COVER STORY: Unplugged by Jacqueline Doherty
Highlighted companies: AT&T Inc. (T), BellSouth Corp. (BLS), Verizon Communications Inc. (VZ), Comcast Corp. (CMCSA), News Corp. (NWS), EchoStar Communications Corp. (DISH), DirecTV Group Inc. (DTV)
Summary: Friday afternoon the FCC approved AT&T's $86 billion acquisition of BellSouth. The combined company will provide retail phone service in 22 states, own the largest U.S. cellular company (Cingular Wireless), and become one of the biggest business telecom providers. But the $225b conglomerate faces significant challenges:
Bottom line: Shares are up 46.5% this year to a recent 35 amid enthusiasm for the BellSouth deal. They currently trade for 13.6x next year's expected earnings. If AT&T's P/E multiple retreats to 11, the bottom of its normal range, the stock could fall nearly 15%, to $30. If the company misses Wall Street's earnings targets, the downside could be greater. Investors are advised to pull the plug now.
- Recent deals fail to address the ongoing decline in the retail telephone sector; retail line customers are dropping by 2%-4% each quarter as they opt for wireless or VOIP.
- Cable competitors are preparing to deliver a triple-play of voice, video and internet service, stealing customers and deflating prices. Competitor Comcast signed up 483,000 telephone subscribers in Q3, compared with 326,000 in Q2 and 211,000 in Q1, bringing its total to 2.1 million. And cable providers say once they're entrenched in the retail market, they will begin going after AT&T's commercial accounts.
- To counter cable's 'triple-play' AT&T is rolling out its own version of voice/video/data, Project Lightspeed, which combines fiber and copper wires to deliver video to customers' homes. But skeptics worry whether the company can make the technology work over large areas. The system sometimes crashes or freezes, and there are rumors that AT&T is finding its servers can't handle as many homes as expected. The company might need to use more servers. Other solutions, such as buying a satellite company or rolling optical fiber to homes as competitor Verizon was forced to do, are costly but potentially unavoidable. Some analysts speculate that once the BellSouth deal closes, AT&T will acknowledge Project Lightspeed isn't working.
- The most enthusiastic forecasts see AT&T revenue growth of only 1% in the next two years; anticipated double-digit earnings, if they materialize, will be mainly from post-merger cost cutting.
Related: Net Neutrality: The Real Issue Behind the AT&T/BellSouth Showdown, AT&T Promises to Respect 'Net Neutrality' in Revised BellSouth Merger Plea To FCC, AT&T May Buy DirecTV, Says UBS, AT&T Considers Its Next Move, AT&T: Unfulfilled Innovations Since 1993, Can Direct-Broadcast Satellite Build a Third Broadband Pipe?, Citi: Buy AT&T and Sell Verizon, Jim Cramer's Take on T. Conference call transcript: AT&T Q3 2006
Emerging and Converging by Sandra Ward
Highlighted companies: Taiwan Semiconductor Manufacturing Co. Ltd. (TSM), Petrobras Energia Participaciones S.A. (PZE), Companhia Vale do Rio Doce (RIO), China Mobile Limited (CHL)
Summary: Barron's interviews Arjun Divecha, Partner of Grantham, Mayo, Van Otterloo and pioneer in emerging-markets investing. Five years ago emerging markets traded at about 9x earnings. Since then, they're up 250% and trade at 13x earnings. The fact they're only at 13x times earnings proves how much the fundamentals have improved, but at the same time makes it is hard to say emerging markets are a 'screaming buy' -- but relative to other equities, they certainly are cheaper. Some key points:
Related: Emerging market ETFs include: BLDRS Emerging Markets 50 ADR Index (ADRE), iShares MSCI Emerging Markets ETF (EEM), iShares MSCI Brazil Index ETF (EWZ), iShares MSCI Malaysia Index (EWM), iShares MSCI Mexico Index ETF (EWW), iShares MSCI South Africa Index (EZA), iShares MSCI South Korea Index Fund ETF (EWY), iShares MSCI Taiwan Index (EWT), Vanguard Emerging Markets Stock VIPERs (VWO), Claymore/BNY BRIC ETF (EEB)
- He sees nothing on the horizon that looks ugly in most emerging markets. If there is going to be a crisis, he says, it is going to come out of the U.S. or the developed markets, not the emerging markets.
- Because many emerging markets are dollar linked, those who are worried about the dollar should stay away.
- He is most overweight Taiwan, which has underperformed other emerging markets by 136% in the last five years. He likes Taiwan Semiconductor Manufacturing Co. Ltd. (TSM), which has a 50% market share in global foundry, enabling them to set pricing terms due to their overwhelming size. The current tech slump has 2007 forecasts down 20%.
- He still likes Thailand, despite their recent currency control debacle.
- Brazil stands to gain from falling interest rates. He likes everything there, but cautions that Petrobras Energia Participaciones S.A. (PZE) and Companhia Vale do Rio Doce (RIO), which make up a big part of its stock index, may be hit by lower energy/commodity prices.
- Korea was hit by a consumer lending credit-card bubble in 2002-2003. But at 10-11x earnings, it's cheap -- a buy and hold.
- India is his 'least favorite market' because of its valuations (20x earnings). A huge speculative boom leaves little upside room and much risk, and it doesn't yet have the infrastructure to support its 8% GDP growth.
- Slightly positive on China. He likes consumer-oriented stocks such as China Mobile Limited (CHL) which stand to benefit from a governmental shift from export- to domestic-oriented.
Safeway: Ripe For A Fall? by Kopin Tan
Highlighted companies: Safeway (SWY), Whole Foods (WFMI)
Summary: Grocery retailer Safeway's canny upgrade of its supermarkets to lifestyle stores offering quality prepared foods and fancy vegetables has fueled 80% of company growth and pushed its stock up 48% in 06'—three times the average industry gain. But Safeway may be overripe due to 1) A high 17.8 P/E and a 4 1/2 year stock price high of $35. 2) The fancier shopping experience works in wealthier neighborhoods but the next stage of upgrades in poorer areas will be a harder sell. 3) Increasing competition from high (Whole Foods (WFMI)) to low (corner deli) end rivals and foreign invaders (Tesco) will make meeting 12-15% growth projections harder in a low margin industry. 4) Safeway says its new Blackhawk gift card kiosks' profit potential is vast because of a commission with each sale but no inventory expense, projecting Blackhawk will add $50 million to earnings in '06, double that in '07. But it's a risky start up and competition will lower commission rates. CIBC analyst Perry Caicco says Blackhawk's an underestimated earnings booster already, leaving little room for upside. 6) Safeway's high P/E and stock price will deter any buyout suitors. UBS analyst Neil Currie projects a P/E of 15 in 2007, with earnings of $1.90, meaning Safeway should be worth about $29. Bottom Line: Shares surged 48% in '06 to a recent $35, but the many challenges facing Safeway make the stock probably worth closer to $30.
Related: More coverage of Food/Restaurant stocks.
Home Depot, Lowe's Are Poised To Nail Down Gains by Christopher C. Williams
Highlighted companies: Home Depot (HD), Lowe's (LOW)
Summary: Home Depot’s shares have dropped 13% ever since its current CEO Robert Nardelli took the reins six years ago, but there are plenty of reasons to hold on tight. Earnings per share are up 140% since 2000, yet Home Depot's shares trade for only a dollar more now than they did in 2004, and competitor Lowe’s are standing still from the start of '06. Over the past year, Home Depot shares are down 1.4%, while Lowe’s has dropped 7.2%. Barron's remains positive on both stocks. Once the housing market hits bottom, as many analysts believe it is close to doing, the only way is up. "The stock screams 'very statistically cheap' on earnings, book value, cash flow and sales," says Todd Lowenstein of HighMark Value Momentum fund, who recently bought Home Depot shares, while investor Warren Buffett added to his investment in Lowe's in the third quarter. Although ‘07 same-store sales are expected to drop 2%, they could rebound in ‘08, as consumers return to spending on home improvement. The chains sense this positive future, and are investing in more space, new additions to inventory and plans for overseas expansion. Two looming possibilities could prove profitable to investors; a proxy fight may be initiated by Relational Investors, which owns about 1% of the chain, and a leveraged buyout, although unlikely, is not out of the question. In the case of a buyout, shares would rise from a current 40 to an estimated 45 to 58. Barron's: "Investors, fasten your tool belts."
Related: Shareholder Pressures Home Depot to Form Independent Committee to Explore Strategic Alternatives, Don't Scapegoat Bob Nardelli for Home Depot's Stagnant Stock, Home Depot's Dividend Increase: Not What Bob Nardelli Wants You To Believe, David Strasser's Long Case For Lowe's Corp
Powering The Heartland by Thomas G. Donlan
Highlighted companies: Great Plains Energy (GXP)
Summary: Great Plains Energy, formerly Kansas City Power & Light electric utility, weathered a white elephant nuclear power plant built in the surplus years of the 70's and 80's, increased regulation after the Three Mile Island accident and a recent battle against a hostile takeover. In 2003, KCP&L got new management, a new name (GXP) and a new business model, then set about repairing its image with regulators, consumers and investors. A long, strong marketing campaign helped counteract a big rate jump planned to fund a new coal plant. To sweeten the pill, GXP promised 450 megawatts of coal fired power, reduced emissions, a 100 megawatt wind farm and increased efficiency to handle demand. As a result, GXP won regulatory approval for rate hikes, enabling plant construction through cash flow, not debt. GXP announced 20% plant cost overruns although its wind farm was finished in September on time and on budget. Still, shares have gained 17% since summer '05 and are trading at a P/E of 15.9, less than the industry average of 17.7. With a 5.2% dividend and if they beat the Street's $2.01 per share projections, GXP could garner 15% returns in '07. CEO Michael Chesser says GXP plans to grow earnings at 2%-4% a year. Bottom Line: With GXP's turnaround, shares could return 15% over the next year even after a 17% rise since last summer.
Related: Highest Yielding Utility Stocks: Electric Utilities; Time To Go Long Electricity
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