COVER STORY: Big Ripple by Andrew Bary
Highlighted companies: Homebuilders' ETF (XHB), Toll Brothers (TOL), WCI Communities (WCI), Home Depot (HD), Countrywide Financial (CFC), Centex (CTX), Pulte (PHM), Lennar (LEN), KB Home (KBH), Levitt (LEV), Bluegreen (BXG), Whirlpool (WHR), Cendant (CD), Realogy (H), Wyndham Worldwide (WYN), MDC Holdings (MDC), Hovnanian Enterprises (HOV), Lowe's (LOW), Mohawk Industries (MHK), DR Horton (DHI)
Summary: Weak home sales, growing inventories, dwindling orders and falling prices have all contributed to a weakening housing market. Hardest struck have been the home builders, who are off as much as 65% from last summer's highs. But with the investment community firmly entrenched in their bearish outlook, the time to consider catching some bargain-basement prices in housing stocks may be rapidly approaching. Various companies are analyzed in depth (see "Highlighted companies" above, particularly those in bold), considering factors such as book value (many home builders presently trade at or below book value) and price-to-earnings ratio (P/E) -- home builders currently average about 6. While it's possible the current lull is just the beginning of a full-out bust of the housing boom, similar to the tech-stock-bubble bust of the late 1990's, bulls counter that such factors as relatively low interest rates, a still expanding economy, and positive demographic factors bode well for the sector. Many top investors, while admitting they were too early in buying-in to the group, are sticking with the sector, sensing the bottom is near or "within squinting distance." While conceding that "it may be early for housing-related stocks," Bary concludes that with its attractive valuations, the housing market may bottom sooner than later, especially if signs of recovery begin to emerge or if the Fed starts cutting rates, and that these previously battered stocks could take a sharp upturn way before any corresponding growth in profits.
Quick comment: This week's Barron's cover story take a clearly bullish stance on homebuilder stocks, the opposite of Marc Gerstein's must-read argument that homebuilder stocks are a value trap, Lon Witter's prediction in last week's Barron's that the broad market will fall 25%-30% as it becomes clear the housing market is in significant decline, and William Trent's bearish summary of the housing market data. Clearfish Research, in contrast, takes a bullish perspective consistent with this Barron's article, making the case for an easy landing, in which he points out that predictions of housing-market gyrations have historically been unreliable and the numbers behind the headlines continue to surprise the pessimists. As noted in the Barron's article, Toll Brothers CEO Robert Toll argues that the market has illogically lumped together well-capitalized builders and weaker upstarts, providing opportunity for value investors to buy stocks of companies with solid track records at close-to-book-value prices. Note that famed contrarian investor Bill Miller has almost 4% of his portfolio in homebuilder stocks, namely Beazer Homes (BZH), Centex (CTX), Pulte Homes (PHM) and The Ryland Group (RYL). See Bill Miller's entire portfolio as of June 30th, including the allocations to each of these stocks, and the excerpt from his letter to shareholders in which he discusses housing stocks. Seeking Alpha has an easy-to-bookmark section devoted to ongoing coverage of the housing market.
INTERVIEW: REITs' Still-Rosy Outlook by Sandra Ward
Highlighted companies: Cohen & Steers (CNS), Trizec Properties (TRZ), Mills Corporation (MLS), Starwood Hotels & Resorts Worldwide (HOT), Hilton Hotels Corporation (HLT), Strategic Hotels & Resorts Inc. (BEE)
Summary: Interview of Marty Cohen, Co-CEO of $23 billion investment-services giant Cohen & Steers. The article focuses on Real-Estate Investment Trusts (REITs), one of Cohen & Steers' main empire-building instruments. Over the past two years, REITs have consistently outperformed other sectors. Cohen attributes their current growth to stagnant supply coupled with increased demand, leading to rent and revenue increases (rent increases have a high 'flow-through' to overall profitability, because operating costs don't change substantially with increased rents). Cohen concedes that if the economy slows substantially, real-estate values and profits will likely slow as well. However, he does not see signs of a recession, and believes that current Fed policy improves the probability of a soft landing or continued growth. A slow-but-consistent economy is ideal for REITs, because as long as real-estate fundamentals continue to improve and interest rates remain low, REITs will continue to be a solid investment. Buyouts and takeovers, which have dominated the sector over the past two years, have helped its performance as well. Looking at the world markets, Cohen is bullish on European and Asian REITs, particularly in Hong Kong. On the domestic front, Cohen sees the hotel sector as a standout among the REITs, due to an unprecedented increase in the revenue per available room (revpar).
Quick comment: ETF REIT plays: Cohen & Steers provides the underlying index for the iShares Cohen & Steers Realty Majors ETF (ICF). That, along with iShares Dow Jones US Real Estate (IYR), streetTRACKS DJ Wilshire REIT (RWR), and Vanguard REIT ETF (VNQ) all perform similarly and are viable plays on the US REIT market. As noted in the article, Cohen & Steers stock (CNS) has grown explosively over the past two years, vastly outperforming the REIT ETFs, who themselves have way outdone the major overall indexes (see chart). This illustrates the advantage of investing in a REIT-focused company who continues to seek-out other income-oriented investments like utilities and high-yielding stocks, rather than focusing entirely on one sector. While Cohen makes the case for a 'soft-landing' of the current real-estate slowdown, SeekingAlpha contributor Richard Kang paints a far gloomier picture, asking, "Does a minor soft-landing follow the most extended residential real-estate cycle on record?"
End of the Line for Brokers? by Jacqueline Doherty
Highlighted companies: Bear Stearns (BSC), Goldman Sachs (GS), Lehman Brothers (LEH), Morgan Stanley (MS), Merrill Lynch (MER), Citigroup (C), JPMorgan Chase (JPM)
Summary: After a four-year run that has seen shares of some Wall Street brokerage stocks more than double in price, analysts have begun cutting-back on earnings estimates amid worries of increased risk and slowing growth. Brokerage firms take the bulk of their profits from the following business lines: 1) Prime-brokerage services, which provide cash-management services, lend on margin, clear trades, provide reporting services, and lend stock to cover short positions. 2) Fixed income services, which sell home-equity asset-based securities and mortgage-backed securities. 3) Private-equity investments - the firms raise funds and broker deals between private investors looking to increase ROI and non-publicly-traded companies. 4) Proprietary trading. In each of the categories, the article raises significant question-marks as to their ongoing profitability. 1) Prime-brokerage lines are suffering from increased competition to court high-volume hedge funds, leading to decreased profit margins. Newer players in this arena are lending money against securities under riskier terms, increasing risk-exposure across the board. 2) A housing-industry slowdown would reduce the production of new mortgages, leaving firms with bloated overheads. A 25% drop in mortgage applications suggests this scenario may be soon-in-coming. 3) The recent flood of money into private equity (see Unleashing Leverage in this week's Barron's) may signal the beginning-of-the-end for the private-equity party, as huge waves of capital push funds to invest in sub-par ventures. The decline of initial public offerings [IPO] in the U.S. by approximately 50% makes it more difficult for firms' private-equity shops to exit their initial investments via IPOs. 4) Although investment banks don't normally divulge proprietary trading gains, most firms acknowledge recent gains have been substantial. Extrapolating such strength into the future may be unrealistic.
Quick comment: Since gaining an astonishing 40% between March, 2005 and May, 2006, the Dow Jones US Investment Services Index ($DJUSSB) pulled-back heavily between May and June. Present market action suggests investors are unsure whether the investment services industry is in for trouble, as the article suggests, or whether the recent pullback is merely a stepping-stone on the way to even bigger gains. Probably the easiest way to play the Barron's article's bearish perspective is to short the streetTRACKS KBW Capital Markets ETF (KCE).
Beyond the Battery Mess by Jay Palmer
Highlighted companies: Dell Inc. (DELL)
Summary: Interview with Dell founder/chairman Michael Dell and CEO Kevin Rollins. Key claims from Dell and Rollins: No problem with the company's fundamental business model and market position as Dell is still the most profitable company in the PC industry. US PC sales are dominated by corporate demand, and Dell's direct model works well for that. (Corporations don't purchase PCs from retail stores.) Dell Inc. made a mistake cutting spending on customer service, but that's now being put right and corporate satisfaction with Dell, reflected in reorder rates, is still high. Dell is investing in design, but corporations don't buy PCs for their design. Revenue growth in Asia is strong, and Dell is taking share in Japan and China in particular. Dell and Rollins refused to predict improvements in profitability as the company is no longer giving guidance, but did say that they expect the corrective actions they are taking to lead to medium term margin improvement. Some poignant quotes: "We are making the investments we believe are needed, but, much as we would like these to show a return within 90 days, the pay back will take longer." "We are now reinvesting in service and it has already started to improve markedly." "The batteries were a quality problem not at Dell but at our supplier [Sony (SNE)]... A point you might want to consider is that we used only 18% of Sony's battery output for the period. Where did the rest go?" "It is fair to argue that (computer) prices did go down too far too fast, at least in relation to costs." "I don't think that corporate satisfaction has declined anywhere near what we are talking about on the consumer side." Dell also brushed-off talk of tension between him and Rollins, and denied rumors that he is considering taking back the CEO job. Dell pointed out that he has recently become a buyer of the stock. (He purchased $70 million of Dell shares in May). The company has said it will buy back about $1 billion worth of shares this quarter.
Quick comment: Some may view the interview as defensive (the questions were reasonable but aggressive), but the article may succeed in refocusing investors on Dell's entrenched position in the US corporate market. For other recent commentary on Dell's stock, see Trading Places: HP, Dell Reverse Rolls from last week's Barron's Summary, in which Mark Veverka contrasts Dell's recent blunders with HP's (HPQ) new sense of purpose, Paul Kedrosky's Mr. Market's Dell Mood-Swing Thing which argues that the market has overreacted to Dell and HP's performance, and Paul DeMartino's more bearish With Dell, the Herd Instinct May Be Right. Interesting also to contrast the upbeat tone of HP CEO Mark Hurd's comments in his fiscal 3Q conference call (see transcript) with the defensive tenor of Dell and Rollins' comments in this week's interview.
Betting on Chocolate Chips by Sandra Ward
Highlighted companies: Anadigics Inc. (ANAD), RF Micro Devices (RFMD), Skyworks Solutions (SWKS)
Summary: Down some 40% this year amid a general slump in telecom, Anadigics' Inc. (ANAD) shares could more than double as the company's financial performance continues to improve, some analysts feel. The company manufactures computer chips that amplify cellphone power. They have posted consistent gains over the past six quarters, making the current slump puzzling. Market cap. is $277 million; projected revenues are $165 million for 2006 and up to $350 million by 2008. The company has excess plant capacity and can double production without expansion. Anadigics stands to benefit from the slimming-down of cellphones and other portable devices, which then require more of its power amplifiers. Analysts project a price target of $10-11/share; some feel even 'mid-teens' are not out of the question. The coming year's earnings estimates range between 34 and 45 cents a share - 13 times earnings. If past history of adding 5 to 7 cents a quarter to earnings is an indication, the company could earn up to 80 cents/share by 2008.
Quick comment: The Barron's article has already been picked up on by Reuters; expect to see some market reaction to the piece in today's trading.
For Warnaco Execs: It's Time to Sink or Swim by Richard Phalon
Highlighted companies: Warnaco Group Inc. (WRNC), Phillips Van Heusen (PVH), Pep Boys (PBY)
Summary: Shares of Warnaco Group - maker of household brand-names such as Speedo, Chaps, and Calvin Klein - have plummeted this year due to various and seemingly unending troubles such as product mistiming, shipping problems, and implementation issues. Last week investors were encouraged by the $40 million purchase of a 5.6% stake in the company by hedge-fund manager James Mitarotonda, whose assertive style may be what's needed to bring the otherwise sloppy operation around. "[We bring with us] people with very strong operating backgrounds, who have successfully run businesses," he said. Mitarotonda has built its reputation by seeking out small and midsize undervalued, underperforming companies. In his proxy-filing, he attacked management for favoring itself with cheap stock and undeserved performance bonuses. Mitarotonda's SEC disclosure form says he's ready to help management explore any value-producing ideas, including a possible sale to a rival like Phillips Van Heusen (PVH). At the same time, a wait-and-see investment posture may be advisable, buying shares on substantive operating improvement, and not hazy promises.
Quick comment: While the article has already been picked up on by GoogleNews, Barron's doesn't take a strong position for or against, so a violent market reaction seems unlikely. Michelle Leder has done a good job of covering Warnaco's accounting problems and compensation issues.
PLUGGED IN: Why is Cable Bidding Big for Wireless by Tiernan Ray
Highlighted companies: Comcast Corp. (CMCSA), Verizon Communications (VZ), Vodafone (VOD), Time Warner (TWX), EchoStar Communications (DISH), DirecTV (DTV), News Corp. (NWS), Deutsche Telecom (DT), Sprint Nextel (S), AT&T (T), BellSouth (BLS)
Summary: The big surprise in the current multi-billion dollar airwaves auction in Washington is the aggressive bidding of SpectrumCo, a consortium controlled (52%) by the U.S.'s biggest cable player, Comcast (CMCSA). Comcast's bids seem to indicate the cable giant may plan to own and operate its own wireless network. There is speculation that Comcast's bidding is less-than sincere - in order to drive-up spectrum prices, or a covert attempt to help consortium partner Sprint Nextel (S) buy spectrum - but their aggressive bidding has convinced most observers that Comcast sees wireless in its future. Not all Comcast share-owners are happy with this development. Investing in a wireless network could mean billions of dollars in new capital expenditures; cable investors have waited a long time for the cash flow promised from network upgrades of the previous decade, which are finally paying attractive returns, and they're anxious a new round of investment could siphon-off most of that cash. But analysts generally believe Comcast will be prudent with any wireless investment. For Verizon [owned by Verizon Communications (VZ) and Vodafone (VOD)] and AT&T (T), there is reason for concern; they may soon be forced to contend with a new cellular entrant.
Quick comment: Recently, Andrew Schmitt gave 'Baby Bells' the upper-hand over the cablecos in the battle for residential subscribers, despite the cablecos' deployment of voice services, because, "Most baby Bells already have a wireless infrastructure. None of the cablecos do. This is why the Baby Bells ultimately have the upper hand... They can migrate their customers (and their phone numbers) to a wireless infrastructure, and Comcast... cannot." In this context, Comcast's aggressive bidding may not be such a "mystery wrapped inside an enigma." Noteworthy is an excerpt from Comcast's Q2 Earnings Conference Call Transcript, in which the questioner asks co-CEO John R. Alchin, "I was wondering if you’d be willing to comment a little bit about the AWS spectrum that’s coming up for auction relatively soon, especially in light of the form that was filed and the ownership that Comcast has. Could you give us a sense of what you think you might use the spectrum for?" His response: "I think the real commitment that we’ve made is to the partnership that we have with the other MSOs (multi-service operators) and Sprint. We’ll be rolling out two markets with wireless products by the end of this year. We’re keeping our options open in terms of registering. It’s like going to a Sotheby’s auction and buying the, you know, the baton to participate and if there is something opportunistic in the way of, you know, prices that we think are attractive for our shareholders, we’ll be in a position to participate."
THE TRADER: CBS Holds Hidden Value by Michael Santoli
Highlighted companies: CBS Corp. (CBS), Viacom Inc. (VIA)
Summary: Since early April, CBS (CBS) share prices are up 14% - a market cap. increase of $2.8 billion. Within its sector, it remains a cheap stock that investors are prone to hold for the long-haul. Since its Jan. 3 split with Viacom (VIA), CBS shares are up 8%, while Viacom is down 10% - despite Wall Street's preference of the latter. One reason is that CBS has one of the most undervalued cash-flow streams from radio, TV and billboard advertising available. Aside from network and production assets, the company owns 179 radio stations, 39 TV stations, a major outdoor-advertising division, Showtime, and publisher Simon & Schuster. CBS trades for less than nine-times its enterprise value; comparable companies routinely fetch substantially higher multiples. CBS has been divesting radio stations, and recently sold 15 of them for 14 times trailing Ebitda (Earnings Before Interest, Taxes, Depreciation and Amortization). Credit Suisse analyst William Drewry says he expects CBS will continue to sell radio stations, perhaps another 25. He figures the company will return the cash to shareholders via a buyback. A value for CBS in the low- to mid-30s doesn't seem all that challenging. With its 2.3% dividend yield, the possible return gets that much more interesting.
Quick comment: In its 2Q Earnings Conference Call (see transcript), CEO Leslie Moonves conceded that radio has been the weak link in CBS's otherwise strong core operations. Looking at a 1-yr chart, CBS shares have been rising consistently since mid-October 2005.
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