Beacon Asset Managers'  Instablog

We agree with Cramer that agriculture could break out, but then again we see agriculture as a demographically supported sector that will always be in demand and should generally experience healthy long-term growth.  Growing populations spur an increased need for for food, and mechanized machinery offers a good means for increasing production while offsetting costs.  And while Deere will certainly continue to benefit from increased worldwide agricultural production, we believe that Agco Corp. (AGCO) offers more room for upside returns.   

Agco is the world’s third-largest maker of farm machinery, offering a full line of tractors, combines, hay tools, sprayers, and forage and tillage equipment sold through four core brands–Massey Ferguson, Challenger, Fendt and Valtra–in more than 140 countries.  The company was established in 1990 with the management buyout of Deutz Allis Corp. from the German-based Kloeckner-Humboldt-Deutz AG.  The company, which went public in 1992 at an offering price of $14 per share, quickly became a global leader through market growth, development of “cutting edge agricultural solutions,” and extensive acquisition efforts, including the 1994 takeover of the Canadian-based, world-wide tractor sales leader, Massey Ferguson Ltd.  Agco derives 58 percent of its sales from Europe, Africa and the Middle East (EAME); 21 percent from North America; 18 percent from South America; and 3 percent from Asia Pacific.

The year 2008 proved to be a watershed for the company, as it posted record sales of $8.4 billion, a 23 percent increase over 2007, and earnings per share of $4.09, more than 60 percent higher than in 2007.  The company attributed its strong performance to robust sales and high operating margins in the EAME region, a “return to profitability in  the North American market, and record tractor sales–both for the company and within the industry as a whole–in South America.

Agco’s record breaking year ended with the global financial meltdown and a worldwide recession, which helped bring the company’s sales and earnings back down to earth in 2009.  On Oct. 27, the company reported a third quarter profit of $10 million, or 12 cents per share, down from $99 million, or $1.01 per share, reported in third quarter 2008.  For the full fiscal year 2009, the company expects net sales to decline 23 percent to 25 percent from 2008, and expects to see adjusted earnings per share in the range of $1.30 to $1.50.  Company executives attributed the reduced sales and earnings to softened market conditions that led to reduced demand, higher inventories and lowered margins.  The EAME region saw the weakest demand, followed by North America, and then South America.

While Agco is not expecting any improvement in fourth quarter 2009, owing to continued “dampened worldwide industry demand for farm equipment,” the company remains quite optimistic about the long-term future.  In particular, the company points to world population growth and the associated increased demand for agricultural products as primary drivers for future growth.  In the EAME region the company sees long-term growth opportunities in Eastern Europe, primarily Russia, Ukraine and Kazakhstan, which are increasingly turning to Western-style agricultural practices using modern equipment.  These countries have immense amounts of farmland, and Agco sees significant demand for agricultural technology, a demand that can be met when credit markets recover.  

  In Asia Pacific, the company expects to see continued market share growth in Australia and New Zealand, and is working to develop joint-venture opportunities in China that would give access to distribution and production capabilities for both the local market and sourcing to other regions.  China is currently the world’s largest market for small, low-technology agricultural tractors, but Agco believes that farm consolidation in China will lead to the need for larger, high-horsepower tractors, which are the company’s core product.  

And in South America, Agco has a strong market position in Argentina and Brazil, with the latter holding significant potential for farming expansion driven by its expanding role as a world leading exporter of soybeans, sugar cane and coffee.

On a demographic basis, Agco executives are probably right in thinking that world population growth will drive increased demand for agricultural products, and thus for Agco’s farm machinery.  However, population growth is not going to be a major factor in  either Eastern Europe or China, as the countries of Russia and the Ukraine are experiencing negative population growth, while China and Kazakhstan are hardly growing at all.  The labor forces of Russia and the Ukraine are already in decline, while those of China and Kazakhstan have peaked and are expected to go into imminent decline.  So, even though population growth may not be a driver of increased sales in these countries, declining labor forces generally lead to higher labor costs, which should spur the demand for cost-saving mechanized solutions as offered by Agco products.

Source: Bigcharts.com

While Agco competitors, like Deer & Co. in particular, will also benefit from demographic influences, we feel that Agco‘s share price has the best potential for upside growth.  The company is significantly less leveraged than Deere, with a long-term debt to equity ratio of 0.13, compared to Deere’s at 1.78.  The company shares, currently at about $29.65, trades at a Dec. 2009 P/E of 14.30, falling to 12.80 for Dec. 2010.  This compares to Deere, currently trading at about $50.40, which trades at an Oct. 2009 P/E of 19.30, falling to 18.80 in Oct. 2010.  Agco has a trailing 12-month P/S of 0.41, compared to Deere’s P/S of 0.86. 

Disclosure: No Positions.

We thought we should list this historical performance in table format in terms of total returns (% Gain), number of days (or rally duration) and annualized returns (% GPA). The tables are listed below.

There have been 34 cyclical bull markets since 1900, not including the current bull. The median gain has been 69.1 percent over 614 days equating to an annualized gain of 36.8 percent.

The current "Monster Rally" has posted a 59.4 percent gain over 253 days, for a currently annualized gain of 96 percent.  This places it:

Total returns: 22nd out of 34;

Days: 29th out of 34;

Annualized gains: 5th out of 34;

Comparing it to the last two periods of "Generational Opportunity," 1939 to 1947 and 1974 to 1982, the current "Monster Rally" is ahead in terms of returns, but not in length.

The average bull market statistics in the period 1939 to 1947: Returns 58.5 percent, 681 days and an annualized return of 39.3 percent.

The average bull market statistics in the period 1974 to 1982: Returns 49.7 percent, 423 days and an annualized return of 41.3 percent.

Therefore, despite the market's short-term overbought position, this data would suggest there is ample head room left for further gains over the next 365 days. However, in statistical terms the gains going forward should be more moderate.

Total Returns


Duration


Annualized Gains

In particular we believe that Skyworks Solutions Inc. (SWKS) should benefit from the combination of an innovative product line and demographics that favor increasing demand for their wireless line of products.  The company makes integrated circuits and semiconductors that are used in wireless telephone handsets and infrastructure, as well as in numerous other products with wireless functionality.  Skyworks, which was formed in 2002 with the merger of Alpha Industries and the wireless communications division of Conexant Systems Inc. (CNXT), built its reputation as a military contractor, and still serves as sole-source provider of radio frequency components for the U.S. military’s Aegis radar system.  

The company’s success lies in part to the fact that it makes its circuits out of gallium arsenide, a material that performs at higher speeds and with less energy consumption than the industry-standard silicone.  And makers of wireless devices are always looking for  higher speeds, while those making portable devices are also seeking lower energy consumption so as to conserve battery life.  Key customers for Skyworks include Nokia Corp. (NOK), Motorola Inc. (MOT), Sony Ericsson (SNE), LG Electronics Inc. (LGERF.PK), Research in Motion Ltd.(RIMM), Dell Inc. (DELL), Hewlett-Packard Co. (HPQ), Apple (AAPL), and Samsung.  The company also has strategic, partnerships with Qualcomm Inc. (QCOM), Broadcom Corp. (BRCM), Texas Instruments Inc. (TXN), Infineon, Marvell Technology Group (MRVL), MediaTek and ST Ericsson.   

Skyworks Solutions describes itself as “an innovator of high reliability analog and mixed signal semiconductors,” offering “diverse standard and custom linear products supporting” a wide range of applications, most of which are focused on the wireless field.  In fact, the company currently supplies semiconductors to all top-tier mobile phone handset original equipment manufacturers, and claims that it is gaining market share with all market leading smartphone providers.  Skyworks is seeing increasing market share with semiconductors supporting “push-to-talk” functionality, and with other wireless applications such as netbooks and pocket computing devices.  The company also states that it is “PA/FEM shipments” are “significantly outperforming handset market growth,” and that it achieved 34 percent compound annual growth rate between 2003 and 2008, and currently holds more than 40 percent of the worldwide market share.

Along with gaining market share, Skyworks is benefitting from the rapid evolution of wireless applications, or, more specifically, as 2G technologies are replaced by 3G and Edge technologies.  While the company considered 2G’s market growth low, with many competitors, few opportunities to be a “sole source” provider, and a relatively low “dollar content,” Edge and 3G provides a high market growth, with few competitors, emphasis on “sole source” providing, and a dollar content two to six times greater than that of 2G, depending on the product.

And unlike other high tech sectors such as desktop computers, wireless applications–especially cell phones–are still very much a boom market.  Demographically speaking, cell phones have proven to be the best-selling consumer product in the world, with the product becoming so ubiquitous that they have effectively started to reach the bottom of the economic pyramid.  In just 12 years cell phone sales have grown 10-fold, from almost 108 million sold in 1997 to an estimated 1 billion-plus expected to be sold by the end of this year. 

The International Telecommunication Union estimated that mobile cellular subscriptions topped 4 billion by the end of 2008.  And even though the market for cell phone sales is considered to be saturated in the U.S. and Europe, there is plenty of room for increasing sales in the developing world.  Moreover, even though the developed world market may be saturated, it is estimated that the average American purchases a new cell phone every 12 to 18 months.  And with cell phones evolving into “smart phones” with a wide variety of applications far beyond “speak and hear,” sales should continue to climb for years to come.

Source International Telecommunications Union

With cell phones and other wireless applications maintaining robust growth, Skyworks is clearly in a strong position to continue growing its revenue stream.  

On a trailing 12-month price to earnings ratio of 22, the company’s share price, at about $12, seems fair, especially when compared to many other companies in the industry that are trading with much higher P/Es.  The shares would seem expensive based on their trailing 12-month P/S of 2.55, but this is justified by the company’s high gross margins.  

Looking forward, the consensus estimates for the company’s earnings give it a P/E of 13.1 as of the company’s fiscal year end Sept. 2010, dropping to 11.3 in Sept. 2011.  While the consensus earnings per share for fiscal 2011 is $1.05, the high end of the range is $1.28.  A P/E of 20 on that high estimate would give the shares a price of $26.


Source: Bigcharts.com

The company reported fourth quarter 2009 earnings on Nov. 5, that beat analyst estimates by .10 per share, and marked a 19 percent increase in revenues over the prior quarter.  The company also guided first quarter 2010 revenues and earnings above analysts expectations, and predicted sales would rise 13 to 15 percent year over year. Skyworks CEO David J. Aldrich said the company will continue to benefit from “powerful, multi-year waves” of growth in broadband access, infrastructure capacity and smart grids.     

If the company can continue to surprise to the upside–which we believe, for all the reasons highlighted above, it will–then it should generate enough revenue growth to meet the higher estimates, and with an improving earnings outlook, should easily break into new highs not seen since 2002.

Source: Skyworks Solutions Inc.

Disclosure: Long Skyworks Solutions

“Wait a minute! Docosahex-what? Arachid-what? Made from microalgae? Fungus?  And, what does this have to do with babies, teenagers and the soon-to-be elderly?”    

Docosahexaenoic acid, or DHA as its more commonly referred to, is one of the primary omega-3 fatty acids, the same omega-3s that have become all the rage as a food supplement due to their purported health benefits for the heart, brain, eyes and infant development.  Arachidonic acid–ARA–is an omega-6 fatty acid that is considered an “essential fatty acid” crucial for muscle and skeletal repair and growth, and, along with DHA, considered a key component neurological development and maintenance. 

The health benefits of omega-3s and in particular DHA emerged in the 1970s with a study of Greenland Eskimos who consumed large amounts of fatty seafoods, but displayed virtually no incidence of heart disease.  In 2004, the U.S. Food and Drug Administration (FDA) gave DHA “qualified health claim” status that research is supportive, though not conclusive” that its consumption may “reduce the risk of coronary heart disease.”  

Other studies determined that DHA and ARA were crucial in brain, eye, muscle and skeletal development in babies.  Meanwhile researchers have also determined that DHA may inhibit plaque development in the brain thought to be responsible for Alzheimer’s disease, and there are indications that DHA may inhibit the growth of some cancers.  Research of these health benefits and others with both DHA and ARA are ongoing, with one of the largest being a U.S. National Institutes of Health study to evaluate DHA in Alzheimer’s disease.

A primary source of DHA and other omega-3s is fish oils, and fish oil as an omega-3 and DHA dietary supplement essentially went mainstream in the late 1990s as their apparent health benefits become widely known.  Fish receive their DHA intake from algae, and scientists with Martin Marietta (which merged with Lockheed (LMT) in 1995)who were researching the beneficial use of algae in long-term space flight, spun off from their parent company and developed and patented the methods for deriving DHA from algae, and ARA from a fungus.  

These scientists formed Martek Biosciences in 1985, brought the company public in 1993, and introduced their first DHA and ARA infant formula in 1995 in Belgium, and received FDA clearance for its use in U.S. infant formulas in 2001.          

Martek’s core product application remains DHA and ARA as a supplement in infant formulas.  Sales of Martek DHA/ARA for infant formulas have more than doubled since 2003, climbing from less than $150 million in 2003 to $300 million in 2008.  The company claims 99 percent penetration of the U.S. market, which it views as a “$170 million to $190 million market opportunity;” and 40 percent penetration of the international market, which it pegs as a $300 million to $325 million market opportunity, with the primary future growth driver being Asia.  Martek considers consumer demand for infant formula as “stable despite the weak global economy.”   

The company’s secondary product application–DHA supplements and additives for adults–has also seen robust growth, with sales climbing from about $11.5 million in 2006 to an estimated $38 million for 2009.  Martek sees growing sales across all segments of this market in the years ahead, and believes there will be increasing consumer awareness about the health benefits of DHA.    

The company should see increased future sales based on demographics.  Although it already has all but complete penetration of the U.S. market for infant formulas, The number of women entering their key child-bearing years is set to increase by roughly 250,000 per year for the next 10 years as the large cohort of Generation Y replaces the much smaller Generation X.  Along with more of them, Gen. Y is commonly believed to be much more health conscious with relation to food than members of Gen. X and the Baby Boom.  This should be a boon to Martek’s sales of DHA/ARA supplements to pregnant and nursing mothers, as well as to DHA/ARA supplements for other adults.  

And as the large cohort of Baby Boomers age their interest in health supplements will undoubtedly increase.  The more evidence they hear supporting DHA’s health claims regarding Alzheimer’s Disease, coronary heart disease and cancer, the more money they will pour into DHA supplements, and the more likely that they will purposely purchase products (currently more than 50 and growing) containing Martek’s patented “life’sDHA.”   

While the company would appear to be a two-trick pony, it recently entered into a joint development agreement with BP plc. (BP) Biofuels to produce microbial oils for use in the biofuels industry.  The goal of the agreement is to “establish proof of concept for large-scale, cost effective microbial biodiesel production through fermentation.”  BP committed $10 million to the initial phase of the collaboration, under which BP will own any new intellectual property developments, with Martek receiving exclusive license for application and commercialization in nutrition, cosmetic and pharmaceutical applications.  While this agreement adds nothing to the bottom line in the near, or even mid, term, Martek scientists proved visionary in the past, and certainly have the wherewithal to discover new products and applications through this project. 

The share price is well off its all-time high of about $67 hit in early 2005, and down about 70 percent from its 52-week high of $31.60.  The share price has declined about 40 percent since early September after recording a 12 percent year-over-year decline in quarterly revenues caused by retail companies de-stocking old inventories of infant formulas.  Martek executives projected strong fourth-quarter 2009 and full-year 2010 revenues, on anticipated increasing sales in both infant formula and adult products.

In our opinion, one problem with valuing Martek, is does one value the shares on a food company or a biotech company basis? Being conservative, we believe a company should be valued on its growth prospects.  Martek sells on an October 2009 consensus P/E of 15.1.  This falls to 13.1 on a consensus forecast for October 2010.  However, the forecast for 2010 earnings per share vary enormously, with the highest being $1.80 and the lowest $1.28 and consensus of $1.40.  

Therefore, we believe the shares are attractive given the revenue growth potential in its adult market products, strong cash flow, improving demographics, and the company’s stated goal of improving gross margins.  We feel that the company should earn between $1.40 and $1.50 per share for the year ending October 2010.

The company is expected to report fourth 2009 quarter earnings between Dec. 11-16.  Consensus estimates call for earnings per share of $0.33.

Source: Yahoo.com 

Disclosure: No Positions.

The Conference Board, a private research group, said its monthly Consumer Confidence Index fell to 47.7 this month, from a revised 53.4 in September, which was originally reported as 53.1. The current month's reading was well below economists' projections of 53.2, according to a survey conducted by Dow Jones Newswires.

The downturn in consumer confidence at this stage of the recovery is to be expected, as it has occurred in previous recoveries (please see chart below), and does not negate the buy signal on the economy given during the summer.

Source: Ned Davis Research
 

Although concern over jobs is the primary factor behind the decline, the rise in U.S. retail gasoline prices since the beginning of the year is also a likely, though recently unspoken, factor.  This price rise is about $1.10, or 69 percent (see chart below).

A sustained move above $3.00, or an oil price of above $85, would in our minds put a brake on the economic recovery and bring another outcry over commodity speculation by hedge funds.


Disclosure: No positions.

Of course, how much money is dependent on numerous factors, among which the most important would be how many people are dying.  In short, demographics.

While the U.S. population grew by about 17 million people during the first six years of this decade, the number of people dying every year remained relatively static at roughly 2.4 million per year.  In fact, in 2006, the U.S. death rate hit an all time low of 776 deaths per 100,000 population, according to the U.S. Centers for Disease Control.  U.S. government data for that year, which is the most recent available, also showed that the U.S. life expectancy at birth reached a record high of 78.1 years. 

Barring any cataclysmic disasters or high mortality pandemic disease outbreaks, the annual number of U.S. deaths will likely remain static for at least the next three years, reflecting the declining number of Silent Generation births between 1925 and 1935.  In 2013, the number of Americans turning the key life expectancy age of 78 will start to increase, and then rapidly accelerate beginning in 2018, to reflect the steady increase in Silent Generation births beginning in 1940, that turned into a flood with the Baby Boomers starting in 1945.

Despite strong consolidation efforts in the 1990s, the U.S. funeral industry remains highly fragmented with the top 50 companies holding only about 30 percent of the market.  In fact, the majority of U.S. companies still operate as a single funeral home, earning annual revenues of about $1 million.  These smaller operations are able to successfully compete with the larger national companies because business is fiercely local.  The primary advantage held by the larger companies is their ability to share resources, such as vehicles, personnel and marketing costs.    

Companies in the business sell products, such as caskets, burial vaults, burial garments, memorial guest books, flowers, memorial stones, burial rights, cremation urns, and related merchandise.  Services can include body preparation, transportation, facility rental, the opening and closing of burial plots, and cremation.  Caskets are generally the biggest single-item cost of a funeral service.

The largest publicly traded U.S. funeral industry companies include Service Corporation International (SCI), Carriage Services Inc. (CSV), Stewart Enterprises (STEI), and StoneMor Partners L.P. (STON).  The share prices of these companies, excepting StoneMor Partners which was founded in 1999, all showed significant growth in the 1990s (though far beyond the slow yet steady increase in U.S. deaths during that period), but essentially plummeted at the end of the decade and have been struggling ever since.

The sector has recovered strongly since the March lows, when these companies were priced for extinction.  Since the March lows StoneMor is up about 78 percent, Service Corporation about 165 percent, Stewart Enterprises about 180 percent, and Carriage Services more than 200 percent.  The sector’s strong recovery has left many valuations stretched along with highly leveraged balance sheets.  Therefore, we would strongly advise taking profits as we believe the sector is not set to return to a consistent growth track until 2013 when the number of deaths should turn upwards dramatically.


Disclosure: No Positions.