Avalanche of Earnings and Sector Rotation

by: TraderMark

I think this might be the busiest day all month for our holdings'' earnings... before we get to that, first a quick note on the market.

S&P 1400 remains a ceiling we need to get above to get fully bullish. S&P 1350 is the floor; below that we turn into bears. So in between (where we are now) we are a bit ambivalent, and for now remain range bound as we have been for a while. The market does continue to shrug off bad news so it would appear up is the more approximate short term direction, especially if we get this "rotation" I spoke about - the leadership in this market has been so narrow (luckily the type of stocks we own), but that is not healthy.

While I doubt we can have a sustained move led by the "new bull era" stocks in retail, financials, and homebuilders - it certainly could be an illusion for a few days or a week or two. So we are at the upper end of our range we have been stuck at. Each time we get here, we get beat back like a red headed stepchild.

Microsoft (NASDAQ:MSFT) is not helping matters after hours but then again, earnings results have been ignored and the market just wants to go up most days of late.While these individual company reports are important, right now we are in an environment where sectors are more important than the individual companies - if the sector is down it doesn't matter much what the company says, and vice versa.

1) I've cut back "Chinese Google" Baidu.com (NASDAQ:BIDU) as it's had a very nice run here, and it's gone from "expensive" to "astronomical", but valuation does not seem to matter much with this name - again it has scarcity value - there is no other Baidu.com. Earnings continue to impress. I have no clue why they are bothering with Japan when they have the 2nd biggest internet market (which will be the largest soon enough) to themselves.

  • Profit soared at Chinese language Internet search provider Baidu.com (BIDU), which also guided second-quarter revenue above current expectations.
  • The company said Thursday that net income for the first quarter jumped 71.5% to $20.9 million, or 60 cents a share, in the first quarter, matching the estimate consensus of analysts polled by Thomson Reuters.
  • Costs related to Baidu's Japan operations in the first quarter totaled $4.3 million, which reduced earnings by 12 cents a share.
  • Revenue jumped 108% to $81.9 million. That topped estimates by Wall Street analysts, who were looking for first quarter revenue of $75 million. It also beat the company's own guidance of $73.1 million to $75.1 million.
  • Online marketing revenue for the first quarter was $81.7 million, representing a 108.5% increase from a year ago. The growth was mainly driven by increases in the number of active online marketing customers as well as revenue per customer.
  • For the second quarter, Baidu expects to generate revenue in the range of $111 million to $114 million, above analysts' estimates for $101 million.

2) I don't see the Bucyrus (NASDAQ:BUCY) news out yet as of 6 PM EST. This is one of 2 major mining equipment suppliers - essentially providing much of the "stuff" that actually does the mining.3) Fertilizer maker (non potash) CF Industries (NYSE:CF) beat by 60 some cents, which it did last quarter as well but not good enough in this market and the shares are down in after hours. Also the gain looks due to mark to market more than anything... so not a 'real beat' in my book.

This name does not have potash exposure but is a top nitrogen play along with phosphates. Nitrogen is my least favorite of the 3 nutrients since it is the most easily replicated (i.e. in China) so for the long run, this type of company is far more at risk than the "wide moat" that potash provides some of the other names.

Again, the sector rotation is the #1 thing right now - no matter what is said, these stocks are going to be in a selloff for a bit of time here. Much of this beat was already priced in, the tremendous run up in these names of late. I am hoping to add more of this around the 50 day moving average of $125 (I added a touch Thursday). Lower would be even better; it's at $130 in after hours so I might get my wish Friday.

  • Net sales rose to $667.3 million, up 41 percent from first quarter 2007, driven by substantially higher prices for all products. Phosphate volume increased modestly, but nitrogen volume declined from year-earlier quarter, as wet spring weather affected timing of fertilizer application in some grain-producing regions
  • Operating earnings totaled $251.6 million, up from $90.1 million in year-earlier quarter
  • First quarter results included $69.6 million in non-cash, pre-tax unrealized gains, or $0.78 per diluted share on an after-tax basis, from mark-to-market adjustments on natural gas derivatives. The gains compare to $38.5 million in non-cash, pre-tax unrealized gains, or $0.44 per diluted share on an after-tax basis, from mark-to-market adjustments included in first quarter 2007 results
  • During the first quarter, phosphate volume increased modestly thanks to increased export sales, but nitrogen volume was down from the year-earlier level. CF Industries’ nitrogen sales are concentrated in the U.S. Corn Belt and other grain-producing regions. Weather conditions have led to a later start of field work than last year in some markets.
Some comments about (a) nitrogen prices which are a major input to its business and (b) the hissy fit investors put up a few weeks ago due to the "reduction in corn acreage" in the USDA farming report
  • Looking at nitrogen specifically, CF Industries has a strong forward order book under its FPP, reducing margin risk from potential summer and fall spikes in natural gas costs.
  • Wilson also discussed reported results of the USDA Prospective Plantings report. Issued at the end of March, it predicted that farmers would plant 86 million acres of corn this year, down from earlier estimates of approximately 89 million acres and down from 2007s final acreage of 93.6 million. Corn is the most nitrogen-intensive of major U.S. crops.
  • Putting the estimated 86 million acres into perspective, it would still be the second highest corn acreage since 1944. Beyond that, theres potential upside in corn acreage this spring, Wilson explained, noting that in 2007, actual corn acreage came in more than 3 million higher than the intentions report predicted. Increased acreage for wheat and minor crops could also help offset any reduced nitrogen demand from corn planting, he added.

All in all the story continues, some push out of sales from this quarter to the next and the increase in input prices in both natural gas (for nitrogen production) and sulfur (for phosphate production). I still prefer the potash producers but this stock has traded at a very steep discount to that group so its the "value" stock of the group, if you will.j

4) Coal name Consol Energy (NYSE:CNX) reported Thursday AM - yada yada - none of it matters, this is going to be a 2009/2010 story. Much like fertilizer a year ago, no one is realizing the potential margin expansion we will see here next year and the year after - and this is the ultimate weak US Peso play. (yes the US peso will bounce but our structural imbalances will mean years upon years of US Peso - its just a matter of degree) In the near term, this stock will be sold off as money comes out of commodities and moves to 'early cycle' plays if my assessment is correct. So I'll be buying at lower prices, as I have cut back of late (but I added a touch Thursday)

  • Coal miner Consol Energy Inc (CNX) posted a lower-than-expected first-quarter profit on Thursday, as higher selling prices were offset in part by lower production resulting from the idling of its Buchanan mine in Virginia following a roof collapse.
  • But the company said results would improve later this year as it produces more coal and benefits from sky-high prices for steam coal for power generation and coking, or metallurgical, coal used in steelmaking.
  • "World demand and tight supplies of both steam and metallurgical grades of coal have pushed prices to record high levels," said President and Chief Executive Officer Brett Harvey. (sound familiar? CNBC should be talking about coal in about 9-12 months and how "surprising this all is" just like they talk about fertilizer now; we'll smirk again like we smirk now at their surprise at "food crisis" and "fertilizer pricing")
  • "Financial results in the second half of this year, but more so in 2009 and 2010, are expected to reflect the positive impact that both the spot and long-term pricing environments are having."
  • A ton of eastern U.S. coal that sold for $44.75 last April is now selling for $85.50. Powder River Basin coal from Montana and Wyoming has risen to $15 per ton from $8 in the last 12 months, according to the industry newsletter Coal & Energy Price Report.
  • In light of higher prices and demand growth, Consol expects to increase exports by approximately 25 percent this year, Harvey said.
  • Consol said that U.S. coal exports for the first two months of 2008 were up 30 percent over the same period last year, while imports during the same time fell nearly 10 percent.

5) Diamond Offshore (NYSE:DO) is a (mostly) deep sea oil driller which has been moving with its sector of "oil services" - again, this is selling off as the sector rotation happens out of commodities. Another minor position and I'll have to think about if I want to keep this one around; earnings were solid if not spectacular.

The one area I have not liked in these companies, the "jack up" rigs (which are those that operate in shallow waters and thus are far cheaper to run) is looking to bounce back now that natural gas is seeing a resurgence. But after being spoiled by the increases in fertilizer, everything else seems sort of ho hum. However, this is real 25-40% growth, the likes of which you cannot find in retail, financial, and the like that the market runs to once every 6 weeks.

  • Diamond Offshore Drilling Inc (DO) reported higher quarterly earnings on Thursday on a rise in daily rates for its deepwater rigs, but the profit fell short of Wall Street expectations.
  • In a note to clients, investment bank and research firm Simmons & Co Int'l said the offshore contract driller's results were not "disastrous," but they did not stand up to rival Noble Corp's (NYSE:NE) first-quarter profit, which topped Wall Street by 8 percent.
  • Diamond Offshore's shortfall was due to higher than expected operating costs, analysts said. The Houston company reported first quarter net income of $290.6 million, or $2.09 a share, compared with $224.1 million, or $1.64 a share, last year. Revenue rose more than 29 percent to $786.1 million. Analysts on average were expecting earnings of $2.13 a share, on revenue of $794.7 million, according to Reuters Estimates.
  • Tight supplies and growing demand from exploration companies have pushed day rates for deepwater drilling higher. For example, newer rigs that drill in the deepest water have seen shorter-term contracts above $600,000 per day.
  • Average day rates for the company's high-specification floaters were up 15 percent to $323,000, while the average day rates for intermediate semi-submersibles increased 66 percent to $249,000. But average day rates for jack-up rigs, which are used to drill in shallow waters, fell about 9 percent to $102,000.
  • "We saw continued improvement in Gulf of Mexico jack-up rates," Dickerson said. "We've seen renewals continue to be at modest rises from well to well."
  • Natural gas futures have soared to the highest levels in more than two years, prompting a renewed interest in drilling from exploration and production companies.
6) Massey Energy (NYSE:MEE), another of our coal producers - same analysis as above for Consol Energy (CNX), although its report was much more clean.
  • Coal miner Massey Energy Co. said Thursday its first-quarter profit climbed nearly 29 percent as it earned more on each ton of coal sold.
  • Net income for the three months ended March 31 rose to $41.9 million, or 52 cents per share, from $32.6 million, or 40 cents per share, during the same period a year earlier. Analysts expected the company to earn 33 cents per share according to a Thomson Financial survey. (oops, another story the analysts are way behind on)
  • Revenue increased to $644.6 million from $607.3 million a year before. Analysts predicted revenue of $617 million.
  • Massey said it collected an average of $56.36 per ton, up from $52.26 a year earlier. The company produced a total of 9.6 million tons of coal, down from 9.9 million a year prior.
  • For the full year, the company expects to produce 41.5 million to 43 million tons of coal for average revenue of $61 to $63 per ton.
Again with coal, it is much like a deep sea oil driller - as old contracts fall off the books, new ones come on at the prevailing rates which are increasingly higher by the year. So earnings will go up. And up. And up. Until CNBC shows up in 2009 proclaiming "what the hell is going on in coal!? We had no idea!"
Disclosure: Long all names mentioned in fund except Bucryus, Microsoft; long none in personal account