Tuesday, August 31, 2010

Stat of the Day: Strong Chicago PMI Considering

Considering all the predictions of a double dip recession its amazing to see a Chicago PMI in the 57 range. Especially considering the major weakness in the report was inventories down to 46.5. All other indicators remain very strong and back up our conclusions in the past that the supposed gains in inventories haven't really taken place.

Today the August Chicago PMI came in at 56.7 versus the 56 consensus estimate and 62.3 in July. Definitely a slowdown from July, but any diffusion index solidly over 50 is very positive. New orders were a strong 55 and backlogs were at 56.2. The important numbers remain very positive signaling growth in the future with any support from the markets.

Chicago purchasers report solid but slower month-to-month growth in August. The Chicago purchasers' index came in at 57.2, down sizably from 62.3 in July but still well above breakeven 50. New orders rose in the month, at an index of 55.0 but down from July's 64.6 for the slowest reading of the year. In an offset, backlogs, at 56.2, show a very strong gain for the month. Inventories are a negative, down more than four points to 46.5 to signal month-to-month contraction. But given solid shipping activity, some of this draw likely reflects production needs. Other readings indicate solid activity including greater slowing in deliveries and steady a month-to-month increase for employment.

The thing to remember with diffusion indexes is that lower readings are not necessarily a disaster. The readings in this report are holding well above 50 to indicate continued growth underway for the Chicago economy. The data point to favorable though slowing readings for tomorrow's ISM report on the manufacturing sector and Friday's ISM report on the non-manufacturing sector.

Monday, August 30, 2010

Cash is King! If So, Why Don't Corporate Profits Rule the Market?

Everybody knows the mantra 'Cash is King!'. Companies and even individuals with cash can control their destiny. Well, at least a lot more then somebody burdened with a ton of debt. That's why the disconnect between huge corporate profits and the stock market is perplexing. Doesn't anybody realize that corporate profits leads to cash which should rule the markets?

Clearly they don't because based on 2000, its the expected future earnings that rule stock prices. Of course, that's always part of the equation. Considering history shows (see chart below) that corporate profits tend to continue upward on a regular basis except for some temporary dips during recessions. Once hitting bottom they tend not to dip any further until a new plateau is reached some years/decades later.

Even more amazing is that profits were falling back in the late '90s as the stock market was soaring. The potential for future profits drew everybody into the market yet they never materialized. Now in 2010, profits have nearly doubled in this decade yet the stock market has gone nowhere. Partly because of the excesses reached in 2000 that needed to be worked off and now partly because the general investing public seems so misguided on reality.

Guess the corporations should hire more people instead of making so much money. Investors should be happier with the higher earnings, but maybe it just all comes down to outflows of investments. More workers would mean more confidence, more 401K money, and more spending. Though as we showed in 2000 that doesn't mean more profits. Why do investors chase revenue instead of profits?

For now, we'll have to stick with the facts that higher profits are here to stay, but it doesn't necessarily mean higher stock prices. The companies are undoubtedly more valuable, but value and stock prices don't always match. So much for Modern Portfolio Theory! Unfortunately the markets are hanging onto a cliff. Any further weakness could lead to a massive sell off. Not likely though considering the overwhelming bearishness.

The one think that we know is once the market turns for good, its due for a material rally over the next decade. Corporate profits will continue growing and markets eventually return to mean. So it must catch up to its historical PE around 15. Won't be long before the SP500 earns $110 and even 120. Do the math and you can see that the current tug a war will seem irrelevant down the road. Earnings support significantly higher prices...eventually. Whether the market realizes it or not. Earnings turning into cash will rule!

Sinking Importance of the PE Ratio or so They Say

Interesting article from the Wall Street Journal that summarizes our frustration with the current market. Rather though being the death of the Price to Earnings Ratio (or PE) the markets will likely look back in 5 to 10 years and wish they'd paid attention. Corporate profits are at record levels and companies with low PEs are likely to outperform in the next decade. Especially when considering the PEG ratio or the growth component of the earnings.

Companies with growth rates higher then the PE will undoubtedly outperform. In the markets eyes though, the question remains on how to determine which companies will outperform. Some of the winners like Salesforce.com (CRM) have already soared to outlandish PEs because market has deemed their growth as transformational. The market thinks CRM will grow rapidly even in a weak economy so they've priced in the growth. Other stocks are marred with low PEs and reasonable growth estimates that have a low risk of not exceeding a 6-8 PE.

Regardless, typically financial measurements and styles fall out of grace at the exact moment they should be utilized even more. Also, the most annoying example of the PE being too high doesn't take it into context correctly. The PE only measures the value of a stock but it doesn't measure its value compared to other asset classes. In the late 70s and early 80s, interest rates were much higher then the historically low rates of now. Would you rather have a money market fund making 15% a year or take the risk of owning a stock? Most likely the money market fund but what if stocks got sufficiently cheap. Say 6.5x earnings! Sure wouldn't have been paying 15x or an earnings yield below 7 when risk free money was paying much more.

Oddly we've got just the opposite scenario where numerous stocks yield in the 12-15% range and money market funds pay next to nothing. Can't convince anybody of the 'cheapness' of stocks though due to the market uncertainty. Ironically though that's the time to buy. Not when the market seems it will grow for ever and PEs are in the 20s like in 2000.

  • The stock market's average price/earnings ratio, meanwhile, is in free fall, having plunged about 36% during the past year, the largest 12-month decline since 2003. It now stands at about 14.9, compared with 23.1 last September, based on trailing 12-month earnings results. Based on profit expectations over the next 12 months, the P/E ratio has fallen to 12.2 from about 14.5 in May.
  • P/E ratios fell sharply during the Depression of the 1930s and again after World War II, bottoming at 5.90 in 1949. They plunged again during the 1970s, touching 6.97 in 1974 and 6.68 in 1980. During those periods, global events sometimes took precedence over company-specific valuation considerations in the minds of investors.

  • Equally troublesome, analysts' forecasts are becoming scattered. In May, the range between the highest and lowest analyst forecasts of S&P 500 earnings per share in 2011 was $12. Morgan Stanley predicted $85 per share, while UBS predicted $97 per share. Now, the spread is $15. Barclays said $80 per share; Deutsche Bank predicts $95.
  • But today's economic uncertainty argues against that scenario. Consider that while P/E ratios dropped during the inflationary 1970s, they also fell during the deflationary 1930s. The one common thread tying those two eras of falling P/E ratios: unpredictable economic performance.

Thursday, August 26, 2010

Chances of a Double Dip?

Anybody following the markets know that everybody thinks the chances of a double dip recession has increased dramatically of late. Incredible considering double dips have only happened 3 times in the last 100 some years. Notable doom and gloom expert Roubini upped his estimate to 40% via a tweet yesterday.

Why is there so much gloom considering the best indicator of all time signals that odds are nearly 0%? The Yield Curve has always been the best indicator of booms and busts yet they seem to get ignored all the time. During a boom, negative yield curves get brushed aside. During rough patches, they are assumed not useful this time based on the particular crisis of the time.

The New York Fed produced these charts showing the predictive ability of the spread between the 10 year Treasury bond and the 3 month T-bill. The very positive yield curve predicts a virtually impossible chance of a double dip this time around. Notice how the chances of a double dip in the early '80s was nearly 100%. That was the last time the US economy had a double dip recession and the conditions were completely opposite back then.

Of course, it could be different this time. The housing market was so weak in July that everybody has become uber-bearish. Considering the weakness was mainly contributed to the expiring tax credit, its hard to understand the bearish concern. If anything, housing is likely to pick up going forward. Its already rock bottom and interest rates will only continue to drop and fuel demand if it doesn't pick up.

Yes, this time around a China collapse could damage the US economy or lower mortgage rates just aren't going to work in a tighter credit market. That's all possible, but typically that's how the yield curve gets so positive. The more negative factors the wider the yield curve. Just the opposite happens when the yield curve goes negative. As in 2007, the economy and specially housing was booming so much that the Fed raised rates in order to cut off spending. Bingo, finally the negative yield curve finally tipped the market over. Just like then, now the yield curve will remain full on bullish until the economy recovers.

Don't fight the Yield Curve. Its never different!

Manufacturing Inventories Aren't Rising

What inventory build? The consistent mantra of the GDP rally in Q1 and over the last 3-4 quarter has been that inventories were being rebuilt. Now maybe a smaller decline in inventories helped GDP, the reality is that inventories have not seen but one major inventory increase in the last 2 years.

Any number over 50 shows an actual increase in inventories. A lot of the focus has actually been on a higher number then the prior month such as a 45 versus a 39.

* Thanks to Seekingalpha.com and Chartfacts.com for providing the ability to chart economic data now.

Can the Media Be Any More Negative?

Brian Westbury from First Trust appeared on Fox Business Network's Varney & Co. this morning and defended his optimistic view of the economy. I'll be the first to admit that Brian has been a little too positive, but to me his main flaw is that he hasn't accounted for the negativity of the media.

Varney and his gang are so negative that they even question who is going to get consumers spending when they themselves have just scared everybody into hiding. Even though as Brian points out consumer spending in Q2 was up 4% to an all time record high. Though Varney is right to point out that Brian might be too optimistic, he himself claims that 1% growth is no growth. That 90K private jobs a month equuals no jobs. Come on Fox Business, its less then desirable. Its less then optimum, but isn't 'NO' growth. Your not helping by spinning everything more negative then the reality.

Wednesday, August 25, 2010

Cypress Semi Doesn't See a Slowdown

Great interview with Jim Rodgers, CEO of Cypress Semi (CY). Very interesting to see him talk about how the economy seems booming when he listens to his customers, but while watching CNBC he thinks the world is collapsing.

Just the title of the link tells the story.... "Do Chips Predict More Pain?"... The answer is NO! Global demand is booming regardless of the US housing market.

Tuesday, August 24, 2010

Diamond Management Gets 30% Premium from PWC

Today Diamond Management (DTPI) accepted a deal with PWC for $12.50/sh or roughly 30% over its closing price yesterday. The bid is also higher then the stock price back in April when the stock market in general was much higher.

Why do I mention this deal for a stock you've probably never heard of? That's precisely the reason. With the world economy supposedly falling back into a double-dip why is PWC willing to pay a premium price for DPTI? Why is Dell & HP fighting over a relatively unknown storage company in 3PAR (PAR) and willing to pay a 150% premium?

Our guess is that corporate insiders realize that the global economy is much better then the US centric people that run the media portray it. Hence they are starting to spend as they likely see the recovery gaining a second wind as we move into 2011.

  • Diamond Management (DTPI 12.45, +2.91) is a leading performer among small-cap stocks. The consulting firm will be acquired by PricewaterhouseCoopers for $12.50 per share, which is a premium of roughly 30% over the stock's prior session closing price.

Stat of the Day: Richmond Manufacturing Stronger Then Expected

The market continues to roll over because of weak existing home sales even though the Richmond Fed Manufacturing report came in better then expected and still showing strong growth. After the Philly Fed reported a significant drop last week to -7 everybody was expecting the worse from this report.

Richmond reported a drop to +11 for August up down from the +16 reported for July. So the report weakened but its still signaling strong growth in the 5th District.Orders, Capacity Utilization, and Average Workweek remained strong while Backlog Orders flat lined though similar to the last 2 months. 

Again a very solid report in an environment where the markets have priced in a double dip recession. The data outside of housing continues to not support such a scenario. Summary data from the Richmond report.


Manufacturing activity in the central Atlantic region advanced for the seventh consecutive month in August, but at a more modest pace than a month earlier, according to the Richmond Fed's latest survey. All broad indicators — shipments, new orders and employment — continued to grow but at a rate below July's pace. Other indicators were mixed, however. Capacity utilization grew nearly on par with last month, while growth in backlogs flatlined. Vendor delivery times grew at a slightly quicker rate and manufacturers reported somewhat faster growth in finished goods inventories.

Current Activity

In August, the seasonally adjusted composite index of manufacturing activity — our broadest measure of manufacturing — declined five points to 11 from July's reading of 16. Among the index's components, shipments declined 11 points to 11, new orders slipped three points to finish at 10, and the jobs index eased three points to 12.
Other indicators varied. The backlogs of orders measure flattened, and the index for capacity utilization was virtually unchanged at 14. The delivery times index picked up four points to end at 8. Our gauges for inventories were mixed in August. The finished goods inventory index edged up three points to 11, and the raw materials inventory index trimmed two points to finish at 9.

Monday, August 23, 2010

MedcoHealth Solutions: Ultimate Net Payout Yield?

MedcoHealth Solutions (MHS) provides investors the rare opportunity of a growth stock with a strong enough balance sheet and earnings to have a massive Net Payout Yield. MHS recently announced another $3B stock buyback program and they only have a market cap of $19B. That's an easy 15% yield if they spend it this year. Considering they bought back $1B+ in each of the last 2 quarters the yield is very attractive. Companies with this much cash flow just don't trade at these multiples.

Unfortunately in this market most investors are looking for yields in bonds and dividend paying stocks. Considering MHS only offers the buyback portion of the Net Payout Yield, most investors are missing this high yielding stock. Considering the likely increase of dividend taxes in 2011 at least for high income individuals (the ones buying dividend yielding stocks in the first place), buybacks should be treated more advantageously but investors are too busy looking backwards. Buybacks are also tarnished by weak stock market results over the last 10 years. Even MHS has made the mistake of buying too soon. The stock trades in the $44s today and they bought at an average price of $58 in Q2.

Many an investor claims they'd rather have the dividends to invest how they saw fit, but in reality they'd all likely just plow the money back into stocks like MHS. Though with at least 15% less money due to taxes not to mention potential transaction costs. How is that better? After all, if you wouldn't reinvest the money immediately why do you still own MHS in the first place.

The main issue with MHS is that Obamacare has scared away investors. MHS is a pharmacy benefits provider that everybody assumes must be doomed from this bill. Assumptions abound that less money will flow to the bottom line for this sector. Competition from CVS Caremark (CVS) will be too strong. UnitedHealth (UNH) will drop them as a customer. Fears are relentless but the executives are buying stock like its going out of style. Nearly $500M in July alone.

Stone Fox thinks the concerns over the business plans of MHS are over done, but that doesn't make them a investment candidate for the Net Payout Yield portfolio alone. Their massive payback to investors is what solidifies our view. Analysts still consider the 5 year growth rate to be in excess of 16% due to the continual roll off of high cost drugs to generics over the next few years and the stock only trades at a forward PE of 11. Maybe the analysts are wrong, but management with the best insight to the future of this company couldn't agree more with those numbers.

Many investors discredit buybacks, but history has shown that these companies outperform over time. That's the key - overtime. MHS continues to reduce the float and at prices higher then the current quote. Rather then seeing management as incompetent for buying too high, see this as your chance to buy below when executives pulled the trigger over and over. Experts on this company have given you the ability to buy below them. Don't pass it up.

Share Repurchase Programs - Q2 Report
During the second quarter of 2010, Medco completed the remaining $331.6 million in authorized share repurchases under the prior $3 billion program. Also, under the new $3 billion share repurchase program approved in May 2010, Medco repurchased a total of 12.0 million shares for $696.5 million with an average per-share cost of $58.14. In total, Medco repurchased 17.6 million shares for $1.03 billion during the second quarter of 2010 with an average per-share cost of $58.45.

For July 2010 to date, Medco repurchased 8.7 million shares for a total cost of $489 million at an average per-share cost of $56.13.

Sunday, August 22, 2010

Doug Kass Calls a Bottom Again

So far he has been 2 for 2. Kass called the 'generational' bottom back in March 2009 and again called a bottom at the end of June leading to the large rally in July. He isn't overly bullish but he doesn't see the market going much lower with SP500 earnings of $90 next year.

Stone Fox is much more bullish then Kass, but we do agree with his reasoning that the tax and regulation issues holding this market back will likely start to loosen up. The Democrats have a multitude of reasons to become more market friendly as their policies of the last couple of years have done nothing for job creation and the economy. Some bullish moves should help the market going into the November election.

Kass has been the best caller of bottoms over the last couple of years so we'll stick with his predictions until he is proven wrong. Not to mention that the SP500 has a ton of support over the next 15-20 points lower so its not rewarding to go short at these levels.

Clip from Fast Money

Another Report on Small Investors Fleeing the Stock Market

Just reported the other day on the outflows of equity funds and into bond funds that were hitting dangerous levels. The New York Times reported over the weekend about how small investors continue to make the wrong move. This time its the movement into bonds even as corporations continue to recover.

Some $33B has exited equity mutual funds at a time that billions should be flowing into the funds. Fidelity also reported that the percentage of equity holdings in 401Ks is down to 57% from a historical average of around 70%.

What is scary is that small investors likely consider bond funds as safe and don't understand the risk of investing in bond funds. If interest rates go up, these bond funds will drop in price. Completely different risk from investing in a bond that you plan to hold to maturity where your just accepting company risk if they were to go bankrupt.

Another interesting stat is that while money flowed into stocks in March & April as the market peaked, money actually flowed out of stocks in July even with a 7% rally. Its possible that the flash crash scared investors or maybe the relentless fear of another depression is having a self fulfilling prophecy as it scares individuals into not spending or investing.

Regardless, money continues to flow into bond funds at levels similar to the tech boom in 2000. We all know how that trade worked out.

  • Investors withdrew a staggering $33.12 billion from domestic stock market mutual funds in the first seven months of this year, according to the Investment Company Institute, the mutual fund industry trade group. Now many are choosing investments they deem safer, like bonds. 
  • Until two years ago, 70 percent of the money in 401(k) accounts it tracks was invested in stock funds; that proportion fell to 49 percent by the start of 2009 as people rebalanced their portfolios toward bond investments following the financial crisis in the fall of 2008. It is now back at 57 percent, but almost all of that can be attributed to the rising price of stocks in recent years. People are still staying with bonds. 
  • The stock market rose 7 percent last month as corporate profits began rebounding, but even that increase was not enough to tempt ordinary investors. Instead, they withdrew $14.67 billion from domestic stock market mutual funds in July, according to the investment institute’s estimates, the third straight month of withdrawals.

Friday, August 20, 2010

SalesForce.com Surges 17% on Just Decent Earnings - Buy RVBD, TMRK on Valuations

Even though this market is adverse to risk, money is still jumping into some of the high flying techs such as SalesForce.com (CRM) or Priceline.com (PCLN) Last night CRM reported a strong earnings report that beat estimates by some 7%, but the stock trades at over 70x next year estimates. Solid report, but does it really suggest the stock is worth buying? It doesn't to us, but that doesn't keep the stock from going up. CRM is a homerun from a corporate standpoint as they are taking over the online CRM market.

Unfortunately everybody has caught onto this story and the stock has soared. As usual though the market tends to trade in a heard leading to a handful of stocks hitting absurd valuations. We'd rather see investments in say Riverbed Technology (RVBD) or Terremark Worldwide (TMRK). Both have similar growth patterns and will benefit from the new move to online CRM systems and cloud computing.

In fact all 3 companies have growth rates for the next 5 years in the 20%+ range. CRM only grew revenue by 25% in Q2 so the perception of huge growth is outside the reality. CRM is a great company, but it hasn't grown any faster then RVBD of late. RVBD expects growth to exceed 30% for all of 2010 and this growth has been picking up each quarter as the need to optimize networks continues to grow. And RVBD only has a forward PE of 28 which is likely to be lower then earnings growth in the near term.

TMRK is a big beneficiary of the growth in cloud computing such as the services offered by CRM. So while we suggest that investors follow the markets of CRM, we're not so sure about buying the stock. RVBD and TMRK provide much better valuations with similar growth. The key is that growth is similar though the perception is that CRM is by far the faster grower.

Highlights of CRM Q2 earnings:

-- Raises FY11 Revenue Guidance to $1.595 Billion to $1.6 Billion
-- Operating Cash Flow of $76M, up 66% Year-Over-Year
-- Deferred Revenue of $683 million, up 24% Year-Over-Year
-- 5,100 Net New Customers in Quarter
-- Total Customers at 82,400, up 30% Year-Over-Year 


Disclosure: Long RVBD, TMRK

Junk Bond Funds Continue to Disagree with a Double DIp

If Junk Bond investors (JNK) aren't scared of a double dip in the US economy, it makes us wonder why stock investors remain so concerned. After all, junk bond companies are always at the highest risk of default when the economy turns weak. Sure company balance sheets are very strong now, but that's only the companies that have high quality bonds such as IBM that recently borrowed at the unheard of 1% for 2 years.

Any company that still has to pay a high yield must have a very weak balance sheet. Wouldn't have to pay high interest rates otherwise. These companies would be crushed if the economy fell into another recession. This dichotomy in the markets is perplexing. Either the SP500 will rally back to recent highs or this index will eventually roll over.

Its interesting that JNK collapsed with the flash crash and corresponding drop to lows below the flash crash, but it has since not seen the same struggles as stocks. 

Thursday, August 19, 2010

Sears Holdings Pummeled on In Line Earnings

Somebody keeps forgetting to tell investors/traders that earnings reports hardly matter at Sears Holdings (SHLD). At least the earnings per share or loss in this case. SHLD is all about cash flow, real estate, and share buybacks. Over time, Eddie Lampert will continue to shrink the shares outstanding to the point where he controls all of the company. Currently RBS Partners (Lampert) and Fairholme Capital Management (Berkowitz) control roughly 70% of the outstanding shares in SHLD. The lower the share price the easier it will be for him to buy shares and dramatically increase his ownership control.

Highlights from Q2 report:
  • Significantly improved profitability in the Kmart format as gross margin increased 230 basis points over the second quarter last year;
  • Adjusted loss per diluted share for the second quarter of $0.19 in 2010 and $0.17 in 2009, and adjusted EBITDA for the quarter of $254 million in 2010 and $268 million in 2009.
Share Repurchase
During the 13- and 26- week periods ended July 31, 2010, we repurchased common shares at a total cost of $272 million and $273 million, respectively, under our share repurchase program.  Our repurchases for the 13- and 26- week periods ended July 31, 2010 were made at average prices of $75.57 and $75.61 per share, respectively.  During the first half of fiscal 2010, we repurchased a total of 3.6 million shares.  As of July 31, 2010, we had remaining authorization to repurchase $309 million of common shares under the share repurchase program.

Our opinion is that you keep buying the stock right along side Lampert and Berkowitz. If we controlled enough money, we'd happily shrink the float as far as possible. Maybe someday.

Disclosure: Long SHLD

Stock Mutual Fund Outflows Continue Unabated

Typical herd mentality for investors to be piling into bond funds at record low interest rates. They did it in 2000 with tech stocks. They did it in 2006-07 with real estate on the coasts and now bonds.

ICI reported that total equity funds had a $1.4B outflow last week and over $12B for the last five weeks. The positive news is that bond funds had a lot more money flow into them leaving the weekly net increase of nearly $6B. When the market turns it could be sudden and dramatic.
Until then though, it'll be difficult to gain much ground with dry powder held by institutions such as mutual funds continually sucked out.

7/14/2010 7/21/2010 7/28/2010 8/4/2010 8/11/2010
Total Equity -3,192 -1,157 -4,074 -2,201 -1,427
Domestic -3,235 -1,402 -4,296 -2,122 -2,073
Foreign 43 246 222 -79 646
Hybrid 430 370 69 233 213
Total Bond 6,138 7,931 7,099 7,551 7,169
Taxable 5,200 6,944 6,112 6,350 5,788
Municipal 937 987 987 1,201 1,382
Total 3,376 7,144 3,094 5,583 5,955

On a very bright note, Intel (INTC) agreed to buy McAfee (MFE) for nearly $8B in cash. Though the 58% premium did nothing for the market today though it should've lit a fire under valuations, the deal will eventually lead to an $8B cash inflow to stock funds. Such deals do provide cash inflows for the market. Since corporations are flush with cash, they could provide the support needed as individuals continue to leave at the wrong time.

Wednesday, August 18, 2010

Copper Miners Underproduce Expectations by 6% a Year: BHP, RTP, FCX Struggle

Interesting report from Financial Times that magnifies some of the recent negative reports on copper mining activities. Stone Fox has been very bullish on copper for a while now because of the promise of high demand from China and a return of demand from the US. So far the demand from the US hasn't materialized but the production issues and lower grade ore deposits have more then offset any lagging demand.

As the report shows, the top 4 public miners produced 12% less copper then in 2009. Thats while prices have been above historical averages.

  • In the first half of the year, the world’s top four listed copper miners – Freeport McMoran, BHP Billiton, Xstrata and Rio Tinto – saw their collective output drop 12 per cent from 2009.
Freeport McMoran (FCX) remains our best pure copper play and operator. They also mine gold which happens to be very positive at this time. Lihua International (LIWA) could be a huge beneficiary of this trend towards lower mining output. LIWA is a Chinese recycler of copper and produces refined copper that utilizes a much lower portion of copper and hence cheaper. For now the market has ingored most small cap Chinese stocks so that negativity needs to play out.

The major negative is that just about all analysts are bullish on the copper market. On the flip side though, FCX only trades around $70 which is far below its 2008 high close to $120. So even if the commodity analysts are very bullish that hasn't parlayed into higher stock prices.

Article highlights:
  • The reason is supply: the superstar copper mines of the 1980s, such as Escondida in Chile, may have already seen their best days and few believe there is enough new production coming onstream in the next few years to meet even modest demand growth.
  • Richard Wilson, chairman of Brook Hunt, the metals consultancy, says the copper mining industry has undershot production expectations by an average of 6 per cent a year in the past five years. “One of the key issues surrounding copper supply has been the inability of copper mines to meet their production targets,” he says.
  • “Most mine projects will exploit the highest ore grades possible in their early years of production to facilitate rapid payback of capital. The trade-off then becomes sharply falling grades as mining progresses,” says Mr Wilson at Brook Hunt.
  • And, in spite of fears over the strength of the global economy, copper demand has been robust, industry executives say. Tom Albanese, chief executive of Rio Tinto, tells the Financial Times: “We could have sold more copper [in the first half of 2010] if we’d had it.”

Tuesday, August 17, 2010

Hartford Financial Bought By Hedge Fund Giant Paulson

While it doesn't really matter to the stock going forward, its nice to see that Hedge Fund Legend John Paulson loaded up on Hartford Financial (HIG) last quarter. Paulson was famous for betting against the sub-prime sector at the height of the housing boom. His dealings with Goldman Sachs (GS) are what got them into trouble.

Considering Paulson has already bought some 44M shares now worth nearly $900M it doesn't exactly portend the stock going up. Its not like he plans to buy more this quarter, but it is nice to see a financial expert back our opinion that HIG trading at 50% of book value is absurd. Otherwise it doesn't change our opinion one bit, but he possibly will bring to light the absurd valuation in this stock.

  • Shares of Hartford Financial Services rose Tuesday after the New York-based hedge fund run by billionaire John Paulson revealed that it had increased its stake in the insurer.
  • THE SPARK: On Tuesday, Paulson & Co. Inc. reported it held 44 million shares in Hartford Financial Services at the end of June, according to a Securities and Exchange Commission filing. The hedge fund owned 12.75 million Hartford shares at the end of March.

Monday, August 16, 2010

Terremark Worldwide Bounced Around By Analyst Moves

Its amazing how much impact analysts have these days. After the frauds in 2000 and the common thought on the street that the process is rigged, its amazing how many people still wildly follow the moves of analysts. Now with the widespread dissemination of information by the internet its even more preposterous that stocks swing wildly based on a upgrade or downgrade by sometimes randomly never heard of analysts.

The prime example the last week or so is Terremark Worldwide (TMRK). After earnings on the 4th, it appeared that TMRK was headed for a major breakout with strong growth forecasted and the every important cloud computing offering showing sizzling growth. Stock jumped to recent highs of $9.25 the next day. Then, out of the blue an analyst downgrades the stock and it swoons the following day. On Monday, Wells Fargo hits it again and before you can even read the first report the stock is down some 20% after a solid report. Whats amazing is that nothing earth shattering was highlighted by the analysts. In fact, the first downgrade was based on valuation alone with the target raised to $10. In a rational market, buyers should've stepped in when the stock sank back to the mid $8s. This isn't a rational market though as traders focus solely on the analyst move and not valuation letting the stock fall to the mid $7s.

Finally, this morning another random analyst upgrades the stock and boom its back up 6%. What did this guy unearth that made investors pile in today? Well, I'm still trying to figure that out. Guess we all just need some hand holding at times.

8/6 - RBC Downgrade
Terremark had posted a smaller net loss for its fiscal first quarter, with revenue roughly in line with, and its net loss per share a penny below, Wall Street's expectations. RBC analyst Jonathan Atkin downgrade its stock to "sector perform" from "outperform" and increased his target price to $10 from $9.

"We see comparatively less upside to our (increased) $10 price target and prefer to wait until there is greater visibility on the company's ability to convert its impressive bookings pipeline into recurring cash flows," Atkin wrote in a note to investors. He said he would also prefer to wait to recommend buying the stock until it's clear that Terremark can achieve its increased guidance for fiscal 2011.

8/16 - Benchmark Upgrade:
The Benchmark Company is out with a research report this morning, where it upgrades shares of Terremark Worldwide Inc. (NASDAQ: TMRK) to Buy, from Hold; it has a $9.00 price target on the stock, up from $8.50.

The analysts also increased their estimates on the name. As for valuation, the analysts remarked, “Terremark is valued at 10x FY2011E and 8x FY2012E operating income before depreciation and amortization (OIBDA or EBITDA). Our $9 per share price target equates to 11x FY2011E and 9x FY2012E OIBDA, within Terremark’s recent trading range.”

Do your own research and don't follow analysts. After all, the more bullish guy is the one that downgraded the stock because he has a $10 target. TMRK was a clear buy once it sold off following that downgrade. It's still a good buy for anybody looking for a solid cloud computing stock. Just be careful who you follow.

Disclosure: Long TMRK

Puda Coal Reports Monster Results

This morning Puda Coal (PUDA) reported a whopping 50% beat on its Q2 earnings. PUDA reported .36 while the street expected only .24. PUDA is a coal mine consolidator and producer of clean metallurgical coal in China. Being an uplisted Chinese stock it is still very untrusted and under followed. They reported $82M in revenue for the quarter so its not a small operation. Not to mention that the consolidation of 12 mines over the next year or so should add significantly to revenues creating a decent sized coal miner. Everybody currently wants operations in Australia so why not go directly to the source and buy assets directly in China?

The stock trades at a significant discount to its prospects and risks currently trading at just 4x the estimated 2011 earnings of $2.17. Considering how easily they just beat the Q2 numbers those could turn out to be very conservative. The market continues to doubt these Chinese stocks but at some point they won't be able to doubt their prospects.

Highlights from Q2 earnings report:

-- Second quarter revenue increased 71.5% year over year to $82.3 million
-- Gross profit increased 235.2% year over year to $12.1 million
-- Gross margin increased to 14.7% from 7.5% a year ago
-- Operating income grew 291.0% year over year to $10.4 million
-- Net income rose 400.5% to $8.7 million from $1.7 million in the second
quarter of 2009
-- Excluding non-cash gains related to the fair value of derivative
warrants, adjusted net income rose 295.5% to $7.3 million, or $0.36
per diluted share
-- Sales of cleaned coal increased 36.5% year over year to 601,000 metric
tons (MT)
-- Average selling price of cleaned coal grew 25.7% year over year to $137
per MT
-- Acquired 100% of the assets and mining rights of the Da Wa Coal and
Guanyao Coal mines in Pinglu County for an aggregate purchase price of
$42.0 million

Sunday, August 15, 2010

China Watch: China Up, US/Japan Down

It seems some of the developed markets still haven't figured out that China and the emerging markets rule the world now. The US was down Friday and Japan is weak tonight based on a weak Q2 GDP report. But does it matter when China was up nicely on Friday and is up another 1.3% today?

Anybody looking at the wrong markets is likely to underperform the remaining months of this year. The stock markets in China have turned around in a dramatic fashion yet the US market remains weak. We're heavily invested in China based plays such as local stocks like Puda Coal (PUDA) and Lihua International (LIWA). Both companies trade at lower PEs then the growth rate of China. How is that possible? You'd think a fast growing China stock would trade at 15, 20, or even 30x earnings. Well, you'd think so but I guess every small cap China play is a fraud, but any India company brought public by the large US investment banks is considered safe. See the MakeMyTrip.com (MMYT) IPO last week. Company is fast growing but isn't profitable and now trades in the mid $20s yet both PUDA and LIWA have earnings in the $1+ range and forecasted 2011 earnings closer to $2 yet they trade sub $10. Somebody explain to me how going public via the supposed corrupt Wall Street firms provides that sort of credibility. Anyway, thats another discussion.

As you can see from the chart below (where can I get a free chart that shows up to the minute data for China?), China is turning much more bullish especially when you add in the big gain today.

PUDA reports in the AM so be careful with that stock. They should have positive earnings but it will be interesting to see how the market handles the lack of coal mining revenues. They were expected to start in May but its still in the process of commencing. It should be built into the stock and only a minor delay in the very positive long term future. Still the markets tend to be inefficient in these small cap plays.

Edit 7:50am: Shanghai ended up 2.1% while Japan was down 0.8%. Considering the China is now the 2nd largest economy, I'm still puzzled why the US is following the Japanese market. Buy the dips.

Friday, August 13, 2010

Do Corporate Profits Matter Anymore? Valuations in Coventry Health Care, Foster Wheeler, and Hartford Financial Suggest Not

Coventry Health Care (CVH), Teradyne (TER), Foster Wheeler (FWLT)

The market has become increasingly technically driven making investment decisions based on fundamentals virtually worthless. Too many investors feel the fundamentals could collapse with a double dip just as they did in 2008. As I wrote in a previous entry [Coventry Health Ups Guidance - Stock Limps Higher], even a company showing fundamental improvements is ignored by the market. CVH trades at a 7 PE multiple which in normal environments would be 2-3x higher.

James Altucher published a piece in the Wall Street Journal highlighting 7 reasons why the SP500 could hit 1,500. Nearly a 40% gain from the current levels. He highlighted several reasons regarding the strength in corporate profits something that is historically important to stock prices. When the market stabilizes, profits will once again become important so its key to understand where the market could go based on current projections.

Corporate Profits at Record Highs:
After tax corporate profits hit a record high recently. Earnings per share weren't at record levels for various reasons such as share dilutions in the financial sector. Higher earnings but higher shares outstanding equals less per share. This also highlights the benefits have weak employment reports. Less employees equals higher margins and much higher profits. Worker productivity has been off the charts. So while the employment picture might be disappointing if your looking for the job, its a little ignorant for the market to get wrapped up in anything but the bottom line of corporations. After all, aren't we as investors wanting corporations to make more money? Has anybody recently called up the CEO of a stock they own and complained because they aren't hiring enough people?

2011 SP500 Earnings at $94:
Estimates for 2011 are quickly approaching the pre-recession high of around $100. A double dip would naturally dent the earnings profile, but the market appears to be betting highly on the negatives only giving the market a forward PE of 11 versus the historical average around 15. Several industries should see higher per share profits while the financials will be impacted because of the significant share dilutions over the course of the last 2 years.

Again a lot of the recession fears linger from the lack of jobs, but the lack of hiring is because corporations are much more productive these days. Basically too good at making profits that investors don't trust the profits will continue. Another reason for profits growth, is that roughly half of SP500 profits come from locations outside the US. If a bunch of people in China get better jobs or raises, the US employment picture won't improve, but the one in China will and so will profits of US corporations.

Record Cash on the Balance Sheet:
Corporations now hoard nearly $1 Trillion of cash on their balance sheets. Partly helped by huge profits and partly a stat that should over time always continue growing larger. Its an amazing sign of how strong most balance sheets have become in the face of a recession. Profits snapped back much faster then the stock market. Foster Wheeler for example has nearly $1B of cash or nearly $8/share. The stock currently trades for only $23. This example could be repeated over and over. Dividends, stock buybacks, and cash buyouts will soar if the double dip fear ends. Google (GOOG) just paid $700M in cash for a private company. Don't forget that companies will keep adding to those coffers on a daily basis. GOOG makes enough money each quarter to pick up a $700M cash deal and still increase the cash hoard.

Even Private Equity funds have $500B to spend providing more fuel to any spending spree. Though I'll admit that its very perplexing that they haven't spent that money yet. Valuations just don't get much cheaper then now.

Earnings Yield
Cash is definitely King! Though apparently investors aren't so sure it isn't better to invest in Treasuries yielding a lot less then corporations with high cash flows. Remember CVH? That new guidance provides a earnings yield of 14%. FWLT has a Enterprise Yield of over 14% (strip out the cash) with earnings expectations of $2.1 this year. It almost seems lost that these companies are very profitable and will likely make a lot more money over the next decade. Investors seem utterly uninterested in the concept of being an owner and making all those profits. It just doesn't seem to matter, but some day it will.

Other stocks like AerCap Holding (AER), Hartford Financial (HIG) and Teradyne (TER) also have yields over of over 10%.

Trade: Bought Cisco Systems

Bought Cisco Systems (CSCO) for the Net Payout Yield portfolio after its follow thru selloff this morning. CSCO was down roughly 10% yesterday following what were decent earnings especially compared to their value. Does valuation matter anymore?

After hours on Wednesday we wrote a little note [Cisco Whacked 7% on 18%+ Guidance]. At that point, we mentioned potentially buying the stock considering how cheap it has become so after letting the market over react we made a purchase today when it was down nearly 1% again and it closed nicely at breakeven. Way too much pain for a generally strong quarter. Remember, in the long run its not whether or not they beat revenue estimates that drives the stock, but whether or not revenue and more specifically earnings expand. CSCO has great potential on that front.

The reason CSCO was purchased for the Net Payout Yield portfolio was two fold. First, we needed better technology exposure in the fund as Microsoft (MSFT) just isn't cutting it and we see much more upside in CSCO. Second, CSCO has $40B in cash on the balance sheet and has bought back over $65B of its own stock. That's an incredible amount over the years and explains why it now has a sub 1 PEG ratio.

Very impressive cash flow and stock buybacks. CSCO had a roughly 8% Net Payout Yield based on Enterprise Value. Combine that with the growth potential that still lies ahead and CSCO is an easy buy at these levels.

  • Cash flows from operations were $3.2 billion for the fourth quarter of fiscal 2010, compared with $3.0 billion for the third quarter of fiscal 2010, and compared with $2.0 billion for the fourth quarter of fiscal 2009. Cash flows from operations were $10.2 billion for fiscal 2010, compared with $9.9 billion for fiscal 2009.
  • Cash and cash equivalents and investments were $39.9 billion at the end of fiscal 2010, compared with $35.0 billion at the end of fiscal 2009, and compared with $39.1 billion at the end of the third quarter of fiscal 2010.
  • During the fourth quarter of fiscal 2010, Cisco repurchased 99 million shares of common stock at an average price of $23.33 per share for an aggregate purchase price of $2.3 billion. During fiscal 2010, Cisco repurchased 325 million shares of common stock at an average price of $24.02 per share for an aggregate purchase price of $7.8 billion. As of July 31, 2010, Cisco had repurchased 3.1 billion shares of Cisco common stock at an average price of $20.78 per share for an aggregate purchase price of approximately $65.0 billion since the inception of the stock repurchase program. The remaining authorized repurchase amount as of July 31, 2010 was $7.0 billion with no termination date.

Disclosure: Long CSCO

Thursday, August 12, 2010

Don't Extrapolate Slower Growth

This view my Richard Berner of Morgan Stanley goes a long way to back up the statements of CSCO CEO John Chambers on their earnings call last night. Though everybody chose to hark on the comments about slowdowns in June and concerned customers, he actually stated that July picked up big time. In fact, CSCO plans to hire another 3K people this year bringing the yearly increase to nearly 10%. Now is that suggestive of a company concerned about a meaningful slowdown or somebody just providing a conservative outlook? You be the judge, but the latter is much more likely. And really were you surprised that CSCO talked about a temporary slowdown in June? Seriously people!

Dr. Copper and Lihua International

As the US markets sell off back into a technically negative levels below the 200ma, Dr. Copper continues to suggest that the panic over a slowdown in China and weak jobs reports in the US are very much overdone.

The below real time 24hr price chart of Copper shows little additional impact from the US selloff today and in fact Copper continues to hold up at a very strong $3.26. Not very indicative of a weak China or a slowing US.

Lihua International (LIWA) has become one of our favorite copper plays beyond the big play of Freeport-McMoRan (FCX). LIWA reported Q2 earnings of $.34 that easily surpassed the estimate of $.28. More importantly though (because analyst estimates shouldn't rule valuations) the stock trades at only 4x the EV of roughly $160M. LIWA has $85 in net cash on its balance sheet and generated a whopping $9M in cash for Q2.

Why then is the stock trading so cheaply? Really why do all the small cap Chinese stocks trade at amazing discounts to growth rate? Possibly the market lacks knowledge of the companies or its more of a trust issue. After the financial crisis do you really trust US companies any more? In the last decade the US has already proven that auditors and rating agencies can become complicit with management to avert the rules in place to prevent fraud.

Another possible concern is that a lot of companies like LIWA are expanding at fast clips and the market is likely concerned about over expansion. LIWA just doubled its smelting capacity in July and is looking to double again in 2011. That is a natural concern for any business but that are amazingly profitable is a solid balance sheet. The concern should only come if they were piling on high debt levels. The exact opposite is happening though. LIWA is generating piles of cash and the market for recycled and refined copper in China is expected to continue growing. Where else can you buy a company if an Enterprise Value of $160M that expects to make $40M in net income this year and then double and quadruple capacity in the next 12-15 months?

Highlights of Q2 results:

-- Sales increased 55% year-over-year to $75.5 million.
-- Gross profit increased 49% year-over-year to $14.5 million.
-- Net income increased 48% to $9.9 million, or $0.34 per diluted share,
compared with $6.7 million, or $0.31 per diluted share in the second
quarter of 2009.
-- EBITDA increased 45% year-over-year to $13.0 million.(2)
-- Strong balance sheet with $87.6 million in cash and cash equivalents as
of June 30, 2010.
"We are operating near full capacity while trying to keep pace with demand and continuing to expand our business," said Mr. Zhu. "We remain on track to initiate construction on our planned new copper recycling facility in the fourth quarter of 2010, which we expect to come online in the second half of 2011. This new plant and additional smelting capacity will increase our annual refined copper output to 100,000 tons from our current capacity of 50,000 tons per annum (just doubled to 50K so thats not even in the numbers yet). We also plan to expand our copper and CCA wire drawing capacity by the end of this year through the addition of new high-speed production lines. We believe these key initiatives will enable us to better address the growing customer demand for pure copper replacement products."

Disclosure: Long LIWA, FCX

Wednesday, August 11, 2010

Cisco Systems Whacked 7% After Hours on 18%+ Guidance

This market has become unreasonably brutal. Cisco Systems (CSCO) forecasted revenue growth of 18-20% for the next quarter yet the stock is getting absolutely whacked after hours. This is for a company trading at only 12x 2011 estimates around $1.8.

The market has lost all touch with valuation measurements. With $40B in cash, CSCO only has a market cap of $95B and earnings to exceed $10B. Trading at 9x EV is obscene for a company basically growing at around 20%. Even the CEO John Chambers commented about how the market doesn't believe they can continue to grow at the high end of their long term growth rate of 12-17%.

This stock could easily trade at double the current value based on the growth they are seeing in a weak economy. The market continues to value stocks as if they expect earnings to be cut in half. CSCO isn't owned in any of our portfolios, but its starting to appear a lot more interesting considering the compelling valuation. Just ignore all the noise regarding them missing revenue estimates. That just isn't a valuable news bit.

Stat of the Day: Ceridian-UCLA PCI Predicts Growth

Another stat that continues to confirm a slow but steady recovery. Contrary to the huge down day today on fears of a double dip, most of the economic data continues to suggest the economy is making very positive progress. Whether the drop today is due to slower growth from China or the meaningless lagging words from the FED, it's clearly disconnected from reality.

The Ceridian PCI is a measure of the diesel traffic used in the US. According to their information, traffic increased by 1.7% in July and over 8% from last year. So after a weak spot in June, the market appears to be back on track. Not to surprising considering the US economy is growth and global economies like China continue to grow at a fast clip even if its down to say 9% from 12%. It still adds up to increased traffic and hence growth.

  • Though the PCI fell significantly in June, a careful examination of the daily data revealed that June was not as bad as the headline number suggested because of a late Memorial Day and due to the second half of June being stronger than the first. This more positive interpretation of the June data has now been confirmed with a strong July PCI.
  • Year-over-year growth for July of 8 percent represented the eighth straight month of mid to high single digit year-over-year percentage growth after approximately two years of decline. The sustained growth is welcome news; however, the PCI needs to reach year-over-year growth of 10 to 15 percent in the near term to drive a meaningful increase in employment.
  • "The key takeaway from the July report is that the economy continues to recover – which is encouraging – but the pace needs to substantially pick up to put people back to work," said Ed Leamer, chief PCI economist. "With the unemployment rate still at 9.5 percent and consumers understandably nervous about opening their wallets, it is hard to be very optimistic about economic growth. On the other hand, there is nothing about the PCI that is supportive of the pessimistic double-dip view."

Tuesday, August 10, 2010

China Watch: Imports Disappoint Causing Market Drops

Interesting how a 22% jump in imports causes the markets to fear a slowdown. Guess it's all about perspective, but seriously all the reports focus on the % of increase versus the raw numbers. Actually can't even find a report that compares the raw numbers though the exports were supposedly a record.

China markets dropped nearly 3% today so it had a huge impact on the markets, but was it really warranted. The markets never seem to under that slower growth is still growth. Slower growth still requires more copper, iron ore, coal, and oil then last year.

- Traders said the weak July import numbers in China dealt a blow to investor confidence because soft demand for inbound goods and services could have negative implications for the global recovery. China's exports grew 38.1% in July from a year earlier, down from June's 43.9% rise, and imports rose 22.7%, slowing from June's 34.1% increase. While imports rose for the ninth consecutive month, the increase was below the 30.2% median increase forecast by economists.

Interesting comments from the Norfolk Southern CEO regarding a continual increase in shipments. Steel making isn't slowing down and coal shipments remain steady. Today's drop and fears about a double dip all seem like major over reactions.

Buy the dip is likely the best course from here. Markets are over reacting to solid growth numbers from China. As usual they sweat the little stuff and miss the big picture.

Thursday, August 5, 2010

Puda Coal Signs Deal For Investment in 6 Mines

Finally some news from Puda Coal (PUDA), Chinese coal consolidator, on funding for them to acquire and consolidate 6 more mines in China under Phase II of the Pinglu Project. Being that PUDA has a market cap of roughly $200M, a lot of uncertainty hung over the stock due to the expected $150M needed to acquire these 6 mines and then upgrade them. Not to mention another 4 mine project in the works as well.

That's a lot of dilution feared by the market unless they found a partner so it's likely held the stock price down. Now PUDA has come to an agreement whereby the Chairman and an outside party will contribute 60% of the funds allowing PUDA to keep 40%. Considering the profitability it would've been ideal to see some type of government loan for a % of the deal, but PUDA is still obtaining these mines at very accretive levels. Not sure yet what this deal does to the targets for over $2 in EPS next year, but it shouldn't hurt.

Details on the 6 mines provided back in March:

Purchase price: $110M
Capital Expenditures: $56M
Coal reserves: 145.6M MT
Type of coal: Thermal
Current Production: 1.2M MT
Future Production: 2.7M MT

This would leave 4 additional met coal mines to be consolidated under the Jianhe Project. Considering that these mines are more attractive hopefully the company will be in a better position at that point to keep a much larger position. They should start throwing off a lot of cash that should be able to pay for a considerable portion of these mine purchases.

Earnings Update: Liz Claiborne Jumps on Earnings Talk

Lately Liz Claiborne (LIZ) has basically been left for dead, but today they forecasted a substantial improvement to 2H operating results and a solid profit in Q4. Even though the estimates for Q3 were already for a profit of $.04, the stock had traded down some 50% due to fears of LIZ slipping back into a spiral down. The news was very encouraging that LIZ has indeed finally turned the corner hence the stock is up nearly 15%.

LIZ is a core holding in our Opportunistic and Growth portfolios since we think this franchise from includes Juicy Coture, Lucky Brands, and Kate Spade has huge upside potential once the restructuring finally produces results. Its been several years in the process now, but its apparently finally taking hold. Now with management back to focusing on managing the existing businesses we expect much better results and higher margins due to the elimination of weak business lines.

Highlights from Reuters:

* Q2 adj loss $0.19/shr vs est loss $0.46/shr

* Sees adjusted profit in Q4

* Sees "meaningful improvement" in H2

* Sees margin improvement from J.C. Penney deal

* "Three years of work on the portfolio, on resource allocation, on channel mix ... on inventory and inventory systems and on cost structure are beginning to yield an improved earnings picture," Chief Executive William McComb said on a call with analysts.

* The owner of the Juicy Couture, Kate Spade and Lucky Brand chains said adjusted income in the third quarter would be flat to slightly negative, while the fourth quarter would turn positive for the company.

Wednesday, August 4, 2010

August Investment Report

July was a good month as this portfolio regained a significantly part of the losses from May/June. A lot of the issues that we incorrectly thought wouldn't impact the markets were mostly resolved during July providing for the strong market reversal. In the end our theory was correct, but it took the market a couple of months to accept it.

China & Copper
One of the biggest concerns in the market was the slowdown in China leading to a major bottom in the Chinese stock markets at the start of July. This major reversal of a leading market that peaked in December is leading the way for this global market advance. At these levels, China still needs to gain 20% just to return to the recent April highs so the gains have likely just started.

Copper made a major reversal just as many a technician expected further declines. Copper now sits at $3.4/lb and could easily retest the recent $3.6/lb and possibly the highs in the $4+/lb range. As such a short on Freeport-McMoran (FCX) was covered at the start of July and quickly turned into a long position. Towards the end of July, China recycler and producer of refined copper products, Lihua International (LIWA), was bought. LIWA recently added another copper smelter to double production yet with the stock trading at a sub 10 PE before this news it hardly budged the stock.

Other investments to take advantage of a return to China is local coal producer Puda Coal (PUDA), along with US met coal producers Alpha Natural Resources (ANR) and Massey Energy (MEE). Small Chinese stocks trading in the US continue to be the cheapest plays, but they do offer a high level of risk hence the diversification into much larger domestic plays that benefit from the return of China.

Earnings Yield
With the double dip likely out of the way, many stocks remain at extremely cheap levels with 10%+ earnings yields. Too much focus is placed on dividend yields, but not much focus is placed on the amount of earnings a company has compared to its valuation other then the PE. This is while the 10 year Treasury yields only 3%. This makes stocks earning a lot of money much more attractive then fixed income. Some of the companies in this portfolio such AerCap Holdings (AER), Foster Wheeler (FWLT), Hartford Financial (HIG), Atwood Oceanics (ATW), and Teradyne (TER) have earnings yields far in excess of 10%. For example, AER has a yield of nearly 16% with the potential for plenty of growth in global airplane leasing. These incredible yields provide great growth opportunities providing for superior return options. On top of that, leverage is being utilized to invest in yields substantially above margin rates.

All in all, the markets remain extremely cheap even after a strong July. The volatility will remain high going into the elections in November. Since the Democrats and Obama will likely lose power, this should be bullish for the markets going into the elections unlike the normal cycle where uncertainty leads to market declines. The likelihood that gridlock will block anti market, pro regulation environment should push stocks higher. At this point, the portfolio will likely remain stable until selective opportunities present themselves to prune positions.

Earnings Update: Hartford Financial Reports Solid Numbers

The stock for HIG is dropping after hours due to the usual confusion surrounding their earnings. The key is that adjusted earnings of $.92 beat estimates of $.76 and that core earnings were weak due to a DAC unlock charge and several one time charges. Nothing to fret about with the stock trading at $23 and the book value jumping to $41 in the Q.

Look for a rebound tomorrow as sanity returns following a through review of the financials. A very profitable company should not trade below book value. The question should be the appropriate bv multiple hence we continue to hold this stock as a core investment.

  • Adjusted core earnings* of $460 million, or $0.92 per diluted share, excluding impact of DAC unlock charge, elevated P&C catastrophe losses, P&C prior year reserve development and goodwill impairment all of which totaled $0.75 per share
  • Net pre-tax unrealized losses declined 51% from March 31, 2010 to $1.5 billion at end of second quarter
  • Book value per common share of $41.29, up 6% sequentially

Alpha Natural Resources Jumps on China & India Coal Demand Projections

Alpha Natural Resources (ANR) also had a decent earnings report, but the stock is mostly up 5% today because of the growing projections of coal import demand in India and surprisingly to a lessor extent in China. Recently China has become a big importer of coal and especially met coal due to huge growth and various issues with mine consolidation projects that have limited domestic coal production. Some people project that China will be able to limit coal imports as these mines come back online. India is a different story and will likely continue to need external coal supplies to meet surging demand.

Supposedly the headlines numbers of $.62 for ANR was disappointing. It was significantly better then last year and suggestive of higher stock prices so sometimes its best to focus on the trend and the relative valuation. The most interesting comments were on the impact of China and India demand in both thermal and met coal. As the US tries to prevent new coal plants, the rest of the world continues to move forward with them driving up demand. After all, poor consumers can't afford to adopt expensive renewable energies.

Q2 report from ANR:

-- EBITDA from Continuing Operations was $199 million, up from $68 million last year
-- Income from Continuing Operations of $39 million compared with $17 million last year
-- Metallurgical coal shipments increased 122% year-over-year
-- Share repurchase of up to $125 million authorized and $25 million repurchased during the quarter
-- Following the successful amendment, extension, increase and $40 million prepayment of Alpha's secured credit facility during the second quarter, liquidity totaled $1.5 billion on June 30, 2010

--Seaborne demand for thermal coal continues to increase, driven primarily by increasing Chinese and Indian imports. China's electricity consumption rose over 21 percent in the first half of 2010. This growth is drawing increasingly on seaborne thermal coal with June imports on an annualized pace of 97 million metric tonnes, up from an annual pace of 76 million tonnes in May. China is currently projected to import 90 to 100 million tonnes of thermal coal per year. While growing off of a smaller base, India is likely to represent an even greater long-term growth opportunity for seaborne thermal than China due to the relatively lower quality of India's indigenous reserves. Indian imports are forecast to rise at approximately 10 percent annually and are projected to reach 100 million tonnes by the middle of the decade. This rapid Asian demand growth for seaborne thermal coal is straining the export capacity of Indonesia and Australia which together account for approximately 50 percent of the world's seaborne thermal supply. To keep up with growing Asian demand, South African and Columbian coals that traditionally served the European market are increasingly moving into the Asian market, which should create an opportunity for U.S. exports into the Atlantic basin in the near future.

--Global demand for metallurgical coal remains strong despite cyclical challenges, including the near-term slowing of economic growth in China and uncertainties surrounding European economies. Steel production is increasing globally and is primarily being driven by China. Despite a widely anticipated slowdown in the second half of the year, China remains on track to produce roughly 620-630 million tonnes of steel, up approximately 10 percent from 570 million tonnes in 2009. Chinese metallurgical coal imports have risen from nearly flat in 2008 to 34 million tonnes in 2009, and China is on pace to import more than 40 million tonnes in 2010. While internal met coal resources can be developed and imports from Mongolia can be increased over time, China is likely to remain dependent on seaborne imports of high quality metallurgical coal for the foreseeable future. As with thermal coal, India may offer the more persistent long-term growth opportunity for seaborne metallurgical coals due to the absence of quality domestic reserves. Indian imports totaled 28 million tonnes in 2009 but are projected to ramp steadily, nearing 50 million tonnes by 2015. In this environment of growing metallurgical coal demand and limited sources of supply globally, prices have tested near-record levels.

Report on theStreet.com regarding India coal needs:

  • The recent Adani coal deal may just be the beginning, as severe coal shortages could compel Indian power companies to purchase coal mines or forge joint ventures with major coal exporters such as Australia, Indonesia and South Africa.
  • Reliance Industries, the largest Indian company with a market capitalization of $72.1 billion, plans to invest more than $15 billion over the next decade in power transmission projects. The company will bid for three ultra-mega power projects of 4,000 MW capacities each in India. In parallel, Reliance is planning for coal mines in Australia, Indonesia and South Africa, three biggest coal exporting countries.

Stat of the Day: ISM Serives Rises in July

After some weak numbers for June, alot of the economic data for July is started to come in ahead of estimates. Clearly June was a pause because of the fears in the global economy due to the various issues repeated ad nausem. Now with just about all of the issues out of the way including news today that some 75% of the oil leaked in the Gulf of Mexico having been captured or evaporated, the economy can get back to its recovery.

Today the July ISM Services or non-Manufacturing report came in at a strong 54.3 up from the 53.8 in June and easily above estimates that expected a decline. The Business Activity index remained a robust 57.4 showing that growth is likely above the headline numbers that tend to be sentiment based. New Orders rose to 56 and Inventories and Prices Paid relaxed from levels that were too high last month.

All in all it was a very solid report and market is slowly coming to realize that we're likely headed towards a strong recovery in the 2H versus the double dip. As shown in the table below, Business Activity has consistently been above the headline ISM number. Its interesting to note how few businesses expect lower activity even though the prevailing 'noise' in the markets is for a double dip.

Business Activity

Jul 2010 27 57 16 57.4
Jun 2010 35 56 9 58.1
May 2010 38 53 9 61.1
Apr 2010 39 51 10 60.3

Monday, August 2, 2010

Millicom Cellular Heading to Par

Millicom Cellular (MICC) remains one of the cheapest ways to play the mobile internet revolution and the growth in Latin America and Africa. Due to global growth and the demand for commodities, Africa is becoming a major growth story and MICC provides one of the few investment options.

MICC has cellular operations in the following 7 African countries with the associated market ranking: Chad (2), DRC (1), Ghana (2), Mauritius (2), Rwanda (3), Senegal (2), Tanzania (2). With 12.2M customers and a population under license of 169M, MICC has huge growth ahead. Cellular remains the only viable option in most of these countries.

Not surprisingly MICC is hitting a new 52 week high today. MICC will remain a solid position in the Growth Portfolio for a long time.

Insatiable Bandwidth

Demand in the technology sector continues to be questions. Everybody is so concerned that the cycle has peaked in the semi sector. Some of this is understandable after the Dot Com crash in 2000 and the Great Recession in 2008. Still demand seems to be building for new applications like mobile internet, 3D tv, and cloud computing.

Several of the stocks in our portfolios like Teradyne (TER), TerreMark Worldwide (TMRK), and Riverbed Technology (RVBD) should just be soaring on the Insatiable Bandwidth demand from all these new products. Still only RVBD has broken out but that took explosive earnings.

Interesting clip from the Xilinix (XLNX) CEO on Mad Money. He does a good job of pushing back on the cycle peak. We're just 1 year out of the Great Recession so it seems unthinkable that the tech sector has already peaked. Many a company like TER and XLNX have been posting numbers that match or equal the peaks of 2000, but their stocks lanquish. These could be big winners over the next 5 years as tech finally comes back into favor.