Novellus and CSX: Impressive Earnings or Same Old Safety Dance?

We won't have time to do much of this in the coming weeks since there is an avalanche of reports to review, but Monday was a light day of earnings so I am going to lay out some of the things I review on my own time, on the blog.

As long-time readers will know, I ignore almost all the government reports because they are so flawed; the only reason we are forced to pay attention is because the lemmings of the stock market react to them as gospel. For example, just last week we had all the retailers report - yet on Tuesday, we ignore everything they say and clutch to a government report on retail sales. A report that showed better than 'expected' mostly because... gasoline prices were higher. (i.e. consumers had to spend more because gas prices were up - green shoots).

Exactly the same justification for a "good" government retail report a month ago. Why waste the time? - companies are the way to learn about what is really going on, but even with them, you can't focus on the "art" of earnings (apparently many spend 10 seconds reviewing earnings and seeing if they "beat or miss" - enough analysis for them) - instead look a few layers deeper within the onion: revenue, margins, "how they made the bottom line" and commentary that is not just the "hopeful" forward-looking nonsense.

Two major earnings reports Monday night - Novellus (NVLS) and CSX (CSX); the former is in the very cyclical semi space; basically similar to Applied Materials (AMAT) in semi equipment, and the latter is a railroad.

Pretty similar stories to both, and exactly as we predicted. Revenue (which cannot be gamed) stunk; they are holding their head over water by chopping a lot of humans, right-sizing the business and finishing off with the "we are seeing stabilization" or "bottoming" boiler plate CEO commentary. Almost exactly the same playbook as 3 months ago, and it's working again for both - despite a large miss (and being down Monday after hours) NVLS was up 2% on Tuesday and CSX was up 7%. So this says to me, people's expectations are still low and as long as the CEO repeats the exact same tag lines of 3 months ago, we're good. At least for now.

CSX is more important to me as a tell on the US economy, but technology has been our leadership group, so in terms of "keeping Wall Street propped up," the semiconductor story is very important. I am frankly a bit surprised with what I read that investors are happy with NVLS, but that's why playing "earnings gambling" is not for me; not only do you have to guess the results, but then you have to guess the knee jerk reaction to the results. As for CSX. I have to say it's splendid it is able to remain profitable in such a crummy environment; when world trade resumes at a more normalized pace, this should bode very well for profitability. They might even rehire some of their workers... bonus.

CSX (CSX)

Via TheStreet.com

• CSX(CSX), the railroader, surpassed Wall Street targets with its second-quarter earnings Monday, and said that it sees indications of a bottom developing in some of the markets it services. (of course the last phrasing is all that matters to the stock market)
• The company said it earned $308 million, or 78 cents a share, down from $385 million, or 93 cents, in the year-earlier period. To account for the sale in March of the tony but bankrupt Greenbrier resort in West Virginia, CSX said its profit from continuing operations in the second quarter was 72 cents, compared with 95 cents a year ago. Either way you look at it, CSX beat expectations by a large margin. Analysts were looking for EPS of 62 cents.
• Revenue, however, still compared badly with 2008. CSX said its second-quarter top line fell 25% from a year ago to $2.2 billion. The company blamed the declines on sharply lower volumes and a lesser fuel surcharge compared with a year ago.

Not to worry, "optimistic phrases" were located:


Via Barron's

• Rail operator CSX (CSX) has been having one of those fundamental performances increasingly typical of companies acutely sensitive to economic fundamentals: conditions got worse throughout the second quarter of 2009, but as they closed out the period, those things stopped deteriorating at the pace to which they’d become painfully accustomed.
• Take its coal business: the slump in coal shipments widened significantly in the period, falling 21% in the second quarter, three times the rate of decline the rail experienced in the first quarter of the year. (that's actually horiffic and a 2nd derivative NON improvement, considering how awful 1st quarter was in the real economy) Reduced usage by electric utilities, lower natural gas prices and slumping exports all contributed to the downturn.

So things got worse in the quarter, even though managements across the land said they were seeing improvement or stabilization 3 months ago. And that's why we drove stock prices up - remember, 2nd derivative improvements? So in coal for example that improvement did not happen - yet we still drove stocks up on ANTICIPATION it would happen. When it doesn't happen what do you do?

You repeat the same language. Try try again - and one of these quarters your words will come true.

• But management said that the slide is expected to moderate in the third quarter, but without saying the trend is going to improve.

Overall

• The takeaway from the conference call would appear to be that its end markets are stabilizing at current levels. That’s good enough to allow some investors to get a little optimistic about its outlook.

So that language is not even saying there is any improvement; it's simply saying stabilization at quite possibly the worst levels of economic activity in 6-7 decades. Green shoots.

Via AP

• Railroad operator CSX Corp. said Tuesday it expects shipping demand to sink by double digits again this quarter, but not as drastically as in the second-quarter, as the company looked for signs of an economic recovery.

Again, we were wrong on last quarters "2nd derivative improvement" forecast but we'll roll out the same language this time.

• Jacksonville, Fla.-based CSX's shipping volume fell 21 percent in the April-June period, compared with 22 percent industrywide.
• The number of active train and engine workers was down 17 percent, and the number of its signature yellow and blue locomotives dropped by the same amount.
• The company didn't offer an earnings outlook, but said it now expects to get more money from raising prices this year among its existing customers -- about 75 percent of its annual business. It predicts it will now be able to increase prices by 6.6 percent this year, compared with a previous estimate of 5 to 6 percent. (it's nice to be near monopolies, and this is why Mr. Buffet loves the rails - you can raise prices even in THIS type of environment)

So it's great for Wall Street. For Main Street? Not so much.

• Ward said that cost cuts should continue to buoy sinking demand this quarter. In the second quarter, the company slashed expenses by 27 percent from a year earlier -- mostly through labor reductions.

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Novellus (NVLS)

Via Reuters

• U.S. semiconductor equipment maker Novellus Systems Inc (NVLS) posted disappointing margins and a wider than expected loss, but a robust forecast helped limit share losses in late trade.

I don't follow NVLS closely, but I am sure if I pulled the report from last quarter, it would be almost identical to what is said above... "bad results, stable forecast - green shoots". Similar to CSX, if you are wrong in your happy talk, just repeat it again for the next quarter. Eventually a broken clock will be correct.

• Many investors had bet on a gradual recovery in the chip sector and a bounce in profits for players such as Novellus. Analysts had hoped for Novellus, which competes with larger rival Applied Materials Inc (AMAT), to report fatter margins in line with cost-cutting and a market recovery. "The margin actually came in a little weaker than what people were thinking," said Needham & Company analyst Edwin Mok. "People were expecting the margin to expand sequentially from last quarter to this quarter but it did not."
• "Expectations were clearly that they would be at the high end of guidance or even beat the guidance," he said.
• Novellus Chief Executive Richard Hill said on a conference call he expected revenue of $150-180 million in the third quarter, down 30 to 42 percent from a year ago but sharply better than a 54 percent dive in second-quarter turnover to $119 million, year on year.

So sales are cut in half this past quarter; a quarter I am sure 90 days ago they were saying would be better than the 1st quarter. Again, keep selling the hope - and now we say 3rd quarter will only be down (what a huge range) anywhere from 30-42%, which will be quite the improvement from 54%. Green shoots.

• Novellus reported a net loss of 52 cents per diluted share in the quarter ended June 27. But excluding items such as a $15.9 million charge for workforce reductions and scaling back parts of its business, Novellus reported a loss of $39.3 million, or 41 cents a share. Analysts on average had expected a loss of 38 cents a share, according to Reuters Estimates.

Translation. We lost a lot of money. Even when you exclude the 1x charges for firing a lot of people that only in American accounting "don't count", we still missed analysts expectations. Thankfully, 1x charges never hurt earnings in PE ratios because again - they don't count. That said, we were not profitable anyhow, so it's a moot point. But just wait until we are profitable... next quarter. Or the one after that. Or the one after that... just buy stock.

• Excluding certain items, Novellus posted a gross margin of 32.4 percent, in line with the company's outlook. But on a GAAP-basis, Novellus reported second quarter gross margins of just 26 percent -- matching its first quarter result.

For those not in the know, GAAP is what accountants would use if we took this all seriously. Instead, to inflate stock prices, we exclude many things that hurt profits and hence can claim stocks are much cheaper than they are. That's what happens when you can exclude so many charges as "pretend"... also part of the reason so much executive compensation is in stock options; in non GAAP; they don't count. And almost all analysts now use non-GAAP.

But that's a whole different entry - we went in depth on that subject here [Apr 24, 2009: Operating Earnings v As Reported Earnings]. Just be aware that as we talk up PE ratios, almost all American companies are vastly understating their expenses (hence overstating profitability) as we use non GAAP figures, both by the companies and the analyst community. That's what you have to do when you have a bevy of flaccid companies throughout the dynamic, innovative economy. Have to justify those bonus and option payouts.

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Anyhow, bottom line - we're all happy here. NVLS and CSX are up - the all knowing market has spoken. Buy stocks, the recovery is here... the CEOs said that 3 months ago as well. They were wrong. But they mean it this time. Expect the same song and dance among another couple hundred companies in the weeks to come.

We can dance, we can dance ...

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Comments

[basehitz:]

Mark, I concur with your read on both. Reading a ton of earnings reports gives a better read. Then write your own commentary on how things are going.

What's going to get interesting is:
Tuesday: "Dell executives said Tuesday that many of the conditions that hurt the PC industry over the last several quarters aren't easing."
Wed: “Intel’s second-quarter results reflect improving conditions in the PC market segment with our strongest first- to second-quarter growth since 1988 and a clear expectation for a seasonally stronger second half,” said Paul Otellini, Intel president and CEO.

Somebody poll HPQ to see if it's end demand resurgence with Dell underperforming, or if it's inventory restocking.

Jul 15 07:43 AM

[John Galt:]

I must say you have true talent to spot it all and I agree with you 100%...

Basically the last 3 months or so the government has been promoting "the improvement of the 2nd derivative". In plain english for those of us that forget Calc, that means the government is saying that the rate of change is improving for the better... we getting worse at a slower pace...

Digging through the CSX report ( not just looking at a beat or a loss top line number), you found that in fact things were not getting worse at a slower pace, they were getting worse at a worse pace. The only hope is maybe now they won't. Keep in mind this is a railroad and railroads are leading indicators that move raw matierals ( imputs) for our economy. If I only got to see a few companies earnings, railroads would be one I wouldn't want to miss.

The market rose on the premise that things were getting worse slower, but that's not true... so is the market due for a correction?

Let me also be the first to tell you that I am not happy to be flat out LIED to by our government... but then again, what do you expect? " We are in a crisis of confidence", so if we could just lie to people to make them FEEL better, than maybe this whole mess will go away.

Jul 15 08:37 AM

[ain't no fo...:]

Sometime around late August S & P will put a news item out that will quickly disappear onto a back page of its web site stating that Q2 '09 revenues for the S & P 500 fell by an average of perhaps 18%, and EPS fell by an average of 35% from the COMPARABLE Q2 '08 numbers. No one will notice it.

Despite those sobering statistics, right here and now stock prices are exploding to the upside on the magnificent BEATS by companies like CSX and INTC vs their estimates. That's right, their (and their analysts') ESTIMATES.

As one true visionary headline put it after INTC's earnings were released last night on their headline: "INTEL BLOWS DOORS OFF ESTIMATES!" Yes, indeed.

Quite frankly, a blind, drunk 90 year old Alzheimers patient could have "blown the doors off" Intel's estimates, because they were set so obscenely low by the Wall Street selling machine that it should be criminal.

INTC estimates were set at 8 cents a share... that would be a 70% decrease YoY to their Q2 '08 earnings. 70%!!!! The fact that they "only" missed last year's comparable numbers by 35% rather than 70% is cause for celebration? Are you kidding me?

If they set the bar low enough, which the companies, sell side analysts, exchanges, and the media ALL have a vested interest in doing, you will ALWAYS "blow the doors off" estimates - that is how the Wall Street selling machine works! Its called slapping lipstick on a pig.

Much is made by the folks at Intel and their legion of acolytes that they blew away the sequential numbers... that's all they seemed to want to compare to in their website press release. That is a specious argument and an irrelevant comparison, because Q1 is always a weak post Christmas number, and it was exacerbated mightily this year by the fallout to the post-Lehman "end of days" meltdown. Of course they beat that number handily... it would have been impossible not to.

The reason we look at the quarterly YoY numbers is because year after year the drivers and key metrics of a mature company with established markets will play out most similarly and provide the best insight into their business progress (or lack thereof) when given an apples for apples comparison to the prior year's experience. And in that respect, INTC's numbers stunk, despite the ridiculous low bar that was set by the company and the Street's sell side analysts.

These are Q2 '09 vs Q2 '08 comparisons, EXCLUSIVE of the EU fine:

Revs: 8.0 billion vs 9.47 billion (down 15%)
Op Income: 1.4 billion vs 2.22 billion (down 36%)
Net Income: 1.0 billion vs 1.55 billion (down 36%)
EPS: .18 vs .28 (down 35%)
Gross margin: 50.8% v 55.4% (down 5.5 basis points - that's huge)

And the company noted that ASP's (average selling prices) for microprocessors was down SEQUENTIALLY (meaning down against one a very weak Q1 '09)... that suggests weak real demand across the board.

And two of their largest PC customers have expressed somber sales outlooks - Dell this week, and HP in May.

And everyone concedes that sales were benefitted by restocking of major customers who had bled their own inventories down to incredibly low levels as THEIR sales have been falling.

Despite all, these numbers were considered by the "pundits" to be spectacular, which tells you how desperate the Street and MSM are to paint the tape that they will put up ridiculous estimates just so they can then "blow them away". That is what these guys do... they SELL schit. If they don't sell schit they don't survive (well, except they do thanks to the US taxpayer).

So expect 90% of the S & P 500 to "blow away" lowballed earnings estimates this Q, and the markets to rally, and the Wall Street selling machine to hype hype hype... but remember this, look very closely at what the numbers are, and what they are really saying about the direction of corporate profits, and remember that figures don't lie, but liars figure.

Jul 15 09:56 AM

[mdmrjsds:]

Taking their cue from Ben Bernanke. He's predicted 6 of the last 0 recoveries. Eventually he'll be right. :-)

Jul 15 06:45 PM