recent balance sheet: as of June 30th, inventories have shot up 63.5% from Dec. 31st's level and 49.2% from March 31st's level. This ramp-up seems seasonal. 2Q '08's inventory level was 67.4% higher than 1Q '08's; that earlier ramp-up did not portend a drop in earnings for the rest of '08 or even the for the first two quarters of '09. 3Q and 4Q revenue growth justified the increase. The company clearly is expecting that seasonal growth to continue this year. If that expectation is not met, however, then Compass will be stuck with a lot of inventory. Revenue for the first half of '09 has grown nowhere near the rate that inventory has, even if annual revenue growth has grown 18% from 2005 to 2008.

For this metric, standard interpretation says "stay away." Even if the reason is merely seasonal, its inventory bulge for the first half of this year - on the heel of declining revenue in the same timeframe - sends out warning that Compass might very well stumble soon. The only point of doubt comes from the seasonality factor.

Putting all of the above together, it's evident that Compass is an oddity in the Low P/E Bin: a low P/E speculative growth stock. It's selling at way above its book value. One of its solvency metrics is horrible, even if its liquidity position is great from a value investor's perspective. Its EPS growth is quite high, and its most recent results show no sign of a stumble. Compass is one of those companies with a current knack for expanding gross margin in the teeth of a current revenue drop. Its inventory level, although perhaps seasonally justified, is disturbingly high relative to 2008's and its revenue for the first half of 2009.

The inventory factor is what makes Compass a speculative low-P/E growth stock. In the near term, the speculative element is the weather. If this coming winter if going to be mild, Compass will be stuck with a lot of inventory that it can't unload. If this winter's going to be a cold and snowy one, however, the inventory problem will disappear like 2008's 2Q bulge did.

Ove the longer term, another speculative element is a pickup in demand for Compass' sulfate of potash fertilizer products amongst its agricultural customers. According to the company's most recent M D & A, price sensitivity is the current factor damping demand for this segment. Compass' target customers are evidently not prosperous enough to not worry about the expense. If they become so, then the company will have no trouble selling its specialty fertilizer even at current record prices. So, the second speculative element is the hope that Compass' farmer and turf-seller customers will become prosperous again. To put it another way, Compass is in part a speculative bet on agricultural commodities going up further.

Putting it all together, Compass looks like a great stock to someone who believes that: a) Compass' growth record, not impugned since 2005, will continue; b) the coming winters will be cold and snowy, and winter road conditions will be bad enough to further boost demand for Compass' rock salt; c) agriculture is in for a boom, creating upped demand for Compass' sulfate of potassium specialty fertilizer. For someone who believes that roads won't need that much winter treatment in the future and agriculture won't be entering a boom anytine soon, or that Compass' recent record won't be continued for other reasons, Compass' inventory jump-up sends out a red-flag warning.

A value investor, on the other hand, would shy away from Compass because of its low shareholder's equity. That paucity not only makes for a very high debt-to-equity ratio, but also for a very low book value per share relative to the stock's current price. Although it has a record of increasing its dividends, its free cash flow cushion hasn't been all that great until last and this year. That's not enough of a change in ways to make a true value investor comfortable - and the yield isn't all that high anyway.

What to make of this stock is up to the reader. The above analysis, I hope, managed to clarify what kind of an opportunity Compass represents, for what kind of person, as well as clarifying any cautionary or warning signals from the company's financials.

One more point: Compass has more than $10.2 million in net losses from interest-rate- and natural-gas-price derivatives that it intends to bring on the books as expenses in the near future. Those losses represent a drop of 31.3 cents' worth of EPS that will show up in the income statement soon. Had they been expensed in 2Q '09, Compass' earnings in that period would have been only somewhat above 2Q '08's. If natural gas prices keep dropping, then there will be more losses even though said drop will lower Compass' unhedged natural-gas costs too. Given that 2Q EPS was 42 cents as compared with 2Q '08's 5 cents, even though revenue did drop in the same timeframe, it's safe to assume that Compass will be a net beneficiary from a further natural-gas price drop. I note this point to show that Compass' EPS is going to be sliced downwards by 31.3 cents in the near future. Had Compass expensed the losses last quarter, EPS would have been 10.7 cents - still a gain from 2Q '08's, but far below the reported one.

[Note: I have to remind everyone that I'm not licensed as an investment advisor in my home jurisdiction of Ontario in Canada, nor do I qualify for such designation.]


*: Buybacks were not responsible: Compass started off with a large negative shareholder's equity. As of the end of 2003, right after it first started trading, its shareholder's equity was -$128.1 million. As of the end of 2008, shareholder's equity was +64.5 million. Several years of earnings were required to reverse the initial shareholders' deficit. As of 2Q '09, shareholders' equity was +$143.9 million.

**: Your guess is likely to be better than mine. I don't even want to to try to guess why.

Wednesday, July 29, 2009

Banco Santander Disappoints; Barron's Vs. Minyanville

In the next-before-last issue of Barron's, there was a bullish article on Banco Santander. Today, before the bell, it announced second-quarter earnings that were down 4% from 2Q '08's. An increase in provisions for non-performing loans was the drag-down. The rest of its segmentation shows profit increases.

Because the number of Santander's common shares has shot up recently, EPS figures declined more rapidly than net income itself. 2Q '08's diluted EPS was 0.35 euros. Assuming that the number of shares of Santander was the same on June 30th as it was on March 31st., 2Q '09's diluted EPS would be about 0.284 euros. That drop of 0.066 euros, if accurate, means that Santander's 2Q EPS has dropped about 18% from the same quarter a year ago. The 0.284-euro estimate may be optimistic, given that the number of Santander's common shares has increased in each of the last three quarters.

The stock is well above the price it opened at as of the Monday after that Barron's article. Although Santander closed down 1.65% today, and lost a further 1.20% in after-hours trading, its after-hours closing price of $13.69 is 66 cents above July 20th's opening price of $13.03.

Run-ups attract other kinds of hopefuls, though. In the article "Have We Reached A Top?", Minyanville's James Kostohryz disclosed that he was short the stock as of the time of that article's posting (yesterday afternoon). Santander's dropped more than 50 cents per share since the posting of that Minyanville article. Odd that both articles can have a gain attributed, but that's what difference in timing gives you.

Daily Wrapup For July 29th

It was a definite down day for the three major averages. As was the case yesterday, a rally near the end of regular trading kicked in. Unlike yesterday's, though, today's was insufficient to push any of the three into a gain position. All three were in loss territory for today's entire trading session; it was the Dow that fared the best of the three. The S&P 500 fared the worst. Although a lousy durable-goods report contributed to the down day, even if it was partially compensated for by an encouraging Fed Brown Book report on the U.S. economy, the main drag-down was oil prices. Hammered by a surprise leap in inventories, light sweet crude plummeted 5.8% today. The hoped-for demand isn't appearing, at least with respect to inventory drawdown, so the plummet was taken as indicative of a pushed-back recovery process. Despite the recent leap-up in oil, there hadn't been much publicly-expressed bullishness. Now that oil has dropped, there is publicly-expressed bearishness. An example can be found at Yahoo! Finance's Tech Ticker, where an oil trader calls crude "well overpriced." On the other hand, the same la-di-da complacency that accompanied oil's rise to $73 last month wasn't in evidence yesterday or the day before.

Like oil and the three major averages, the lowest quintile for the Low P/E Bin fell today: 10.81, from yesterday's 10.88. The S&P dividend yield remained the same once again, holding at 2.77%. After ETFs, stocks with market caps of less than 500M and ones with yields of 10% or more were eliminated, the Bin was left with ninety stocks; its membership dropped by two from yesterday. Here are the changes in the Bin, as dash-listed below:

- Allianz SE
- Duncan Energy Partners LP

- Hillenbrand, Inc.
- Honeywell International Inc.
- Hugoton Royalty Trust
- Sempra Energy

The first Arrival is one that's been in and out of the Bin before. Allianz is far from its earnings date, but it dropped today as if it had announced a disappointing result. A 2.57% loss on the day was more than enough to lower its P/E to Bin levels. The other Arrival is yet another energy income trust. Duncan Energy, though, is in the business of transportation and storage; although it deals solely in natural gas and natural-gas liquids (so it has no stake in the oil-storage mania), it's similar in business model to Sunoco Logistics Partners. Like Sunoco Logistics, its 2Q earnings were up sharply. In Duncan Energy's case, the resultant bump-up in 12-month trailings was enough to put it in the Bin.

Hillenbrand was one of the few stocks that wasn't down today, at all. Although it closed unchanged, the drop of the lowest P/E quintile was enough to get it out of the Bin. Honeywell was down on the day, but its earnings were down too - enough to push it out. Hugoton's market cap dropped, once again, to below 500M. Sempra, on the other hand, was like Hillebrand: it moved out of the Bin because the cut-off P/E moved below its own.

Like the above-mentioned Bin newcomer, Qwest Communications announced an increase in 2Q earnings. In Qwest's case, it reported 12 cents EPS for 2Q '09 which made for one cent higher than 2Q '08's 11 cents. Despite that gain, and despite indications that it beat the consensus, the report did Qwest no good today: its stock dropped 3.20%, even though that loss was half-reversed in after-hours trading. Qwest's dividend is relatively recent, but its 8 cent-per-quarter payment gives it a yield of 8.14%. After rallying strongly in April, the stock's been a trading range until a little more than three weeks ago, when a break-down established a lower level. It's been in the Bin since inception, and its recent 1-cent gain in 12-month trailing EPS all-but assures it'll stay one if its stock keeps acting in the same way.

That's all for today's Wrapup. Thanks for reading, and may your buying opportunites come quietly.

Notice Regarding Stock Screener And Bin Changes

Lately, I've noticed that Stock Screener is slow to react to earnings changes, and occasionally misses a stock that should be in the Low P/E Bin. I've tried to compensate by manually getting rid of any stock I've found whose P/E has expanded because of earnings drop, but my doing so only covers one part of a proper adjustment. The other part, finding stocks that have entered the Bin because their earnings have gone up, I cannot do. There's too many stocks in the entire Stock Screener universe; if that filter doesn't work properly, I have to search manually. Finding new Bin stocks in the entire stock universe requires too comprehensive a manual search for me to do.

I've decided that working one end of the earning-changes line, but not the other, will introduce a further distorting volatility in the number of stocks in the Bin. A long time ago, I was taught that it's best to be accurate but it's second best to be consistently wrong; the latter is easy to fix and doesn't bollix things up more. In this situation, I cannot be completely accurate; so, I'm going to go back to using Stock Screener without anticipating it anymore.

Tuesday, July 28, 2009

Another Barron's Pan

In its "Weekday Trader" feature, written by Naureen S. Malik, Barron's has panned the Low P/E Bin stock BHP Billiton. The line of reasoning goes something like this: the prices of the commodities Billiton mines and sells have been shooting up lately. So has oil, which Billiton extracts too. They've been rallying on anticipation of returning growth in world demand, as well as China stockpiling, but the latter source of demand is temporary and the former isn't showing up yet. The last time metals had sustained rallies, there was real world growth and a real demand increase underpinning them. Now, there isn't; only expectations have shot them up. Consequently, given the high expectations, there's a real anticipation air pocket in those commodities and the stocks of companies who extract and sell them. If the recovery doesn't go as well or smoothly as the market's currently expecting, both metals and metals companies will fall - perhaps fall hard. There's no guarantee that will be so, but the risk/reward dyad has tilted towards low reward and high risk at these levels.

The argument makes sense, and Billiton has been on a real tear until recently. There's an additional cautionary factor relating to cyclicals in general: commodity, oil and cyclical stocks rarely show up in the Low P/E Bin when they're bottoming. [Peter Lynch made this point in One Up On Wall Street.] That's because the bottom is typically a time when earnings have turned into outright losses for those stocks. They tend to be hustled out of the Bin by then.

In a time like this, it may be a good long-term risk to take in a commodity Bin stock because reflation is clearly the order of the day. Except for the off chance that there'll be deflation this cycle, which the authorities may have overcompensated for, there's a good chance that a commodity stock currently in the Low P/E Bin will show a real long-term gain because the growth-inflation mix benefit industrial metals. Billiton's primary earnings generators are those kind of metals.

Actually, BHP Billiton is a bit of an oddity: had last year seen the top of a long-term commodity bull market, the Bin would have had lots of them. With the exception of Anglo-American, which has currently suspended its dividend, Billiton is the only mining stock in the Bin. On the other hand, oil and gas producers, including income funds and integrateds, outnumber the utilities. Had there not been a clear push towards reflation, I would be worried about that particular subsector.

Perhaps I'm being too easygoing. BP has reported a drop in earnings that's going to shove it out of the Bin. The stock sunk 2.61% in regular trading. [The company beat expectations, though.]

Daily Wrapup For July 28th

Another mostly down day for the three major averages ended with only one of them up: this day, it was the NASDAQ that beat the other two. Both the Dow and S&P were slightly lower, although the former was down more than 1% at the day's low and the other was close to -1%. The NASDAQ was down for most of the day, but managed to rally strongly around 1 PM to push up to about a 0.50% gain by 2:30 PM ET. It fell back to about even later, but a late-afternoon rally pushed it back up to close with a 0.39% gain. The same rally shaved off most of the other two averages' losses. This day, the most featured economic news was a drop in the Conference Board's consumer-confidence reading. Another report, showing that the Case-Schiller housing index turned up as of May, was largely shrugged off. Making things even more muddied, ABC News' own consumer-confidence survey shows an uptick for last week. The Conference Board's index is monthly.

The lowest-quintile P/E cut-off fell today, roughly in line with the Dow and S&P. It dropped to 10.88 from yesterday's 10.92. Once again, the S&P dividend yield remained unchanged. After ETFs and stocks with market caps of less than 500M were eliminated, along with any issue that yielded more than 10%, the Low P/E Bin was left with ninety-two stocks: once again, unchanged from yesterday. Here are today's changes in the Bin, as dash-listed below:

- FirstEnergy Corp.
- Sempra Energy

- Bank of Hawaii Corporation
- SK Telecom Co., Ltd.

Today's Arrivals got back in the Bin through P/E compression. Both FirstEnergy and Sempra are utilites whose P/Es have recently fluctuated around the lowest-quintile cut-off. They've both been the beneficiaries of a relatively unnoticed climb in both natural gas and electric utilities lately, which was interrupted today. FirstEnergy got knocked down 2.57%, without any news to explain it, and Sempra declined 1.09%. The utilities themselves were the third-worst sector performer, dropping 1.10% on the day. Only basic materials and energy fared worse.

Both Departures left because of better than expected earnings. The first, Bank of Hawaii, got out because of a run sparked by its earnings report released yesterday before the bell. After languishing around $35 for the balance of this month, the stock leapt up 8% yesterday after drifting upwards for the last two trading sessions of last week. It closed at $39.18 today, enough to put its P/E above the cut-off. SKM's earnings report was received less dramatically. It announced a 2Q '09 profit last night that was up slightly as compared to 2Q '08, one that was somewhat above expectations. The stock climbed 1.73% today, although a small part of this gain was shaved off in after-hours trading.

One stock that leaped up today was CVB Financial, closing at $7.31 for a gain of 5.48%. When the stock was much lower, although above its 52-week nadir reached two-and-a-half weeks ago, the company announced a secondary offering whose proceeds are to be used for repaying the TARP money it took. That offering was set at $5.90/share, which puts today's closing price at 23.9% above the offering price. Nice gain if you can get it; the underwriters got as many as they could. The over-allotment for the offering was, I need hardly elaborate, taken up.

That's all for today's Wrapup. Thanks for reading, and may you enjoy finding 24% gains by way of the good-old-fashioned means of analysis.

CVB Gets Ready To Get Out Of TARP (Updated)

CVB Financial has announced a stock offering of about $115 million, the proceeds of which are to be used to help repurchase the $130 million in TARP preferreds currently held by the U.S. government..."[s]ubject to approval from the U.S. Treasury and banking regulators" of course.

After closing down 0.97% on July 20th, the stock got hammered a further 5.54% in after-hours trading. Its last trade, as of 5:53 PM ET, was at $5.80.

I still believe that my earlier analysis holds up, although a plummet of that sort does tend to shake confidence. There's no fundamental damage that can come from CVB getting out of TARP, which increasingly resembles a monkey on the back. There are currently 83.3 million shares outstanding, and the offering would add another 20 million at the last trading price. Had it been retroactive to 2Q, its 2Q earnings of 17 cents/share would be 13.7 cents when counting the dilution. The lifting of the 5% TARP burden, though, will save the bank about $1,625,000 per quarter. Had that as well as the dilution factor been applied to 2Q earnings, they'd have been 15.3 cents.

So, as indicated by the above calculation, the offering will be net dilutive. Had it kicked in as of March 31st, all else being equal, it would have diluted earnings by 10%. There's also a financing factor: at CVB's July 20 closing price of $5.80, the dividend yield is 5.87%. If the offering price is the same, then CVB is taking on a 5.87% obligation to get rid of a 5% one. I know of the TARP-strings, and I believe that it's better for the bank long-term, but the additional payout is going to be a drag on retained earnings.

I note in closing that getting out of TARP ain't what it used to be. Instead of the "yippee!", a sense of sobriety is settling in - at least, for CVB. Perhaps the fortunes of Citigroup have something to do with it.


Update: That last paragraph turned out to be somewhat pessimistic given CVB's subsequent performance: two days subsequent to the original post, CVB closed at $6.30.

As it turned out, even though I was using $5.80 as a hypothetical number, I was close to the real offering price and number of shares to be issued. Last night, it was announced that there will be 19.7 million shares offered at $5.85/share. As is often the case in an underwriting, the price was lowballed a bit so as to make the offering attractive. Oversubscribed offerings makes the offeror happy...not to mention the brokers who get an allotment to dispense to their favored clients.

Update 2: As of the end of trading on July 23rd, CVB got up to $6.72. I wonder if the point will be reached when someone complains about a "giveaway" offering price for the secondary.

Update 3: The offering was consummated last night, and (needless to say) the underwriters exercised their over-allotment option. So, CVB ended up issuing 22,655,000 shares at $5.85 per. Since the stock closed at $7.31 today, I don't think that the dilution factor has caused any near-term nervousness. A recalculation of the above earnings, using the real number of shares to be issued as the dilutor, gives 13.4 and 14.9 cents respectively. 14.9 cents implies a dilution factor of -12.3%. Had it been reported instead of 17 cents, CVB would have beaten the Street consensus by 4.9 cents instead of 7 cents.

Monday, July 27, 2009

Olin's After-Hours Disappointment (Updated)

Olin Corporation disseminated its earnings report after the bell, which announced second-quarter EPS of 36 cents. That's down 23.4% from 2Q '08's 47 cents, but it's a result that also beat the Street consensus by three cents. Revenues for 2Q '09 were in line with expectations. Its upcoming dividend, declared Thursday, was the same as the one for the previous quarter.

And yet, Olin's stock has plummeted 7.08% in after-hours trading. It had gained 1.64% in regular trading, before the results went out.

The most likely reason for the plummet was its third-quarter guidance, found in this report. Management expects the third quarter to be worse, with an estimate of 20 cents. The reason given is that its primary market, chlor alkali products, is still bad and is getting worse. Olin's earnings have been saved from being gutted much further by its Winchester division, which makes small arms. In part becuase of fears of further gun control, small arms have been selling quite well in the U.S. this year. The stock of Winchester's competitor, Smith and Wesson, has shown it over the past several months. Olin, however, only has Winchester as a division. Management expects its more central chlor alkali division to show an operational segment loss in the third quarter.

If management's goal was to talk down expectations, they certainly succeeded with respect to Olin's stock. Its after-hours spill makes Olin similar to General Electric, another Bin stock that plummeted after 2Q earnings were released. In GE's case, the plunge resulted from disappointment over revenues. Olin's revenues met the consensus, so the most plausible reason for the latter's plunge was guidance disappointment.

Except for this other candidate: Olin's had quite a run since its dividend was declared. Its price at the end of today's after-hours trading, $13.25, is only seventy-five cents above its close on the day before the company declared its dividend. Dividend season hast given, earning season hast taken away.

Update: It would be somewhat of an understatement to say that Olin had a bad day once regular trading began. It dropped quickly to $12.71, recovered to about $13.30 as of 1 PM ET, and drifted downwards for the rest of the day. It closed regular trading at $12.98 for a drop of 8.98%. After-hours trading pushed it down a further 1.39%, to $12.80.

Daily Wrapup For July 27th

Most of the day was a downer for the three major averages. After starting off in near-even territory, they sunk to a loss postion right after 10 AM. With the exception of the Dow, they stayed there until nearly the end. The NASDAQ continued to underperform the other two: it sunk the lowest, and barely eked out a gain right at the end of regular trading. The 11% increase in new home sales from last month's level did little to help the overall market; one reason for the lack of enthusiasm was sales prices still being on the decline. There also seemed to be some skepticism about the number itself, even if some people are opining that housing is bottoming. Petroleum products kept going up, and gold has been recovering from its June drop. Copper made another eight-month high.

The lowest-quintile P/E cut-off rose again today, to 10.92 from Friday's 10.87. The S&P's dividend rate remained the same, though. After ETFs and stocks with market caps of less than 500M were thrown out, as well as stocks with too-good-to-be-true yields, the Low P/E Bin was left with ninety-two stocks: a number unchanged from Friday. Here are the internal changes in the Bin, as dash-listed below:

- DCP Midstream Partners, LP
- Hillenbrand, Inc.
- San Juan Basin Royalty Trust
- SK Telecom Co., Ltd.

- Anglo American plc
- Financial Federal Corporation
- Garmin Ltd.
- Sempra Energy

DCP Midstream got in the Bin because of its yield dropping below 10%. Hillenbrand, a supplier of funeral products, arrived because the lowest quintile P/E cut-off rose to meet its own. SK Telecom's P/E fell to the point where it got back in the Bin. The last arrival, San Juan Basin Royalty Trust, is an oddity in the breed. Its yield has dropped precipitously in the last year. In July 2008, its monthly distribution was 32.15 cents. October 2008's was 45.01 cents. Starting the subsequent month, its distribution plummeted; the payout reached 0.615 cents in April. After a rise to 2.627 cents in May, its monthly payout plunged to only 0.5951 cents in June. This near-erasure of its payout made San Juan Basin one of the few royalty trusts to not qualify for the Low P/E Bin because of too low a yield. The announcement of this month's distribution, with an increase from June's to 3.5394 cents, was enough to push its yield above the S&P 500's dividend rate. If there were ever a petroleum-based income trust with a hair-raising income volatility, San Juan Basin Royalty Trust would be it.

Two of the Departures, Anglo American and Garmin, got out because their yields fell below the S&P's cut-off. Financial Federal and Sempra got out because of P/E expansion.

One Bin stock that dropped precipitously today was Cal-Maine Foods, a purveyor of shell eggs. It reported 2Q '09 EPS of 43 cents before the bell, a drop of 72.1% from 2Q '08's $1.54. This drop, as well as a reported 9.3% drop in revenue, was enough to send the stock plummeting 9.55% on the day. Cal-Maine's earnings have been quite volatile over the last year: its 2008 annual EPS were more than triple 2007's. The drop in this quarter's earning could be seen as a return to a more normal level. Pre-report, and pre-drop, Cal-Maine's P/E was 6.78; its P/E was so low in large part because the abnormality of '08's results was recognized. Its dividend was cut this morning, pushing its yield down to 4.07%. Cal-Maine was plugged by a few analysts in Barron's two weeks ago, at a price that was below today's closing. The overall rationale behind the recommendation was that, at $25.43, the stock has enough of a P/E cushion to make it a good value even if earnings dropped significantly. Anyone who bought on that recommendation, right after the market opened, still has a small gain as of now. Time will tell if the other points of optimism are borne out sufficiently to keep the stock from going much further down.

That's all for today's Daily Wrapup. Thanks for reading, and keep the egg jokes handy.

Management Compensation And Anchoring

One of the perennial issues regarding management is compensation levels, and the usual assumption is that they're way too high. Value investors tend to echo those complaints, seeing high compensation levels as evidence of management chicanery and/or fecklessness. There's also some talk about the good old days, when top management was happy to grow a public company at five figures annually.

I realize I'm breaking somewhat with the consensus on this issue, but I wonder how much of the presumption that management is generally overpaid is the result of anchoring bias.

Let me bring in a example in the same timeframe, but from a different career. Back in the day when a CEO was happy to work for $50,000 a year, plus perks like the unwritten right to be the only employee to drive a fully-loaded Cadillac and status goods such as an imposing office plus a taboo-surrounded exclusive address, it was tough financially to be in professional sports. A player had to be in the top league to have a serious chance at making middle-class-level money from his skill. It wasn't uncommon for players to work other jobs off-season. The biggest ice hockey star of the 1950s, Maurice "Rocket" Richard, had a base salary of $15,000 a year in the early-mid 1950s; it was later dropped to $12,000 a year. The most he ever made in a year (including bonuses) was $25,000.

In other words, the biggest ice hockey star prior to Gordie Howe made, at best, about as much as a senior vice-president of a large company. A more normal compensation level for him was middle-management range.

Professional sports stars are heroes to many, and we like to believe that they were woefully underpaid back in the olden days. Not so for management: much of the charge of overpaying is anchored in 1950s salary levels.

It's a pity that the 1950s aren't studied more closely by those management critics who invoke the salary levels of those times. Critics of management culture back then pointed out that the "Organization Man" had to always be on his toes, had to carefully conform to the corporate image, even had to marry in a company-compatible way, had his [yes: back then it was "his"] choice of home circumscribed by an unwritten pecking order, and had to be careful to show due deference to the boss and to top management. The boss that wanted to be everybody's friend was quickly sized up as a potential tyrant, if rubbed the wrong way. One of the rules of organization survival was, "if you play the boss [especially the top boss] at golf, better make sure he wins." It was a time when a union man could cause a scandal, and become a folk hero, simply by buying a Cadillac and driving it to work.

Anyone studying the writings of corporate critics in the Organization-Man era would have to conclude that, along with the relatively modest paycheck which a CEO drew, the top boss had a large psychic payment in terms of status. The two definitely hung together, and the explosion in CEO pay could be seen as monetizing that status.

Unfortunately, many of today's critics of management lack a sense of history. Many of them also live on our anchoring bias. It's hard to swallow the conclusion that 1950s [and 1960s] management were woefully underpaid in terms of money, a conclusion that also follows from the top-management salary explosion of the last thirty years, but the point about status suggests a trade-off was in place too. Perhaps the "outrageous" salaries of today's management represent the better of the bargain, especially since the prestige of top management has eroded to the point where activist investors have a fighting chance against management over any issue. In the 1950s, none of them did; none of them. Not even Benjamin Graham himself.

New Articles In Enter Stage Right

Thnaks to a near-last-minute flash of inspiration, I have two articles posted in this week's Enter Stage Right. The first one is a critical look at the current effort to change around the health-care system in the U.S., and the second is a poke of fun at the modern education system.

If you're here from either, welcome.

Sunday, July 26, 2009

CenturyTel: Is Its Dividend Safe?

- CenturyTel is a communications-service company with operations in 25 states, but is concentrated in five.
- CenturyTel has been an acquirer for at least nine years now. That strategy has not led to it becoming a growth company.
- As of about a year ago, CenturyTel's management acknowledged such by raising the quarterly per-share dividend from 6.8 cents to 70 cents.
- Recently, CenturyTel has merged with Embarq in an all-share deal; the combined entity will be known as CenturyLink. CenturyTel's total shares outstanding will nearly triple.
- At Friday's closing price, CenturyTel's yield is 9.16%. This yield indicates a market judgment that the dividend may be cut, or at least is not safe.
- In examining the question, I use conservative estimates of operations cash flow and a pessimistic estimate of needed capital expenditures.
- I do not predict that its dividend will be cut, but I conclude that its post-merger free-cash-flow margin of safety is insufficient to consider its dividend safe. Management may have to scramble to meet the dividend in '09.
- The task of keeping the dividend at the same rate will not be impeded by debt-maturity obligations in 2009, but may in 2010. Management might be able to refinance the $500 million in debt due, but they might not. If not, then the obligation to repay the principal will cut into any free-cash-flow accretion from the merger (as well as any economic-recovery benefit) as of next year.


Before the Embarq merger, CenturyTel presented the image of a company aiming to change its ways. Unusually for a telephone company, its payout ratio was paltry until mid-2008. Its 2007 payout ratio was only 7%; its 2000 payout ratio was 11.7%. During the last decade, it showed a real appetite for growth through acquisitions.

Ostensibly, CenturyTel does look like a real grower. Its 1999-2008 continuing-operations EPS growth, as derived from logarithmic regression, clocks in at 19.30%. This rate is well above its 10-year return on equity, which is only 12.54%. The disparity between the two figures suggests something other than operational performance is fueling that growth.

In 2002, CenturyTel restructured, and reclassified part of its earlier net income as being from discontinued operations. That restructring resulted from an overly ambitious acquisition spree in 2000 colliding with 2001-2's hard times. That lowering of 1999-2001's contunuing-operations EPSs added to its growth rate, even if subtracting a $2.91 per share extraordinary gain in 2002 lowered that rate somewhat. Subsequent to the rationalization, EPS growth has been boosted by share buybacks. The EPS growth rate from 2003 to 2008 was +11%, while the growth rate in net income was -0.958%. To be fair, the latter growth rate does reflect a 40.7% drop in net income from 2007 to 2008. However, EPS growth from 2003 to 2007 was 13%, while net income growth was only 4.69%.

As of the most current earnings report, for Q1 '09, CenturyTel's payout ratio is 82.2%. Its yield is 9.16%: the following discussion will explain why.

What Century's been up to is illustrated by the following pair of facts: its shareholders equity is $31.52 per share, slightly higher than Friday's closing price of $30.58, but its book value is less than zero. The company has $4.105 billion in goodwill on its books, which makes up 50.6% of its total assets as of March 31st. Goodwill as a percentage of fixed assets net of depreciation, has grown steadily from 76% in 1999 to 138% in 2008. Raw goodwill has grown 6.62% per year, as also derived by logarithmic regression.

This spurt, as you may have guessed, is the result of acquisitions. Perhaps surprisingly, those sprees were not done with debt after 2000. CenturyTel's debt-equity ratio hit its peak in 2000, at 1.71, but declined steadily later in the decade. It hit its nadir in 2005, at 0.733. The ratio has crawled up since then, but it only topped 1 in 2008. As of March 31st, it has gone back below 1.

Instead, the financing has largely come from CenturyTel's cash flow. The reason for the company's low payout ratio, until about a year ago, should be evident.

The jacking-up of its per-share quarterly dividend in mid-'08, from 6.8 cents per quarter to 70 cents, would seem to signal the company's resolve to turn a new leaf. As mentioned above, only a large share buyback campaign kept CenturyTel's EPS growth rate in the double digits. Had the company not reduced its average-diluted total shares outstanding from almost 150 million in 2003 to 103 million in 2008, its EPS growth would have been in the low single digits from 2003 to '07...and slightly less than zero from 2003 to '08.

Despite the large payout ratio in earnings terms, the current dividend seems sustainable on a free cash flow basis. If CenturyTel were to leave its total shares outstanding at the current level, its annual dividend commitment would be about $281 million at the current rate. From 2003 to 2008, its free cash flow has never been below $500 million per year. The difference between the two figures would leave a comfortable cushion to sustain the dividend payment, had there been no substantial change coming. Despite the company's EPS falling fron 80 to 68 cents from 1Q '08 to 1Q '09, cash from operating activites barely budged in that timeframe; free cash flow was up slightly. Basic free cash flow analysis shows a fairly well-covered dividend.

Until the merger with Embarq is factored in.

An interesting aspect of the merger is that it conforms to a practice well known in Canadian market lore: it was a reverse takeover. A "reverse takeover" is an all-stock merger where the shareholders of the target company wind up holding a majority of the new entity's shares. The share issuance dilutes the holders of the acquirer to a minority position. That's what's going to happen when CenturyTel and Embarq formally become CenturyLink. CenturyTel will have to issue close to 200 million additional shares, and Embarq shareholders will end up with about 66% of CenturyLink. To borrow a term from Canadian securities regulation, this counts as a "material change."

But will it change the safety of the dividend?

CenturyLink's total shares outstanding will be about 300 million once the two companies are financially conjoined. As mentioned above, CenturyTel's current per-share payout is 70 cents per quarter. It makes for $2.80 per share per year, and would make for $840 million per year with 300 million shares outstanding. CenturyTel's 2008 free cash flow was $566.483 million. Embarq's was $1.062 billion. Both together make for about $1,628 million, or almost double the requirement for a hypothetical dividend at the current rate. Embarq's free cash flow actually increased from 1Q '08 to 1Q '09, from $408 million to $526 million. This increase was mostly due to reducing capital expenditures, but operations cash flow also rose $11 million in that timeframe.

Combined, Embarq's and CenturyTel's free cash flows for 1Q '09 are more than $710 million. Paying out 70 cents per share on 300 million shares would cost $210 million. There would have been a large free-cash-flow cushion had CenturyLink been in existence as of the beginning of this year and paid the same dividend as CenturyTel does now.

Management expects the merger to be accretive to cash flow in 2010. This expectation may be based upon keeping capital expenditures on a tight leash. Both companies have reduced theirs recently. As of the end of 2008, CenturyTel's capital expenditure ratio, as a percentage of fixed assets net of depreciation, was 9.9%; Embarq's was 9.25%, Both are unusually low for each respective company. Had the two entities been combined at the end of '08 by the pooling-of-interests method, their net fixed assets would have been about $10.307 billion. Combined capital expenditures would have been about $973 million. The capital expenditure to fixed-asset ratio would have been 9.44%, lower than CenturyTel's ratio as a standalone company.

Let's assume that a capex crisis pushes the ratio up to 20%, which is somewhat higher than CenturyTel's highest ratio over the last ten years. [In 1999, it was 18.0%.] If combined net fixed assets remained the same, instead of declining slightly due to more accumulated depreciation, then a 20% capex-to-net-fixed-asset ratio would require capex spending of $2.061 billion.

Let's further assume that 2009 combined cash flow from operations is the same as 2008's. Since both companies' first quarter operations cash flows are larger for 2009 than 2008, this assumption seems a reasonable one. For 2008, Embarq's was $1.748 billion. CenturyTel's was $853 million. The two together make for $2.601 billion. Assuming a 20% capex-to-net-fixed-assets ratio, CenturyLink's 2009 free cash flow would be $540 million. This amount would not be enough to cover the $840 million annual dividend payout for 300 million shares.

If I'm more conservative, I can assume that Embarq's cash flow contribution was equal to its lowest operations cash flow in the last three years: 2007's $1.624 billion. [CenturyTel's 2008 operations cash flow was well below 2007's $1.029 billion, and only slightly above 2006's $840.72 million.] Then, combined operations cash flows would be $2.477 billion. Hypothetical free cash flow shrinks to $416 million. That's less than half of the annual dividend requirement for 300 million shares. In order for free cash flow to be above the new dividend requirement, assuming that combined operations cash flow will indeed be $2.477 billion, then capex spending cannot rise to more than 15.8% of net fixed assets. CenturyTel's real ratio was above that level in 1999 and 2001. In order for free cash flow to be double the dividend requirement under the operation-cash-flow condition just above, the capex-to-net-fixed-assets rate will have to be an unrealistically low 7.7%.


Given that hypothetical calculation, I would have to conclude that CenturyTel's dividend is not safe. I'm not predicting that it will be cut; I actually believe that the new CenturyLink won't do so. CenturyTel's already under a bit of a cloud for expanding too much already, and the CEO has publicly promised not to make any more acquisitions until 2010 at the earliest. The company's shift in dividend policy a year ago suggests that management realized, or was persuaded to realize, that growth in CenturyTel's size did not add all that much value to CenturyTel's shares. Going ahead with the Embarq merger is not the type of behavior we'd expect from reformed empire-builders, though.

On the other hand, CenturyTel's management did bend with that change in dividend policy. I think they will avoid the backslider reputation that would be earned if they did cut the dividend.

Saying that the dividend won't be cut, however, is not the same thing as saying it's safe. If "safe" means requiring free cash flow to be double the dividend payout with respect to a conservative estimate of CenturyLink's combined operations cash flow, a cushion that's more or less in line with CenturyTel's recent free cash flow as compared with a $280 million dividend requirement, then CenturyTel's $2.80 per share annual dividend is not safe. The current yield of 9.17% has a risk premium built in, and I think there should be one. Thankfully for the company, it has no material debt-repayment obligation in 2009 - but it will have to retire or refund about $500 million in debt in 2010 and a combined total of $1.315 billion in revolving credit facilities in 2011. Any free cash flow accretion in 2010 will bump into, at a minimum, the $500 million obligation for that year.

[Once again, I have to remind everyone that I'm not licensed to dispense investment advice in my home jurisdiction of Ontario.]

Friday, July 24, 2009

Know Your Biases: Choice-Supportive Bias

As part of its service, Marketocracy provides its mock-fund managers with archived Web pages showing the funds' composition as of a certain day. Perhaps unfortunately, we don't have that same capacity in our own heads. We can't shift our memories to a specific point in time and recall our mental state at that time. We can't fully recall what options we weighed at the time of an earlier decision, let alone our intuitive and emotional states as of then. We even find it difficult to untangle "should" and "could" when re-assessing a previous decision. The question, "I should have done X in retrospect, but could I have at the time?" is a very difficult one to answer.

Instead of reliable archives, nature has given us egos. There's a certain blessedness in that, as we can really cut ourselves down by should-ing ourselves over decisions made without the benefit of later hindsight. Unfortunately, our ego strength also opens us up to a certain bias.

According to Wikipedia, "choice-supportive bias is a tendency to retroactively ascribe positive attributes to an option one has selected [because one has selected it]." As we commit to a decision, we begin to mix in hindsight in a self-justifying way. "I bought stock ABC because I thought it was undervalued" becomes "I legged in to ABC because I thought it was undervalued but wasn't sure it'd be even more of a bargain" to "I'm dollar-cost averaging. ABC is a long-term winner." It's not hard to see how choice-supportive bias amplifies illusion-of-control bias.

On the Street, the most known kind of choice-supportive bias is encapsulated in an old maxim: "A 'long-term investment' is a speculation that didn't work out." As the above example indicates, room could be made for "'Legging-in' means busting your allocation model."

There's no easy way to get around choice-supportive bias, as it does tend to go with a healthy ego. Detail-oriented people have the option of keeping a detail-rich trading diary, and letting it serve as a memory-substitute. Unfortunately, this countering places a premium on making decisions verbosely. Many decisions are based on intuition; as intuition is honed, unverbalized reasons accompany verbalized ones. Few people - and far fewer action-oriented people - have the introspective skill to tease out explicit reasons from their intuitions.

The best way to minimize it is combining a trading diary with cultivating the skill of self-honesty. It's a tricky skill beause we're often prone to confuse self-honesty with being hard on ourselves. Castigating yourself for not seeing a March earnings disappointment in February does tend to cross that line. Some people take up technical analysis in consequence.

On the other hand: if a competent and reasonable stock picker would have foreseen a defect at the time, then there is grounds for self-criticism. Choice-supportive bias does tend to erase legitimate self-improvement opportunities. As noted above, though, minimizing choice-supportive bias also requires minimizing both varieties of hindsight bias: the self-justifying kind, and the self-castigating kind.

Daily Wrapup For July 24th

[Note: corrected number of stocks in the Bin.]

It was a real nail-biter for the NASDAQ when Microsoft disappointed the Street. By 10 AM today, that average was down 1.81%. The other two also fell at that time, although to a much lesser extent. Since the three major averages had rallied so much yesterday, a large part of this mornings's drop can be explained by yesterday's rally going too far. There is still some near-term skepticism regarding the recent rally, with doubts also expressed by some otherwise optimistic technical analysts. By mid-afternoon, the Dow and the S&P were at break-even, and the NASDAQ has shaved more than half its loss. Another dose of late afternoon hope managed to put the first two averages into gainer territory, and the NASDAQ up to -0.31%...a lot better than -1.81%. One sector that rose more than 1%, with the largest majority of gainers of all the sectors, was the Utilities. Many utilities in the Low P/E bin have been recent gainers, and some have been in a bull trend for close to a month. This could be a sign that leadership is passing from the recovery-fueled tech sector to value industries that have largely held up, earnings-wise.

The lowest-quintile P/E cutoff also rose today, from 10.78 to 10.87. Since the S&P didn't change all that much today, its dividend yield remained unchanged at 2.77%. When ETFs and stocks with market caps of less than 500M were eliminated, along with too-good-to-be-true cases, the Bin was left with the same number as yesterday: ninety-two stocks. Here are the changes in the Bin, as dash-listed below:

- Financial Federal Corporation

- Cooper Industries, Ltd.

The sole Arrival, Financial Federal, got back in because the P/E cut-off rose more than its own P/E today. Cooper got out because of a drop in its 12-month trailing earnings.

One utility that's now scraping the upper edge of the Bin's P/E cut-off is Nisource, a natural gas and electric utility holding company. Its operating subsidiaries are mainly in the Midwest and the centre-north Eastern Seaboard; Nisource's electricity operations are confined to northern Indiana. The stock was in a brief trading range until the end of May, subsequent to a slump from early May's pre-June high, after which it rallied. Two trading ranges in June, the more recent one higher than the earlier, gave way to a largely steady rise that's pushed it up from its May 27th low of $10.50 to its present $13.30. NiSource has been a stealthy gainer during that time, and its rise shows that the more visible tech group isn't the only sector that's showing mostly steady capital gains.

That's all for today's Wrapup. Thanks for reading, and enjoy the freedom from near-term earnings anxiety that comes with the value investing credo.

Thursday, July 23, 2009

American Bank Stocks In The Bin

There are currently four American bank stocks in the Low P/E Bin. All of them are TARP-related, but only two have actually taken TARP funds; the other two refused. These banks are:

- Bank of Hawaii (refused);
- CVB Financial Corp. (has applied to return TARP funds);
- International Bancshares Corporation;
- United Bankshares Inc. (refused).

Although each company's banking operations are in different areas of the U.S., and each has different financials, their trading patterns show a distinct similarity. All of them are stuck in ranges; each bank save one has recently broken to the downside only to return to the original range. The bank that's been spared is Bank of Hawaii, whose recent slips have bordered its current range.

There's also another pattern. Of the three than have broken their ranges downwards, two have had repairs that were explicitly earnings-related. These are also the two stocks of the four above that leapt up the most today. CVB Financial was up 6.67%, and ex-Bin stock United Bankshares was up 8.90%. Both of them had 2Q EPSs that were down with respect to 2Q '08's, but were also better than expected. The former has recently announced a stock offering to get itself out of TARP, and the terms of the offering are now even sweeter for the investors fortunate enought to get a piece of it.

International Bancshares has shown the same pattern, but with no news to explain why. As far as I can tell, its break-and-repair pattern is speculative.

Chubb's Second Quarter Earnings Rise, Raises Guidance

Chubb has announced its 2Q '09 EPS as $1.54, an increase of 21.3% from 2Q '08's $1.27. According to the Bloomberg write-up, Chubb managed to avoid subprime-related losses by conservatively investing in mutual bonds, Treasuries and safer mortgage bonds. Chubb is also raising its guidance for this year.

The company is a Dividend Aristocrat: it has raised its dividend annually for at least twenty-five years. Even in the weak first quarter of '09, its free cash flow was more than four times its dividend requirement. Since its capital expenditures are modest in comparison to operations cash flow, it has a lot of room to pay down debt or to meet an extraordinaty spurt of claims if need be. As of that same quarter, its debt-equity ratio is only 0.288. Its total liabilities, on the other hand, are 2.52 times shareholders' equity: most of these liabilities are for insurance claims. In the most recent quarter, its debt-equity ratio shrunk to 0.274.

Chubb's potential trouble spot, Professional Liability Insurance, did see an increase in net unpaid losses. The combined ratio for this segment did increase to 90.6% from 2Q '08's 83.8%. Almost all of that increase came from the Loss (expense ratio) part of the combined ratio. On the other hand, its overall combined ratio dropped to 85.9% as compared with 2Q '08's 88.5%. The drop in the latter ratio explains why net income went up. [Data from the reports linked to from this SEC webpage.]

The stock was up 2.58% in the regular trading day, and rose a further 4.44% in after-hours trading. The increase in earnings, and the increased guidance, point to Chubb remaining a Dividend Aristocrat this year.

H/T: Chubb was recommended by Dividends Value, before today's earnings release.

[Disclosure: Chubb is one of the 20 stocks in my actively-managed Marketocracy mock fund.]

Daily Wrapup For July 23rd

[Note: Added one to Departures and corrected accordingly.]

Another day of earnings season, another jump for the three major averages. Headlines are already announcing that the Dow has passed the 9,000 mark, although this particular write-up does add a caution about the present trading volume. Not all stocks are benefiting from earnings season, but many are. The financials are still under somewhat of a cloud, but the ones in the Low P/E bin have seen the cloud lift somewhat. Ex-Bin stock Caterpillar was still on a tear today, although its 6.73% gain was partially whittled away in after-hours trading. Overall, the stock market is indicating the start of a recovery. Stocks seem to be going farther than what market watchers have gotten used to, and a lot of those rises are based upon better-than-expected earnings. Oil continues to rise: West Texas Internediate closed at $67.16. The crack spread has also leapt up, confounding the relevant inventory data.

In line with the major averages, the lowest-quintile P/E cutoff rose to 10.78. The S&P 500's dividend yield fell to 2.77%. After ETFs and stocks with market cap of less than 500M were eliminated, the Low P/E Bin was left with one less stock than yesterday for a total of ninety-two. Here are the changes in the Bin, as dash-listed below:

- Compass Minerals International, Inc.
- Delhaize Group
- General Dynamics Corporation
- Lockheed Martin Corporation
- Packaging Corporation of America
- Ship Finance International Limited

- Barnes Group Inc.
- FirstEnergy Corp.
- Hubbell Incorporated
- Merck & Co., Inc.
- Ryder System, Inc.
- The Laclede Group, Inc.
- United Bankshares, Inc.

Compass Minerals got back in the Bin because of P/E compression - a bland expression meaning, for Compass, that the stock got hammered today: it dropped 4.62%. Delhaize and General Dynamics also got back in because the stocks fell, but those drops made their yields rise to exceed the new yield cut-off.

Two of the Arrivals got in today because of corrected Google Stock screener inaccuracies. Lockheed Martin should have been in as of the Bin's inception, but it wasn't picked up. I would like to thank Mark of "Smart Money" for highlighting it in a recent post.

The other slip wasn't as serious. It was just a matter of a few day's delay before Stock Screener latched on to the improved earnings of Packaging Corporation of America. Packaging has roared up 32.4% since July 9th, in large part because its 2Q '09 earnings were 80 cents per share as compared with 2Q '08's 34 cents. Despite its two-week rally, the 46 cent boost in Packaging's 12-month trailing EPS was enough to lower its P/E ratio to put it in the lowest quintile. According to this report on its earnings, though, a lot of the EPS boost came from alternative-fuel tax credits. Had those credits not been there, EPS would have been 24 cents...or lower than 2Q '08's.

The final Arrival, Ship Finance International, dropped out of the Bin a long time ago because its yield had gone above 10%. It spent some time in that slot as it continued to sink: at its end-of day nadir, on July 10th, it yielded 12.5%. Evidently, there was a lot of worry about it passing its dividend; a glance at its recent financials will explain why...specifically, in its quarterly balance sheet and cash-flow statement. A very basic forecast-calculation suggests that Ship Finance will barely meet its 30 cent payment in the next quarter. As oil prices have gone up, though, there has been more optimism regarding this tanker stock. [Disclosure: I've had Ship Finance in my actively-managed Marketocracy mock fund since its inception.]

All of the seven Departures got out through P/E expansion. Three of them, Hubbell, Ryder Systems and United Bankshares, got out through a combination of rising stock price and lowered 12-month trailing P/Es. It's coincidence, but those three were also the two biggest gainers of the seven today: Hubbell was up 9.56%, Ryder was up 13.37%, and United Bankshares was up 8.90%.

That's all for today's Wrapup. Thanks for reading, and look upon the averages with wonder.

Wednesday, July 22, 2009

Whirlpool And Trading Ranges: A Cautionary Tale

Whirlpool was one of five stocks I highlighted as trading-range breaking in a post made a week ago. From mid-May to early this month, it hovered in a range of about $40.50 to about $44. Then, it began shooting upwards, peaking at $56.34 yesterday. Today, though, it dropped 9.92% in regular trading and a further 0.49% in after-hours trading. When evening trading ended, it was at $50.50. The fact that its narrowed its 2009 EPS guidance range to the upside, from $3.00-$4.00 to $3.50-$4.00, didn't help even though the consensus estimate is only $3.52. Its revenues were down, which is currently frowned on.

Whirlpool is no longer in the Low P/E Bin, now because its 12-month trailing earnings have dropped to $4.70 as a result of its 2Q '09 earnings coming in at $1.04, but it was a mainstay. It was also a stock that a chart-oriented person might have bought when the excitement was ramping up.

That 10+ percent drop, when after-hours trading is factored in, clearly shows the risk inherent in being swept up by the bandwagon effect. Playing the earnings game doesn't always work, as the GE reversal last Friday also showed.

There seems to be only one way to play the earnings game with ranges. Buy a stock with good fundamentals while it's still in its range (preferably near the bottom of the range), sit back, and wait. Even the earnings effect isn't very reliable: Sunoco Logistics Partners' 2Q EPS jumped, which led to a brief leap-up in yesterday's after-hours trading, but that gain was more than reversed as of market open this morning. It's still in its tight range - perhaps because its revenues plummeted along with its expenditures - even though its 2Q EPS and revenues both beat the Street by a significant margin.

Once again, the vagaries of the market trump even a sensible trader's rule.

There's a more serious risk in range trading: buying in at the bottom of a range only to see the stock sink below it. Recently, the only Bin stocks that have done so are some banks: United Bankshares, and CVB Financial until its latest Street-beating report reversed the range-busting downtrend. Ironically, CVB was a TARP bank while United refused its allotment.

As is often the case, the market surprises and confounds. If there's any meaning to United and CVB's recent troubles, it would be that Mr. Market is still pessimistic about TARP-related banks. Fundamentals have the last say, though, and each bank's are different.

Electric Utlities And Political Discounting

The cap-and-trade bill is being hurried through Congress; as might be expected, two electric utilities are spending millions each to lobby for changes. The Low P/E bin has six electric utilities, not including a company that's misclassified as one. All of them will potentially take a hit from the coal tax provision, although the size of the hit will vary. These six companies are:

- Alliant Energy Corporation. P/E: 10.09. Yield: 5.76%.
- Ameren Corporation. P/E: 8.61. Yield: 6.26%.
- American Electric Power Company. P/E: 10.42. Yield: 5.52%.
- CenterPoint Energy Inc. P/E: 10.19. Yield: 6.60%.
- Edison International. P/E: 8.89. Yield: 3.98%.
- First Energy Corp. P/E: 10.53. Yield: 5.40%.

With the notable exception of Edison, all of these stocks yield between 5 and 7%. CenterPoint has the higest payout ratio; Edison has the lowest.

All of these six stocks dropped today in regular trading. Alliant was down 0.19%, Ameren was down 0.69%, American Electric was down 1.72%, CenterPoint was down 0.35%, Edison International was down 0.95%, and First Energy was down 1.04%. Interestingly, all six stocks were either unchanged or up in after-hours trading. Ameren and Edison managed to either eliminate or reverse their day's losses.

It's no secret that the carbon-tax component of the cap-and-trade bill will affect the electric utilities, even if they have the right to pass the added cost on to their consumers. People can still reduce their electricity consumption if the price gets jacked up.

Some of these companies can be expeditiously handicapped; others don't explicitly break down their power-generation percentage by source. Of the latter, Ameren seems to have the highest percentage of generating capacity powered by coal. Given American Electric's lobbying efforts, though, it might be the highest - although its position as the industry's lobbying co-leader could result from it being one of the biggest in the industry.

Alliant gets about 55% of its electricity from coal. First Energy gets about 53.5% from coal. Edison International has the highest proportion of nuclear, hydro-electric and natural-gas-fired electricity generation sources. Therein lies a disappointment: Edison is also the company with the lowest yield, by far, of all six. Its operations are located in southern California.

If the cap-and-trade bill does pass and get signed into law with the coal-tax part unaltered, then this is one of the sectors to watch for panic bargains. It would be ideal if Edison were slammed down along with the rest of them, but a panic drop seems unlikely for it. Of the six, the long-term financials show Edison with the highest 10-year return on equity - 12.12% - but American Electric with the highest EPS growth rate: 9.78%, as calculated by logarithmic regression.

My own hunch says to watch the ones with the highest amount of coal generation. Although the cap-and-trade bill will impact their fundamentals, a panic sell might very well overdiscount them. Ameren has the lowest P/E and highest yield, with a not immodest payout ratio of 53.9%. Its operations are in Missouri and Illinois. As noted above, it seems to be the most coal-saddled of the six.

Of course, if nuclear- and hydroelectric-rich Edison is beaten down simply because it's an "electric utility"...

Postscript: The natural gas utilities didn't show that pattern. If cap-and-trade is currently being discounted, then this article explains why. [Note: the article's pro-AGW.]

Daily Wrapup For July 22nd

[Note: Corrected number of Bin stocks.]

This day, it was the turn of the NASDAQ to have a gain well above the two other major averages. Given the anchoring effect that surfaces around earnings season, Apple's Street-beating report had an influence. It was the only one of the three major averages to close with a gain on the day. The financials are continuing to have a hard time, which is understandable given that they're the sector that benefitted the most from the initial March rally. Sectors that are scraping the edge of the graveyard often do.

Unlike the NASDAQ, the cut-off for the lowest P/E quintile dropped today to 10.56. The S&P's dividend yield remained unchanged at 2.88%. After ETFs and stocks with market caps of less that 500M were eliminated, along with too-good-to-be-true cases, the Low P/E Bin was left with ninety-two stocks: an increase of three from yesterday. Here are the changes in the Low P/E Bin, as dash-listed below:

- American Electric Power Company, Inc.
- FirstEnergy Corp.
- Merck & Co., Inc.
- Titanium Metals Corporation

- Financial Federal Corporation

The first Arrival, American Electric Power, got back in the Bin because of P/E compression. It had a good run in mid-late June, and another one in mid-July. Now, it's beginning to fall back. It's one of the companies lobbying to have the cap-and-trade bill changed; said bill is explanation enough for its rally fizzling. mentions it as one of the biggest coal consumers in the country along with Southern Co., but mentions no other utilities. That could be because American Electric, along with Southern, is carrying the lobbying ball on this one. The second Arrival, FirstEnergy, is also an electric utility that's come back to the Bin after a long absence. As an industry, though, electric utilities closed down 0.42% on the day. That drop was only marginally less than the Dow's -0.39%, but somewhat worse than the S&P's -0.05%.

Merck & Co. also returned to the Bin, after a much shorter time away than American Electric's or FirstEnergy's. It dropped 0.57% today, a slight one when compared to its 6.12% rise yesterday, but that drop was just enough to push it back in the Bin.

Titanium Metals also got in through P/E compression - a lot of it. The stock dropped 7.97% today, although there was no earnings or other news to explain why. As the name indicates, it makes titanium products. After a nice rally from April 21st to June 11th, in which the stock was up 88.2%, Titanium Metals has been falling quite a bit: in regular trading, it closed today at $7.85. It's had a checkered 10-year earnings history, although the overall trend has been from losses to earnings to increased earnings until last year. That earnings retrenchment continued in the first quarter of this year, when diluted EPS dropped 50% from 1Q '08's. Cash from operating activities dropped even more in the same timeframe, by 57.8%, but slashing capital expenditures kept Titanium Metals's free cash flow dropping only 28.2%. It has passed its 8 cent dividend for the last two quarters, even though current free cash flow would have barely covered it in both of those quarters. I note that the company didn't have much of a dividend record to begin with: its 8 cent dividend was only paid for five consecutive quarters out of the last ten years. Prior to Dec. 13, 2007, the last dividend the company paid was 1 cent per share on August 30th, 1999. Its current book value is $6.06, well below its closing price of $7.85.

The only Departure, Financial Federal, was somewhat of a Bin oddity. Its market cap was small enough to make it almost at the 500M cut-off when it first entered the Bin yesterday. Today, thanks to a mere 0.92% drop, Federal sunk below the cut-off and got ejected.

That's all for today's Wrapup. Thanks for reading, and enjoy the trading ranges while they last.

Tuesday, July 21, 2009

What A Change A Difference Of Opinion Makes

A week ago, I pointed to two stocks that shrugged off bad news. Both of them have not plummeted subsequently; in fact, both are up. One of them, Barnes Group, had gotten its earnings estimate slashed by a KeyBanc analyst. It didn't react all that much to the news, although it sunk slightly the next trading day. Today, however another analyst upgraded it. That news was enough to send Barnes up 6.80% on the day.

The second analyst's conclusion is an interesting one. His case is made on undervaluation - specifically, that the stock's "'valuation now fully discounts expected weakness in the company's transportation and industrial end markets and uncertainty in aerospace markets'" At yesterday's price, Barnes met his free-cash-flow yield target.

Barnes' dividend yield is currently 4.97%. Two other companies with similar yields, Caterpillar and Eaton, have both shot up recently in part because it was feared they would cut their dividends. They haven't, and it's likely that they won't. Barnes' dividend was likely questioned earlier.

I won't put words in the analyst's mouth, but I supect that the upgrade is a dividend play.

Daily Wrapup For July 21st

Last night's Asian rally failed to carry over to North America, except initially. Although the three averages were up at the beginning of the day, in line with the futures, the opening gain fizzled early on in the day. The Dow spent the day well above the other averages because of large leaps in two Dow stocks. Both were long-term residents of the Low P/E Bin. The first is Merck, which gained 6.12% on the strength of better than expected 2Q earnings. The second is Caterpillar. CAT's results so energized the stock, it was up by more than 10% as of market's open. Its gain was moderated as the day went on, but it was the story stock of the day. Not bad for a company whose 2Q '09 earnings were 66% below 2Q '08's. It and Merck also made for a stellar day for the "Dogs of the Dow" strategy. Their performance also kept the Dow out of a loss position for half of the day. All the averages managed to mount a rally at the end, leaving none of them in a loss position at the end of regular trading.

As the markets rose, so did the boundary P/E for the lowest quintile: it increased to 10.52 from yesterday's 10.46. The S&P's dividend rate stayed the same at 2.88%. When ETFs and stocks with market cap of less than 500M were eliminated, as well as ones with greater than 10% yield, the Low P/E Bin was left with ninety stocks: the same as yesterday. Here are the changes in the Bin, as dash-listed below:

- BP Prudhoe Bay Royalty Trust
- Financial Federal Corporation

- Merck & Co., Inc.
- Caterpillar Inc.

BP Prudhoe got back in the Bin because its yield decreased below 10%. Financial Federal is a new Arrival, and it got in because of P/E compression meeting a rising lowest-quintile cut-off. It offers factoring, leasing and lending services primarily to construction- and road-related industries. Perhaps comparisons to more troubled companies have been made, but Financial Federal's financial statements don't show a commonality. It did, however, experience a modest EPS decline in Q3 of FY '09 with respect to the same quarter a year ago.

Both Departures got out because of P/E expansion. As noted in the top paragraph, both Merck and Caterpillar shot up today. Merck's 12-month trailing EPSs rose slightly, from $2.79 to $2.80. Caterpillar's, on the other hand, dropped from $4.02 to $3.00. Merck got out solely due to the rise in its price, while Caterpillar got out due both to stock gain and 12-month-trailing EPS drop.

That's all for today's Wrapup. Thanks for reading, and may your own Dogs leap up.