One Page Annotated WSJ Summary, Wednesday July 5th

by: David Jackson
David Jackson
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North Korea Test-Launches Missiles

  • Summary: In defiance of the international community, a "significant escalation of its confrontation with the U.S. over its weapons programs" and a violation of its self-imposed moratorium on long range missile tests, North Korea fired 6 missiles including one long-range missile. The long-range missile disintegrated 40 seconds after launch. While US officials said that was due to a malfunction, it is possible that North Korea intended to test only the first stage of the missile. The launches are " expected to renew drives by the U.S. and Japan to take more coercive measures" against North Korea. The US hopes that the test will convince South Korea and China to reduce aid to North Korea, but many North Korea watchers believe that South Korea and China fear an economic collapse in North Korea if they cut off aid.
  • Comment on related stocks/ETFs: US investors in South Korean stocks, like those in Chinese stocks, arguably underestimate the political risks of that market. Expect the North Korean missile tests to impact the iShares Korea ETF (NYSEARCA:EWY).

Nissan, Renault Boards Authorize GM Discussion and Nissan Investors Question GM Deal

  • Summary: The boards of Nissan and Renault issued a statement saying they had authorized their CEO, Carlos Ghosn, to pursue an alliance with General Motors, and the French government's finanance minister (it owns 15% of Renault) said he had met with Mr Ghosn to "discuss the possibility". The Nissan-Renault statement left it to GM to make the first move. 9.9% GM shareholder Kirk Kerkorian has already called for GM to join the Nissan-Renault partnership, but GM CEO Rick Wagoner might be reluctant to give Mr Ghosn "a platform from which to question GM's current turnaround strategy". Nonetheless, GM will now be forced to consider an alliance. A GM-Nissan-Renault partnership would have 21.4% of the European auto market versus 19.5% for Volkwagen, and would generate pressure for other auto manufacturers to consolidate to gain scale. However, French Industry Minister François Loos recommended "enormous caution" about a Renault-GM partnership, and "some Nissan investors are expressing skepticism about potential benefits for the Japanese auto maker".
  • Comment on related stocks/ETFs: Although I wrote earlier this week that a GM-Nissan alliance "could also negatively impact Nissan’s stock as many investors won’t appreciate being shakled to money-losing GM in the short run in return for a vague promise of greater long-run profitability", the WSJ article surprisingly provides almost no evidence that Nissan investors are questioning a GM deal other than the fact that Nissan's stock (OTCPK:NSANY) has hardly moved since the possibility of an alliance became public, while GM's (NYSE:GM) moved up. More important background info and opinion on the stock impact of a deal: GM announced horrible June sales numbers, Nissan cut its own sales forecast for the year, and Steven Towns hopes you aren't short GM.

GM's Vehicle Sales Tumble 26%; Ford, Chrysler Also Post Declines

  • Summary: Following its earlier warning that June sales would be weak, General Motors announced that its vehicle sales were down 26% year over year. Ford's June sales were down 6.9%, and Chrysler's were down 15%. (Mercedes-Benz, the other half of the DaimlerChrysler Group, reported that its US car sales rose 14%.) In contrast, Toyota's sales rose 14%, Honda's rose 5.5%, and Hyundai's rose 3.4%. Nissan, suffering from stale models, saw sales fall 19%. The common theme? Fuel efficiency. The details make prove this: GM's light trucks sales fell 37%, Ford's light trucks were down 14%, with F-Series sales down 9.7% and Explorer SUV sales down a whopping 36%. In contrast, Ford's car sales were up 7.1%.
  • Comment on related stocks/ETFs: The impact on profitability and the stocks is larger than the sales numbers suggest, because GM (GM) and Ford (NYSE:F) make more money on light trucks and SUVs than on passenger cars. Honda (NYSE:HMC), Toyota (NYSE:TM) and Nissan (OTCPK:NSANY), in contrast, have less exposure to the light truck and SUV market, so they are less threatened by a switch to more fuel efficient vehicles as fuel prices stay high. In fact, the Japanese manufacturers seem to have competitive advantage in more fuel efficient cars.

New Jersey Casinos Hours From Closing Amid Budget Impasse

  • Summary: New Jersey's budget impasse has left the state government with no money to spend, and is therefore "just hours away" from causing a shut down of Atlantic City's 12 casinos as well as parks, beaches, and historic sites. They'll join a freeze in road construction, operation of state courts and motor vehicle offices and lottery ticket sales. 45,000 state workers are at home without pay, while 36,000 workers in vital services continue to work, but without pay. Mr Corzine predicted that next week parmacy refunds for seniors will cease. New Jersey Democrats are struggling to find an alternative to Governor Jon Corzine's proposal to raise the state sales tax from 6% to 7%.
  • Comment on related stocks/ETFs: Phil Davis says that Trump loses 1% of its profits for every day its Atlantic City casino is closed, making the stock (TRMP) a short. Discussion of the potential impact on other casino stocks Aztar (AZR) and MGM Mirage (NYSE:MGM) here. The next question for fast-moving hedge funds is which stocks will be impacted by the short-term economic impact of the New Jersey government shut-down.

May Chip Sales Rose 9.4% on Solid Demand

  • Summary: The Semiconductor Industry Association reported that May chip sales rose 9.4% by value, driven by cellphones and other consumer electronics. Sales of analog and digital signal processor chips, both used in cellphones, rose 22% and 14% respectively. PC microprocessor chip sales fell 2% "reflecting an inventory correction and aggressive pricing".
  • Comment on related stocks/ETFs: Incrementally positive for the largest play on cellphone chips, Texas Instruments (NYSE:TXN). Incrementally negative for Intel (NASDAQ:INTC) and AMD (NYSE:AMD). Although it's pulled back significantly recently, AMD's stock still seems to reflect more optimism about growth than Intel's, and could therefore be hit harder by tepid revenue growth. Continued growth in the cellphone market will exacerbate doubt about the wisdom of Intel's sale of its communications chip business.

BP Expects Output Drop, New Charge From Refinery Blast

  • Summary: British oil major BP said that its forced transfer of Venezuelan assets to a state-controled JV reduced its oil output by 20,000 barrels a day since Q1, and that it would also take an additional $500 million charge related to the Texas City refinery explosion in which 15 workers were killed in March 2005. The company said that the charge would be somewhat offset by gains from asset sales.
  • Comment on related stocks/ETFs: BP's (NYSE:BP) experience illustrates a key dilemma for energy investors: if you think the oil price will rise, are you better off buying oil stocks or the US Oil ETF (NYSEARCA:USO)? BP's Venezuelan experience illustrates the risk of buying oil stocks. The forced nationalization in Venezuela reduced overall oil production, contributing to a rise in the price of oil; but BP not only failed to gain from that price rise but actually lost out, because it was forced to transfer assets to the Venezualan government.

Oil Rigs Stage Exodus From Gulf of Mexico

  • Summary: The Energy Information Administration expects the price of natural gas in the US to rise from $6.10 per BTU today to over $10 by the end of 2007, because drilling rigs in the Gulf of Mexico are being transferred to more lucrative markets. That will reduce natural gas production and drive up prices, which are determined by local supply and demand in contrast to oil which is a global market. The number of rigs in the Gulf of Mexico has fallen from 148 in 2001 to 90 now, and the number is expected to fall further as more rigs are sent to the Persian Gulf where oil companies are offering higher day-rates for rigs..
  • Comment on related stocks/ETFs: Rig operators mentioned in the article that benefit from the rise in day rates include GlobalSantaFe (NYSE:GSF), Ensco International (NYSE:ESV), and Transocean (NYSE:RIG). Gulf of Mexico oil producers that could be negatively impacted by higher drilling rates include BP (BP) and Apache Corp. (NYSE:APA). The rise in drilling rates is broadly positive for the energy infrastructure stocks.

Millicom Ends Talks With China Mobile

  • Summary: Emerging markets wireless operator Millicom International Cellular SA ended talks to be acquired by China Mobile Communications Corp. The $5.3 billion acquisition had been widely publicised, but broke down over price. China Mobile liked Millicom's business, that its due diligence turned up no unpleasant surprises, but that there was some concern the geographical dispersion of Millicom's networks (Millicom operates wireless networks in numerous emerging market countries) would make management a challenge. People close the negotiations said that China Mobile's board believed that the sell-off in emerging market assets since the initial deal price was set left the deal looking too expensive. In its press release, Millicom said that China Mobile "won't be in a position within an acceptable timeframe to make a binding offer that is suitably attractive, given the current strong performance of the business, or sufficiently certain of closing".
  • Comment on related stocks/ETFs: Millicom's stock (MICC) immediately fell 26% on publication of the press release. China Mobile's stock (NYSE:CHL) ended the day up 2.2%. A China Mobile acquisition of Millicom would have intensified competitive pressure on Ericsson (ERICY), Alcatel (ALA), Motorola (MOT) and Nokia (NYSE:NOK), so cancellation of the deal is a long run positive for those stocks.

Mercury Interactive Gets SEC Warning Of Possible Charges

  • Summary: The SEC sent Wells notices, signifying the likelihood of civil-securities charges, against three Mercury Interactive (MERQ) directors relating to options backdating. Mercury Interactive was one of the first companies caught in the options scandal, and recently restated its financial results for 1992-2004, including restating the 2003 profit of $41.5 million into a loss of $62.6 million. The cost of the option mess to Mercury is not limited to the restatements and potential damages and penalties; the companay said its legal and accounting bill for the clean up will likely be about $70 million, and its failure to file financial results on time triggered a $7.1 million payment to creditors. Mercury's future earnings could be hit in two additional ways: the reclassification of past stock options as "variable" awards makes them subject to detrimental accounting treatment that could impact future earnigns, and options-related tax problems reduced the tax-loss carry-forwards that Mercury can use in future years.
  • Comment on related stocks/ETFs: This article is significant because it highlights the multi-faceted financial impact of the options scandal on the companies involved: damages, penalties, restatements, accounting and legal fees, higher future stock-related costs and lower tax-loss carry-forwards. These costs could significantly lower the future earnings of the companies involved. Additionally, we haven't yet seen any high profile management resignations or dismissals. Arguably the full extent of the potential damage is not yet priced-in to the stocks involved. Here's the full list of stocks involved in the options scandal, and therefore at further risk.

Caterpillar Gets Bugs Out of Old Equipment

  • Summary: Caterpillar's remanufacturing of older viable parts into existing, broken customer machinery is part of the company's effort to sustain growth if the current worldwide construction boom subsides. Caterpillar last year did about $1.5 billion in revenue from this service - about 4% of its overall revenue, but it's quickly expanding this business under the thesis that companies will continue to seek ways to extend the life of their existing machinery rather than buy new. Buyouts of remanufacturing firms are part of CAT's strategy.
  • Comment on related stocks/ETFs: Chad Brand says CAT's aggressive growth plans are altogether achievable. Jim Cramer, a longtime CAT bull, says the company will benefit from the upcoming Highway Bill and shipment to BRIC countries. Now, what smaller remanufacturing companies are takeover bait under CAT's new division?

'Convenient' Bank Poses Inconvenient Outlook

  • Summary: Commerce Bancorp's (CBH) customer-centered approach has become a model for the industry, but deposit growth is now falling amidst increasing competition for retail banking customers from higher-yielding competitors who offer fewer services. It's doubtful the company can sustain both better services and higher rates on deposits, and the bank's liabilities in this rising-rate environment are pressuring its bottom line even more than other banks'. A stock or bond issue is likely forthcoming, to meet regulatory demands on deposits.
  • Comment on related stocks/ETFs: The article makes the case very clearly that if you're looking to short the retail banks on the persistent inverted yield curve (more from Roger Nusbaum on that), Commerce may be the best way to play it. Regarding ETFs, the Financial Select Sector SPDR (NYSEARCA:XLF) and the iShares Financial (NYSEARCA:IYF) are too broad to capture this effect (they include brokers and I-banks); the StreetTracks KBW Bank (NYSEARCA:KBE) and iShares Dow Jones U.S. Regional Banks (NYSEARCA:IAT) are better.

Drug Shows Promise Helping Smokers Quit

  • Summary: A new Pfizer (NYSE:PFE) drug called Chantix (brand name for varenicline) seems to be particularly effective in helping smokers quit. Research published in JAMA this week indicates that Chantix is more effective than GlaxoSmithKline's (NYSE:GSK) popular Zyban and Wellbutrin. The drug, unlike nicotine patches, actually blocks nicotine's ability to attach to the body, so the user no longer gets the buzz from smoking. Some question the objectivity of the studies however, since the majority of the authors had some type of financial relationship with Pfizer, including consulting contracts.
  • Comment on related stocks/ETFs: Follow Pfizer? See recent articles on its sale of its OTC unit to J&J (Eddy Elfenbein calls both companies winners), and its new generic Zoloft.

Regulator Signals Compromise Over Role of Fannie, Freddie

  • Summary: The director of the Office of Federal Housing Enterprise Oversight [Ofheo], responsible for overseeing Fannie Mae and Freddie Mac, said in an interview that the excessive size of their mortgate portfolios creates risk of serious damage to financial markets if they fail to manage their interest rate risks, but that the two companies should be allowed to continue to hold significant mortgage portfolios. He recently ordered Fannie Mae not to increase the size of its mortgage portfolio without permission from Ofheo as it should be focusing on resolving problems with its accounting and risk controls, and appears likely to impose a similar restraint on Freddie Mac.
  • Comment on related stocks/ETFs: Most of this is priced-in to Fannie Mae's stock (FNM), but the comment that Freddie Mac's portfolio may be capped is incrementally negative for its stock (FRE).

HEARD ON THE STREET: Ryanair Stock Is Dogged By Oil-Price Fears

  • Summary: The Irish budget airline Ryanair, traded in the U.S. as an ADR (NASDAQ:RYAAY), has seen its stock decline 14% this year amidst high oil prices and competitive challenges from easyJet and British Air short haul routes. The company isn't hedged against oil prices, and fully 25% of its operating expenses are fuel (sector average = 12-20%). Yet the company's operational efficiency has left many analysts bullish on its prospects and its stock.
  • Comment on related stocks/ETFs: The UK's JetBlue (NASDAQ:JBLU)?

AHEAD OF THE TAPE: Driver's Seat

  • Summary: Private equity funds are generating large returns by financial engineering rather than operational improvements in the companies they buy. Last week three private equity firms, Carlyle Group, Clayton, Dubilier & Rice and Merrill Lynch's Merrill Lynch Global Private Equity, announced that they would take a special dividend of up to $1 billion from Herz out of company cash flows. Last year they acquired Herz for $2.3 billion in cash plus $13 billion in debt. While Herz's performance has improved since the buyout, it's "hardly clear the new owners drove that". In addition to the special dividend, the private equity funds could benefit from an IPO of Herz as well, just as private equity firms did with Warner Music (NYSE:WMG), Berger King and Celanese.

FOREIGN EXCHANGE: Dollar Remains Under Pressure As Rate-Policy Actions Mount

  • Summary: The dollar could come under further pressure this week due to concern that the Fed has finished raising rates while other central banks are not done. Japan's Economic Minister Kaoru Yosano's statement that it is up to the Bank of Japan to decide on rate increases at its policy meeting next week was taken as an indication that it would indeed raise rates, prompting traders to buy the yen. However, a later statement by Finance Minister Sadakazu Tanagaki in support of the zero percent interest rate policy then had the opposite effect. The European Central Bank will make its own interest rate decision tomorrow. While it is expected to hold rates steady, the wording of the statement could fuel expectation of a rate rise in early August.

FUND TRACK: Tough Times for Emerging Markets

  • Summary: Nobody thought the emerging markets run would last forever, but the recent downturn has been stronger than most expected. When -- and where -- will emerging markets recover? Mark Mobius, manager of Templeton Developing Markets Trust sees particular potential in Turkey, and thinks EM investors should generally get used to a longer-term view. The Fed's comments last weeks may help via a spillover effect to EMs, as they were broadly viewed as dovish.
  • Comment on related stocks/ETFs: Abnormal Returns recently collected a number of well-argued opinions why emerging markets remain compelling. If you're interested in Turkey, Groovystocks calls cellphone operator Turkcell (NYSE:TKC) a bargain. (Full disclosure: David Jackson is long TKC.) And note the allocation to emerging markets in Agile Investing's latest model portfolios.

MUTUAL FUNDS QUARTERLY REVIEW: Surviving a Real-Estate Slowdown

  • Summary: Interview with CGM Realty Fund manager Kenneth Heebner. His key points: A significant decline in house prices is coming, with hot markets such as California, Arizona, Florida and the East Coast hit particularly hard. Prices have been set at the margin by people using interest-only and pay-option adjustable rate mortgates; many of them will end up defaulting on thier mortgages, leading to a rise in foreclosures and steep price declines. Evidence that points to future housing price declines include the rapid rise in inventories of unsold homes. He sold the last of his homebuilder stocks in the first half of last year. When the extent of housing price declines becomes apparent, the Fed will pause raising interest rates, and that will avert an economic downturn. "Commercial real estate has a totally different outlook than residential housing." Office and apartment REITs are attractive because growing inability to purchase a home pushes up rents. The most attractive apartment and office REITS are in areas where new supply is constrained; they include Archstone-Smith Trust (ASN), Essex Property Trust Inc. (NYSE:ESS), SL Green Realty Corp. (NYSE:SLG), AvalonBay Communities Inc. (NYSE:AVB) and Vornado Realty Trust (NYSE:VNO). Hotel REITs will do well as the falling dollar will spur tourism and supply is constrained as few hotels were built after 9/11. He owns Host Hotels & Resorts (NYSE:HST), LaSalle Hotel Properties (NYSE:LHO) and FelCor Lodging Trust (NYSE:FCH).

FUND FIEND: Bigger the Better? Finally, It May Be

  • Summary: At the popular Morningstar Investment Conference last week, the money managers 'seemed to share a hymnbook' dictating that riskier emerging markets and small cap investments won't work at this stage as well as 'quality' large cap companies, which are currently trading at historically low multiples. This, due to the fact that in economic slowdowns within higher interest rate environments, only the large fish have the means to grow. Ron Muhlenkamp likes Johnson & Johnson (NYSE:JNJ) for this reason, while Bill Nygren likes Citigroup (NYSE:C), Home Depot (NYSE:HD) and Time Warner (NYSE:TWX).
  • Comment on related stocks/ETFs: Hmm, seems like too comfortable a consensus on this topic filled that room... Roger Nusbaum recently discussed sector rotation and the issue of when large caps will reassert themselves.

SMALL STOCKS: Encore Medical, EZCorp Advance; Deluxe Declines

  • Summary: Encore Medical (ENMC) rose 31% Monday to $6.30 on a merger agreement; Semi stock Mindspeed Technologies (NASDAQ:MSPD) jumped 8.7%; Merge Technologies (NASDAQ:MRGE) fell 41% following the resignation of three executives amidst an investigation into the company's acccounting; Pawnshop operator EZCorp (NASDAQ:EZPW) gained 14% following a raised guidance for quarterly earnings; Deluxe Corp. (NYSE:DLX) dropped 14% on lower guidance for 2006 earnings; ceramics company Ceradyne (CRDN) gained 6.5% on reporting a government contract worth up to $611 million.
  • Comment on related stocks/ETFs: William Trent wrote recently on Ceradyne's positive steps into new markets; Mindspeed's revenue per employee is on the low end of the industry average.

Notable articles on Seeking Alpha today: Press releases sneaked in on July 4th when nobody was looking, Geoffrey Gannon on Google's "other" products, an Indian internet stock to gain from Bollywood going broadband, why Nintendo is stealing the game platform show from Sony and Microsoft, why Oliver Schwindler is bullish on shipping stocks, ETF money management company Agile Investing changes its asset allocation and Roger Nusbaum provides thoughts on its portfolios, and the latest stock picks from Jim Cramer's Mad Money recap.

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