Seeking Alpha
Growth at reasonable price, research analyst, newsletter provider, long/short equity
Profile| Send Message|
( followers)  

Market Outlook:

The market made a valiant comeback on Tuesday after some positive economic data alleviated fears of investors about QE issues. Housing data was very strong as the Case-Shiller Index came in 12% higher than previously for April data. New Home Sales, additionally, jumped to a multi-year high at 476K versus expectations of 466K. That news was solid as it showed the strength in housing is still there. Further, we got good news from Consumer Confidence for June as it rose to 81.4 versus 75.0 expectations. The market is sitting in an interesting conundrum. Good news about the economy is good for companies but likely means QE will taper. Bad news is bad for companies but good for QE continuing. In the long run, QE will end, so its much better to end it when the economy shows its picking up. This data shows that.

For tomorrow, we are expecting the market to likely follow through as we get some end of the quarter (Q2) upside. The key, though, is GDP estimates for Q1. This will be the third estimate, and it is expected to come in 2.4%, the same reading as the second estimate. That news will be key to the market along with overseas developments. German Consumer Confidence and French GDP will also be released tomorrow. Those two reports are key to a bottoming out picture happening in Europe. If those two reports come in strongly, we could see a lot of upside as short covering would definitely bring about some swift upside.

Stocks To Watch:

Today, we are looking at positions in Oracle (NYSE:ORCL) and Anheuser-Busch InBev (NYSE:BUD). Both companies have had key recent developments that we want to discuss as we have coverage on both companies.

Oracle -

Overview

Today, we look at ORCL. The company has a Buy-rating with $40 price target after our update. Coming into the update, we liked shares with a Buy and $36. We are upgrading shares due to the company's recent deal with Salesforce.com (NYSE:CRM) as well as earnings that were not as weak as the market priced.

Recent Developments/Catalyst

The most recent crucial development for Oracle was their earnings report that came out last week. Today, we will delve into that report and update our price model based on it. As was noted, we had a price target at $36 and Buy rating at the beginning of the year. The market did not react well to the latest round of earnings, so we are wondering if this is a buying opportunity or time to decrease our expectations.

Here are the details of the earnings:

The company reported $10.9B in revenue, which was below the $11.2B in revenue from one-year prior. The company reported EPS at 0.87, meeting expectations. The earnings, though, were a bit disappointing for investors. The company only saw a 1% rise in its new software sales/subscriptions to $4B. This area is the key area where ORCL is trying to catch up in the cloud network. The company noted slow growth in Asia and Latin America, but competitors like Salesforce.com saw a rise of 28% year/year in revenue in their last earnings report.

The key for big tech like IBM (NYSE:IBM) and Oracle is getting a combination of software and hardware together to attract clients. The companies were able to maintain high margins for a long period due to their premier position, but companies like CRM, F5 (NASDAQ:FFIV), and other application software companies have been able to build competitive products that can compete on price. We have not seen a dip in ORCL's margins yet, but growth has slowed dramatically.

ORCL claims that their struggles in Q4 was not a matter of business going to competition but rather a matter of weak economic environment over competition issues. We now are looking for slightly less growth in FY2014, but we still expect the company to grow operating income by around 8% next year. We believe that the company will see some pretty solid movement this year as IBM has also noted that there was a push on deals to be made later this year. We would expect another 8-10% operating income growth in 2015FY as the company sees cyclical growth from their cloud network growth. We would expect a slowdown, though, in 2015-2017 to around 5-7%.

When we price that growth rate into our model we are still coming up with a lot of upside in ORCL using a fairly unaggressive model. What that means for ORCL is that shares are cheap. When we look at valuations, we can see that's true. The company has a future PE at 9.5 along with PE at 14. The PEG is also at 1.3, which shows that the stock is not properly pricing growth. This does make sense because the company has not had good results for two quarters, but we are confident that ORCL will see a turnaround I this FY. The company has not had a year where operating income did not improve in ten years, and the lowest growth level was in 2008-2009. ORCL will bounce back, and if you believe in this company as years of history show…they will.

One potential sign of a comeback is that ORCL swallowed its pride and is teaming up with CRM. They are optimizing their cloud with CRM's. The nine-year deal will allow ORCL to use Oracle Linux OS and databases. This move will help ORCL tremendously to appeal more to companies and is one of the reasons we expect a comeback in growth.

We like shares to bounce back this year as we believe shares have more than fully priced in recent issues.

Price Target Analysis

Step 1.

Project operating income, taxes, depreciation, capex, and working capital for five years. Calculate cash flow available by taking operating income - taxes + depreciation - capital expenditures - working capital.

 

 

 

2013 Projections

2014 Projections

2015 Projections

2016 Projections

2017 Projections

Operating Income

14665

15850

16630

17500

18160

Taxes

3520

3804

3991

4200

4358

Depreciation

3100

3300

3500

3600

3600

Capital Expendit.

-725

-750

-650

-675

-750

Working Capital

2143

2143

2143

2143

2143

Available Cash Flow

11377

12453

13346

14082

14509

Step 2.

Calculate present value of available cash flow (PV factor of WACC * available cash flow). You can calculate WACC, but we have given this number to you. The PV factor of WACC is calculated by taking 1 / [(1 + WACC)^# of FY years away from current]. For example, 2016 would be 1 / [(1 + WACC)^4 (2016-2012). WACC for ORCL: 9.6%

 

2013

2014

2015

2016

2017

PV Factor of WACC

0.9126

0.8328

0.7599

0.6935

*

PV of Available Cash Flow

10383

10371

10143

9767

*

Step 3.

For the fifth year, we calculate a residual calculation. Taking the fifth year available cash flow and dividing by the cap rate, which is calculated by WACC subtracting out residual growth rate, calculate this number. Companies with high levels of growth have higher residual growth, while companies with lower growth levels have lower residual growth. Cap Rate for ORCL: 6.6%

 

2017

Available Cash Flow

14509

Divided by Cap Rate

6.58%

Residual Value

220495

Multiply by 20167PV Factor

0.6935

PV of Residual Value

152924

Step 4.

Calculate Equity Value - add PV of residual value, available cash flow PVs, current cash, and subtract debt:

  

Sum of Available Cash Flows

40663

PV of Residual Value

152924

Cash/Cash Equivalents

16101

Interest Bearing Debt

19750

Equity Value

189937

Step 5.

Divide equity value by shares outstanding:

  

Equity Value

189937

Shares Outstanding

4660

Price Target

$40

Anheuser-Busch InBev -

Recent Developments/Catalyst

At the beginning of June, BUD completed its sale to Constellation Brands (NYSE:STZ) for Group Modelo. The deal was worth $4B. Additionally, the company completed its acquisition of Grupo Modelo (OTCPK:GPMCF). The deal was worth $20B. BUD is using Grupo Modelo to get into South American markets. How much can the Grupo Modelo add in value for shares?

In the TTM, Grupo Modelo has made around $7B. That revenue will be added into BUD's business, and the company will definitely benefit from the added liquidity and business acumen of Budweiser. The company took on $14B in debt to finance the deal, and they add some great new beer names to their lineup. The consolidation of the beer business, though, has more to do with the situation in the alcohol industry we believe. With the rise of popularity of craft breweries and different types of beer, BUD has been in trouble in the states. In these emerging markets, the big name brewers are still in charge, and beer is growing at a faster rate. For example, in Mexico, beer volumes grew 3% in 2012 versus 1% in the USA.

To get the Modelo name, the company had to pay a 30% premium as well, which was a steep price to get involved in Latin America in a larger way. Yet the $7B+ addition of sales will add around 15% growth in sales in 2013 and 2014. We look for EPS to increase to around 5.0 this year and 5.5 in 2014, which are solid rates for the company. Yet, we expect a big slowdown in 2015-2017 for growth as we continue to believe beer volume growth will be in craft and not in the big name producers.

Let's breakdown the numbers for the company and highlight our future expectations.

We are looking at, in our model, around 7-8% growth in operating income in 2013 along with around 15% growth in 2014. We expect growth to come down to 2-3% in 2015-2017. The reason we look at growth like this is because we believe the Modelo expansion will bring a lot of growth in the next 18 months, but we expect growth to slow in 2015-2017 due to trends that we have discussed with craft beers and competition rising.

With that said, capital expenditures should drop as the expansion and integration of Modelo drops in 2015. The company could expand growth at a higher rate with more acquisitions in 2015-2017, but capex would be much higher as well. The company has a low WACC due to low beta in the name.

In this model, the company is worth around $125, which we believe t will reach in the next twelve months. The previous price target we had was $100. The model improved greatly with the acquisition of Modelo, and we see shares as undervalued now with that deal. Some signs of that undervaluation can be seen in the company's low future PE at 15. We look for value when future PE is below that level.

Shares have dropped recently on a weaker Brazilian real, which hurts the company with its Group Modelo sales as they convert back to dollars, but this issue is short-term in nature and not reflective of the long-term upside in growth from the company.

On top of the promising upside due to valuation, BUD has an attractive dividend at over 2.2% that is very safe given the company's very large cash holdings and free cash flow. The company has extremely high debt levels right now that are working against the company's valuations, so as those come down upside is even more attractive.

We recommend buying all the way up to $98.

Price Target Analysis

Step 1.

Project operating income, taxes, depreciation, capex, and working capital for five years. Calculate cash flow available by taking operating income - taxes + depreciation - capital expenditures - working capital.

 

 

 

2013 Projections

2014 Projections

2015 Projections

2016 Projections

2017 Projections

Operating Income

13700

15700

16200

16500

16900

Taxes

3425

3925

4050

4125

4225

Depreciation

2750

2800

2800

2850

2850

Capital Expendit.

-3700

-3000

-3500

-3000

-3500

Working Capital

65

65

65

65

65

Available Cash Flow

9260

11510

12385

12160

11960

Step 2.

Calculate present value of available cash flow (PV factor of WACC * available cash flow). You can calculate WACC, but we have given this number to you. The PV factor of WACC is calculated by taking 1 / [(1 + WACC)^# of FY years away from current]. For example, 2016 would be 1 / [(1 + WACC)^4 (2016-2012). WACC for BUD: 6.34%

 

2013

2014

2015

2016

2017

PV Factor of WACC

0.9404

0.8843

0.8316

0.782

*

PV of Available Cash Flow

8708

10178

10299

9509

*

Step 3.

For the fifth year, we calculate a residual calculation. Taking the fifth year available cash flow and dividing by the cap rate, which is calculated by WACC subtracting out residual growth rate, calculate this number. Companies with high levels of growth have higher residual growth, while companies with lower growth levels have lower residual growth. Cap Rate for BUD: 4.34%

 

2017

Available Cash Flow

11960

Divided by Cap Rate

4.34%

Residual Value

275576

Multiply by 20167PV Factor

0.782

PV of Residual Value

215504

Step 4.

Calculate Equity Value - add PV of residual value, available cash flow PVs, current cash, and subtract debt:

  

Sum of Available Cash Flows

38695

PV of Residual Value

215504

Cash/Cash Equivalents

7051

Interest Bearing Debt

60100

Equity Value

201150

Step 5.

Divide equity value by shares outstanding:

  

Equity Value

2011500

Shares Outstanding

1600

Price Target

$125

Source: Oxen Outlook: Buy Oracle And Anheuser-Busch