Bret Jensen's  Instablog

The market continues to struggle. Wednesday’s market consisted of a good rally in the morning giving way to a flat close. As detailed in numerous articles, I believe the market is at best dead money over the next six months. Rising gas prices, increasing inflation, Middle East turmoil, European Debt Contagion fears, a moribund housing market and the end of QE2 are just some of the major headwinds the market is facing. I think “safety” is the word of the day for investing in this market for the rest of year. One of areas that might have some bargains left, is the beaten up European Telecom market. The stocks have been hindered by worries about slow growth and sovereign debt contagion. However, these stocks cash flow and high dividend yields could be enticing here and put a floor under their stock prices. Here are a few that might be worth looking at:

France Telecom– FTE is selling at nine times this year’s and next year’s consensus earnings. Earnings estimates have increased approximately 5% over the last ninety days for both 2011’s and 2012’s projected net earnings. It low single digit revenue growth is offset by a low valuation and a generous yield of 5.7%.

Telefonica– TEF is selling at roughly ten times both this year’s and next year’s projected earnings. It yields a very rich 5.5%. This is one of my favorite high yield stocks, and I have recommended it in other articles. The stock has been punished due to the problems in Spain. However, the majority of its revenues come from outside Spain primarily in Latin America; where prospects are good. In addition, the company’s efficiency efforts in Spain and throughout Europe seem to be yielding good results and offsetting revenue declines there. I believe this company is well positioned for the future and its high dividend yield puts an effective floor under the stock price.

Nokia – NOK is the riskiest of these three picks, albeit the one with the most upside if it can stage a successful turnaround in the smartphone market through its partnership with Microsoft and/or continues to benefit from its market leader status in the low and medium price point share of the emerging market handset universe. Despites its myriad of challenges over the last two years, it has increased operating cash flow by 40% over that time period. It sells at 13 times this year’s earnings and 12 times projected earnings for 2012. It also has over $3 per share of net cash.

Oil prices continue to rise rapidly due to the growing turmoil in the Middle East. This market is looking more and more like early 2008 when the run up in oil prices was one of the factors that tipped the economy into recession (The financial crisis made it the worst downtown since the Great Depression). Energy inflation is already impacting consumer sentiment and it is my belief it will have major impacts to consumer spending and the overall economy. One of the market sectors that is likely to be hit especially hard is consumer discretionary stocks. I decided to look at a basket of twelve well known retail stocks from the beginning of 2008 to the end of July that year (6 weeks before Lehman) to see how they behaved in order to see if this research could give insights on how this sector is likely to trend over the next six months if oil remains at these prices or rises further.

The companies I picked represent various parts of retailing universe. They are Sears, Macys, Best Buy, Abercrombie and Fitch, Walmart, Gap, Amazon, Target, Costco, Lululemon, Tiffany, and Apple. Over the time period of January 1^st, 2008 through July 31^st, 2008 the S&P index lost a little over 12% for comparison purposes. After doing the analysis, these are the results:

1.       Costco and Target lost between 7-8% of their value

2.       Tiffany and Best Buy lost between 14-15% of their value

3.       Sears, Macys, Abercrombie & Fitch, Gap, Apple and Amazon lost between 20-28% of their value

4.       Lululemon lost approximately 50% of its value

5.       Walmart actually gained over 20% over this time period

CONCLUSIONS: So what can we conclude from this limited analysis? (A) Stocks that sell staples like Walmart, Target and Costco should hold up better than the market overall and much better than other retail stocks in an environment with high oil prices. (B) Stores that sell higher end items like Tiffany and Best Buy should move roughly in line with the market. (C) Retailers that sell apparel or basic discretionary items like Sears, Macys, Abercrombie & Fitch, Gap and Amazon should fall harder than the market overall. (D) High beta retailing stocks that sell highly discretionary items such as Yoga wear like Lululemon are likely to be hit the hardest in any kind of oil induced pullback. 
 

Given all the geopolitical and domestic challenges the market currently faces, I would be cautious here. Be careful out there.

Company Overview: Cisco Systems, Inc. designs, manufactures, and sells Internet Protocol (IP)-based networking and other products to the communications and IT industry worldwide. The company offers routers that interconnect public and private IP networks for mobile, data, voice, and video applications; switching systems, which provide connectivity to end users, workstations, IP phones, access points, and servers; application networking services; home networking products, such as voice and data modems, routers and gateways, Internet video cameras, home entertainment storage, wireless home audio, and home network management software; and network and content security, email, and Web security products. It also provides storage area networking products that deliver connectivity between servers and storage systems; unified communication products to integrate voice, video, data, and mobile applications on fixed and mobile networks; video systems, including digital set-top boxes and digital media products; and wireless systems.

 

Prognosis: The stock has dropped nearly 10% today after last night’s earnings report which provided tepid forward guidance and missed on the revenue side.   The stock price is about even from where it was a year ago despite significantly increased earnings and revenues over that time period.

Valuation: CSCO is selling for approximately 12 times this year’s consensus earnings and less than 11 times next year’s projected earnings. It has over $4.75/share in net cash on its balance sheet. It is selling near the low end of its five year range for P/E, P/S, and P/CF.

Catalysts: There are several factors that we believe should provide support for a higher stock price in the near and medium term after the disappointment of its current earnings release fades:

1.     The continued growth of the internet, teleconferencing, wireless, etc…should ensure strong growth; especially outside of the U.S.

2.     Company throws off impressive cash flow and has a large amount of cash on its balance sheet. This gives the company flexibility to buy back stock, continue to invest heavily in R&D and/or acquire new growth assets or technologies

3.     Large established customer base provides geographic diversity and gives them continuous upgrade revenue opportunities

4.     Investments in Telepresence, Physical Security, digital media and other emerging technologies should ensure continued new growth channels

Recommendation(s): Given its low valuation, fortress balance sheet, solid revenue growth and strong cash flow; we feel stock is currently undervalued. In our opinion, the stock should be trading at a more reasonable rate of approximately 12-14 times our estimate for this year’s earnings of around $1.75 after stripping out the $4.75/share of net cash on its books. Our one year Target Price is $26-$30, up from the current price of $21.37.