One Page Annotated WSJ Summary, Wednesday July 26th

by: David Jackson
David Jackson
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UPS's Earnings Miss Jolts Investors

  • Summary: United Parcel Service Inc.'s stock fell 14% in the aftermath of the company's Q2 earnings report. Revenue rose 15% to $11.74 billion, and net income rose 7.6%. EPS of $0.97 fell below the consensus analysts' estimate of $1.00. Package volume rose 6% to an average of 15 million per day, down from 9% growth last quarter. US ground and air deliveries rose 4.7%. UPS' supply chain unit's results were particularly weak: operating margins fell to 2.3% versus 16.5% for the company's US package delivery business. CFO Scott Davis said that the timing of weekends and holidays this year led to a loss of one and a half operating days, equivalent to $0.04 in EPS, and also blamed the rise in fuel prices for lower profitability. He also issued Q3 guidance of $0.87-0.91, below the current consensus estimate of $0.97. Net profit for the full year is now expected to rise 11-12%, at the low end of prior guidance of 11-16%.
  • Comment on related stocks/ETFs: Investors in UPS' stock (NYSE:UPS) will focus on the contrast with FedEx, which reported 27% profit growth for the quarter and has avoided in investing in unnecessary fixed assets and the supply chain management business. According to the WSJ article, Merrill Lynch cut its rating on UPS to "Sell" and said the "valuation no longer makes sense". UPS' international shipping volume was certainly weak compared to FedEx's, which faced the same challenges from higher fuel costs and the timing of weekends and holidays this year. But the more significant issue for investors is whether UPS' results point to a slowing in economic growth as much as company specific problems. The key metric is UPS' unit volume growth of only 6% versus 9% for last quarter. This data point is consistent with the view of the economy painted by the latest Fed FOMC minutes: ".. growth of economic activity in the second quarter slowed substantially from its rapid first-quarter pace." See commentary on the FOMC minues here. TickerSense, meanwhile, says this is a buying opportunity for UPS stock.

Home Sales Fell By 1.3% in June; Inventories Rose

  • Summary: The National Association of Realtors ["NAR"] reported that sales of existing (as opposed to newly built) homes fell 1.3% sequentially in June and 8.9% year over year. Inventories of unsold homes rose 3.8% to 3.73 million, a 6.8 month supply at the current sales rate, the highest level since July 1997 and significantly higher than the 4.4 month supply a year earlier. The median house price rose 0.9% year over year, the slowest rate of increase since May 1995. The NAR's Chief Economist David Lereah claimed that the US housing market is heading for a soft landing, but that if the Fed continues to raise interest rates while consumers are hit by higher oil prices there could be a hard landing.
  • Comment on related stocks/ETFs: It's important to remember that the National Association of Realtors is a trade organization of realtors -- namely those who have the strongest vested interest in a healthy US housing market. In that context, Mr Lereah's comments show that even the realtors are starting to worry about the data. The rise in inventories as measured by monthly supply is particulalry worrying, because it's a lead indicator of house prices. Dont' get too excited about the relative stabilty of house prices until now; look at how the home builders are discounting new homes and how housing starts fell sharply in June.

Mall Rents Climb But Slowing Sales Foretell Weakening

  • Summary: Strip-mall rents rose 0.9% sequentially in Q2 to $18.65 a square foot, and shopping-mall rents rose 1% to $38.89 a square foot, the biggest quarterly rise in nearly three years. However, the absorption of new space by tenants was only 4.9 million square feet. While up from 3.3 million in Q1, that's significantly lower than the two year average of about 7 million square feet per quarter. Moreover, 10.8 million square feet of strip mall space is due to come on the market in Q4. Lloyd Lynford, CEO of Reis, says "New construction this year particularly is back-loaded to the end of the year... investors would do well to be monitoring impact of that construction".
  • Comment on related stocks/ETFs: Commercial and apartment REITs (real estate investment trusts) have solidly outperformed the housing-related stocks so far, but despite strong fundamentals currently, it's not clear whether that can continue because commercial and residential property are ultimately driven by the same underlying forces: jobs growth, interest rates and the financial health of the US consumer. REIT values have been supported by acquisitions, and valuations are expensive. Consolidation in the mall REIT space has included Centro Watt's acquisition of Heritage Properties and Kimco's acquisition of Pan Pacific. But the implication of the data in the WSJ article is that mall REITs -- and perhaps REITs in general -- may be topping out. Two ways to play that: short the REIT ETFs, such as the streetTRACKS REIT Index Fund ETF (NYSEARCA:RWR), or short Kimco (NYSE:KIM), the largest mall REIT. Remember, though, that if you have to pay dividends on short positions.

Amazon Earnings Decline by 58%; Expenses Cited

  • Summary: Inc.'s stock (NASDAQ:AMZN) fell 12% in late trading after the company reported Q2 results. Revenue rose 22% to $2.14 billion, higher than the consensus analysts' estimate of $2.1 billion. But net income was reduced by termination of Amazon's relationship with Toys "R" Us Inc. which directly cost $10 million but also involved higher investment in Amazon's own toy store, and higher spending on technology, Web content and software development for delivery of digital content. Operating expenses rose 34% and content costs rose 58%. Net income of $22 million equated to EPS of $0.05, missing the consensus estimate of $0.07. Guidance: Amazon raised its full year revenue estimate to $10.15-10.65 billion from prior guidance of $9.95-10.5 billion, but lowered its operating income forecast to $310-440 million from $390-520 million.
  • Comment on related stocks/ETFs: Amazon's cut to guidance was severe: the mid-point of its operating income guidance fell to $365 million from $455 million. But almost more concerning was the general sense of uncertainty about the company's long term profit growth in the conference call. Amazon is also investing heavily in Web services, for example. But in answer to a question about when it would be able to generate profits from them, CFO Tom Szkutak said "It is still very, very early for us. We think certainly from a return perspective, certainly we're looking at it over the long term". Another analyst asked how the digital distribution of music and video would impact Amazon's margins, and received this answer: "It's very early and certainly difficult to predict what will happen over time". And when asked about the impact of Google Checkout and eBay's fee increase for fixed price sales, Jeff Bezos flatly refused to answer the question. Yet there's a strong argument to be made that Amazon is the key loser from Google Checkout. Details are in the full conference call transcript, which is a must-read for anyone interested in the Internet or Internet stocks.

Sun Microsystems Swings to a Loss While Sales Rise

  • Summary: Sun Microsystem's Q2 results: Revenue up 29% to $3.83 billion. Net loss of $301 million or $0.09 per share included $156 million of charges for the Storage Technology Corp. acquisition and others. Sales of servers rose 14%, overall product sales rose 30% to $$2.5 billion and service revenue rose 24% to $1.3 billion.
  • Comment on related stocks/ETFs: Sun's stock (NASDAQ:SUNW) rose just over 1% in late trading after the results were announced. Despite tepid revenue growth from IBM (NYSE:IBM), Dell (NASDAQ:DELL), EMC (EMC), Intel (NASDAQ:INTC), and SAP (NYSE:SAP), Sun's results challenge the assumption that enterprise technology spending has slowed. IBM CFO Mark Loughridge claimed on IBM's conference call that: "... a number of transactions around the world, we have seen that the sales cycle for enterprise clients appears to have lengthened, as customers have increased the level of scrutiny and approvals on their transactions. So we saw that most distinctly as we closed out the quarter in the third month... While growth in our SMB [small and medium business] customers has remained generally solid, growth in enterprise space slowed..." However, Sun's results don't support that conclusion. In a remarkable entry on his blog, Sun CEO Jonathan Schwartz wrote last night: "We see no global slowdown in IT. Despite what one competitor said. Our key customers (those that view information technology as a competitive advantage, not a cost center) are continuing to invest. They're investing to drive on-line relationships, fuel competitive advantage, and drive efficiencies - but mostly they're investing because they see a return." One possibility is that Sun is now taking market share, due to its use of AMD chips and Linux as well as its own proprietary processors and software. IBM reported that its server sales were down year over year due to supply chain issues, so Sun certainly took share from IBM. And Dell's recent announcement that it would start using AMD chips in servers is probably recognition that Dell has lost market share to Sun as well. Now the question is whether Sun took share from HP, which leads the server market. HP has yet to announce its fiscal Q3 (quarter ending July 31st) results, and we know that HP took share from Dell in PCs. But did it lose share to Sun in servers? Resources: Sun's press release, the complete Sun conference call transcript, IBM's conference call transcript, and the transcript of HP's conference call for the quarter ending April 30th.

H-P to Buy Mercury for $4.5 Billion In CEO Hurd's First Big Purchase

  • Summary: Hewlett-Packard Co. announced that it is purchasing Mercury Interactive for $4.5 billion net of cash and debt, equal to $52 per share, a 33% premium to Mercury's closing stock price yesterday. HP CEO Mark Hurd had previously said that HP would focus on small acquisitions, but argued that this one was too good to miss. Mercury Interactive's products, he said, will complement HP's own diagnostic and management software products. Mercury Interactive's stock has been beaten down by dismissal of its CEO last year, misuse of stock options and $70 million of legal and accounting fees that resulted from that, and demotion from the Nasdaq to the pink sheets. Mercury Interactive has not yet refiled its 2005 annual SEC filing, and closure of the deal is contingent on its doing so as that will determine the number of shares outstanding and thus the exact value of the acquisition. HP said that the addition of Mercury Interactive will take its annual software sales to $2 billion, with 10-15% growth by fiscal 2008 and a roughly 20% operating margin.
  • Comment on related stocks/ETFs: This is a smart and timely move for HP (NYSE:HPQ), which scoops up a great company and set of products at a bargain, options-scandal-battered price. For that reason it's a horrible finale for Mercury Interactive's (MERQ) investors. But the key question for investors now is: Which other software companies may HP acquire? Two aspects made Mercury Interactive attractive to HP: its business technology optimization software fits well with HP's on-demand software strategy. And second, Mercury's stock has been severely beaten up. There will no doubt be speculation about other potential candidates that fit these criteria. Two possibilities: Keynote Systems (NASDAQ:KEYN), market cap $200 million, and WebSideStory (WSSI), market cap $237 million. Or perhaps HP will move more aggressively into OnDemand services, potentially acquiring RightNow Technologies (NASDAQ:RNOW), market cap $403 million, or SumTotal Systems (SUMT), market cap $134 million. Other suggestions welcome in the comments below. Resources: The full HP press release is here, and details of Mercury's products are available on its web site.

AT&T's Net Income Surges 81% On Wireless Growth, Integration

  • Summary: The company formerly known as SBC Communications Inc., now the new AT&T (NYSE:T) reported an 81% increase in second-quarter net income, citing gains from integrating the old AT&T Corp., which it acquired last year, as well as a boost from wireless sales. AT&T also added 342,000 high-speed Internet customers for a total of 7.8 million, an increase of more than 30% over the year-earlier period. Second-quarter net income was $1.81 billion, or 46 cents a share, a figure that included a charge of $300 million related to the takeover of AT&T Wireless last year by Cingular and a $397 million charge related to SBC's acquisition of AT&T. Excluding the special charges, the company said second-quarter profit was $2.3 billion, or 58 cents a share. Revenue in the latest quarter rose 53% to $15.8 billion from $10.3 billion in the year-ago period, which doesn't include results from AT&T Corp. Including revenue from the old AT&T, revenue for the year-earlier quarter was $16.6 billion. EPS was expected to be $0.53 a share. Shares reacted positively to the earnings beat with AT&T's stock rising 4.2% in composite trading on the NYSE.
  • Comment on related stocks/ETFs: For more on AT&T's most recent quarter, see the conference call transcript.

Xerox Net Falls 39% Following Year-Ago Gain

  • Summary: Xerox Corp. said net fell to $260 million, or 26 cents a share, from $423 million, or 40 cents a share, during the year earlier period, which included a $343 million tax benefits gain. Revenue rose to $3.98 billion from $3.92 billion. Estimates had been for revenue of $3.95 billion and EPS of $0.23. Xerox's shares reacted positively to the news gaining $0.40, or 2.9% in composite trading. CEO Anne Mulcahy said she expects Xerox to post third-quarter per-share earnings of 20 cents to 22 cents, up from 18 cents a year earlier, but below analysts' average of 23 cents as reported by Thomson Financial. She said she expects annual EPS to be "at the high end of $1 to $1.07," which would be more than analysts' average of $1.02 for full-year earnings. Analysts continue to be concerned about Xerox's revenue model.
  • Comment on related stocks/ETFs: For more on Xerox's most recent quarter, see the Xerox conference call transcript. William Trent believes Xerox is a company headed in a positive direction. For more on this, see Xerox Starting to Turn Itself Around.

U.S. Steelmakers See Profits Surge On High Demand

  • Summary: In a sign of continued strength among U.S. manufacturers, U.S. Steel Corp. (NYSE:X), Ipsco Inc. (NYSEARCA:IPS) and AK Steel Holding Corp. (NYSE:AKS) reported strong second-quarter results yesterday amid high demand. They predicted steel prices would sustain their momentum in the third quarter despite concerns about global supply creeping toward excess amid some signs of a demand slowdown in China and other parts of Asia. U.S. Steel reported net income of $404 million, or $3.22 a share, compared with net of $249 million, or $1.91 a share, a year earlier. Sales rose 15% to $4.11 billion from $3.58 billion. Also for the quarter, AK Steel said its net more than tripled to $29.1 million, or 26 cents a share, while Ipsco said its net rose 23% to $156.4 million, or $3.25 a share. Steel customers in North America appear to be restocking their inventories with an average supply of 2.9 months of steel on hand in June, up from 2.7 months in May but down from the 4.1-month supply in June 2005, according to the Metal Service Center Institute in Chicago. Industry officials see no signs of a slowdown in terms of steel supplies.
  • Comment on related stocks/ETFs: To learn more about steel management and inventories, read excerpts from Metal Management (MTLM) CEO Daniel Dienst's June interview in The Wall Street Transcript.

DuPont's Profit Decreases by 4% On Higher Costs

  • Summary: DuPont (NYSE:DD) posted quarterly net income of $975 million, down from $1.02 billion in the year-earlier period. But because the company has been buying back shares, its quarterly earnings rose on a per-share basis, to $1.04 from $1.01 in the year-earlier period. Sales declined about 1% to $7.44 billion. Shares reacted by gaining $0.10 in composite trading yesterday. Dupont stated that second-quarter profit dropped 4%, largely because of higher energy and materials costs, but executives said they expected strong earnings growth in the second half of this year. DuPont forecast per-share earnings, excluding significant items, of $2.85 for 2006, up from $2.34 in 2005. The company said it believes a cost-cutting plan, the rollout of new products and continued high prices for its goods will help to offset high materials costs.
  • Comment on related stocks/ETFs: One alternative income source DuPont hopes to exploit in the future is butanol. To read more about DuPont's recent butanol production agreement with NYSE-traded British Petroleum (NYSE:BP), read Himanshu Pandya's Butanol, an Alternative to Ethanol, Gets a Boost.

Ghosn's Plan Hits a Rough Spot And Nissan Posts Tepid Results

  • Summary: Nissan Motor Co. (OTCPK:NSANY) performed sluggishly in their most recent ending quarter. As part of a three-year plan to boost Nissan sales, CEO Carlos Ghosn made a highly publicized goal of selling 3.6 million cars in 2005 which Nissan met. But to do so, it rushed out new models during the year, including the Murano and Fuga in Japan. That left few new attractions to get motorists into the company's showrooms when the new Japanese fiscal year started April 1. Nissan announced yesterday that its net income was $943.7, up 4.2% from 105.70 billion yen a year ago. But operating income, or profit earned only from business operations, dropped 26% from a year earlier. In the meantimem Nissan, GM and Renault have begun a three-month evaluation of the potential merits of the alliance, after Nissan got the go ahead from board members last week. Nissan intends to roll out eight new models later this year to halt the decline in sales.
  • Comment on related stocks/ETFs: For more on what the analysts think of Nissan's prospects for the rest of 2006, see Steven Towns' Morgan Slashes Nissan Rating and Target and UBS Starts Japan's Big-3 Auto at "Buy".


  • Summary: Trailing P/E or forward P/E -- what's the best way to value a company? An interesting study by an ING analyst found that it doesn't matter much over the long haul: Looking back over the past 20 years, a portfolio composed of 20% of the stocks in each sector of the Russell 3000 index with the lowest trailing P/Es showed equivalent performance against a portfolio with the lowest forward P/Es. He found further that 'in years when the market at large rose, the basket of stocks with low forward P/Es outperformed the basket of stocks with low trailing P/Es, on average by 1.2 percentage points. By contrast, in years the market fell, the trailing-P/E basket outperformed the forward-P/E by 2.5 percentage points,' and explains this is probably due to excessive analyst pessimism during down markets.
  • Comment on related stocks/ETFs: One takeaway here is to watch out for lowered analyst forward estimates during bear markets -- they may be skewed to the conservative end, an inefficiency that one could capitalize on. See also Jeffrey Saut's comments on the market's valuation based on P/E ratios today.

HEARD ON THE STREET: Insurers Prowl for Takeovers Of Annuities Sellers

  • Summary: Since the UK's Aviva PLC announced its intention to buy AmerUs Group (NYSE:AMH) for $2.9 billion earlier this month, a number of midsize insurers have been pegged as possible takeover targets. Conseco Inc. (NYSE:CNO), Phoenix Cos. (NYSE:PNX), Principal Financial Group (NYSE:PFG) and Protective Life Corp. (NYSE:PL) are attractive to larger insurers right now because they sell annuity products to aging baby boomers. Annuities, which generally offer payments over time in exchange for upfront investments, have tax advantages that have made them more popular recently. Industry consolidation is likely, given the heightened competition and need to lower costs.
  • Comment on related stocks/ETFs: The runup in AmerUs stock was further fueled by a short squeeze. As mentioned in the article, the stocks of AmerUs Group peers have not moved much since that acquisition.

TRACKING THE NUMBERS: How to Value Stock Options? Bear Stearns Weighs In

  • Summary: Bear Stearns analysts have proposed a novel method of valuing employee stock options -- open them up for public trading. A recent report from the investment bank encourages companies to sell 10-year options to investors alongside the existing market-traded instruments, eliminating the doubt and inefficiencies associated with current employee options accounting while (potentially) raising their value for employees. Options professionals question, however, how the all-important volatility component could be measured on such long-term options for individual stocks, and some therefore doubt they'd garner much interest. The Bear Stearns proposal further outlined the possibility of granting some employee options in the form of a bond unit with guaranteed payout. Once those bonds are sold to the public, the company can more accurately value the options associated with them.

STOCK WATCH: Where Will AMD's Chips Fall?

  • Summary: Advanced Micro Devices hopes to reshape its longstanding battle with Intel with its acquisition of of graphics-chip company ATI Technologies this week for $5.4 billion. The bull case for AMD sees the ATI acquisition as allowing AMD to finally bundle its microprocessors with chipsets, which Intel has long used to its competitive advantage, and enter higher-growth areas like digital TVs and cellphones. AMD's market share growth in servers remains steady, and speculation abounds that volume giant Dell will begin using AMD chips in more of its products. The bear case on AMD sees the company losing focus and struggling under debt following the ATI acquisition, which was financed with a $2.5 billion Morgan Stanley loan. A price war with Intel is well underway, squeezing margins, and the PC market is soft, as evidenced by Dell's warning last week.
  • Comment on related stocks/ETFs: A great piece by Andrew Schmitt on AMD's ATI acquisition outlined some other important points, and William Trent shares the concern on AMD's financing of this deal. This chart of Intel vs. AMD in 2006 is remarkable.

COMMODITIES: How Corn Became Like Vegas

  • Summary: The futures market for corn, once a sleepy commodities backwater, has recently become extremely dynamic amidst high oil prices and rising demand for ethanol. Open contracts on corn have jumped 77% on the CBOT, and a newer ethanol-futures contract has seen strong and growing participation as well. There's no room left on CBOT's agricultural-futures trading floor (seats are going for a record $3.2 million), while its financial-futures pit has plenty of room available. Prices have been volatile, with corn futures currently up 11% this year, and ethanol up 25%. In the stock market, meanwhile, investors await a batch of ethanol-maker IPOs. Corn prices would have to go far higher for ethanol investment to dry up, some Ag analysts believe. With harvests diminishing, world corn stocks at their lowest point since 1984, and China becoming a net importer of corn, higher pricing would seem likely.
  • Comment on related stocks/ETFs: Follow opinion and analysis of ethanol stocks, including larger players like Archer Daniels Midland (NYSE:ADM) and some emerging small-caps, right here.

Notable articles on Seeking Alpha today: Today's earnings schedule and estimates. Most recent conference call transcripts from: Lattice Semiconductor, QLogic, Plantronics, Fiserv, Xilinx, Getty Images, Flextronics, Foundry Networks, Sun Microsystems, SigmaTel, AU Optronics,,, Colgate-Palmolive, McDonald's, AT&T, Omnicom, Xerox, Lexmark, Agere, and The McGraw-Hill Companies. Mark Mahorney on timing homebuilder stocks. Steven Towns on Nomura's results. Yet another Seeking Alpha contributor argues that gold has topped out. Jeffrey Saut's ETF picks and pans. Geoff Considine on portfolio constuction using Monte-Carlo models. The Alternative Energy Investing team on SunPower. Latest stock picks from Jim Cramer. And finally -- welcome to new Seeking Alpha contributor and wireless industry expert Dean Bubley!

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