Chris Lau's  Instablog

For the fiscal year ending August 29, 2009, full-year EPS will be between $2.03-$2.07 as compared with $1.66 in the previous year. This is a management-provided forecast of 24.7% growth rate for the year.

Top Down (Macro) Assessment on Outlook:

The investor needs to accept that the American consumer is in heavy debt because its net worth has declined due to a decline in home prices. This is already well-known and was the main driver for the stock sell-off in Oct/08-Mar/09.

Consumption rates declined and, more importantly, for the first time in a long time, savings rates are up. The stock market is pricing in an end to a recession. The market, however, is assigning a growth in consumption, which is not likely to be a driver in the technical end to the recession (please see my blog for more information on why the recession is technically defined to end). 

This savings increase trend is not short-term. Government stimulus is short-term. It is what helped FDO produce higher-than-average earnings in 2008 and in its last quarter. More significantly, this trend illustrates that consumers are using whatever government assistance they obtain to shop at Family Department. Therefore, I would assign a more optimistic 2009 EPS of $2.07 for the company.

4. Technology upgrade in FDO stores continues to serve expanding population base of food stamp recipients (~60% of our stores are capable of accepting food stamps as opposed to 25% in 2008). By early 2010, all stores are scheduled to support this.

4. Management enthusiasm. Management provided a Q4 earnings forecast increase, even though last year's one-time stimulus impacting results in June/July 2008 quarter would make this year's comparable a challenge.

5. Adjustments in "key traffic driving categories" and on "basic needs" will sustain customer traffic.

6. Back to School "kick" to revenue will be counted in Q4. If FDO is able to capture market share and generate greater sales (at the expense of higher-end retailers, and other retailers like Walmart (WMT) or Target (TGT).

7. Finally FDO is selling at $30.60, which is a forward P/E of 14.8 (2009 EPS forecast is $2.07). Given the earnings acceleration for this year over last is expected to be higher (a 24.7% growth or a PEG of 0.6), FDO is under-valued in the short-term.

Disclosure:
Author holds a LONG position in Family Department Stors on his KaChing virtual portfolio (a site with over 380,000 registered users). This portfolio is also followed by 560 users.

The Three Liner:

Despite belonging to one of the three permanently shrinking industries (financials, housing, and automotive), Ford is an attractively valued turnaround company. Improving balance sheets, product demand, cost control (we call this "organic growth"), and a healthy credit facility all suggest a higher share price is likely. Odds are high that it will emerge a leader in the automotive sector.

Summary:

The One Liner:

First Solar faces the daunting pressure of acquiring new customers in new geographies (U.S.) as the quality of existing consumers declines and as ongoing industry pricing pressures on polycrystalline silicon increase.

Summary:

Summary:
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For the purpose of this research report, I will explain why investors need to add a currency hedge position to their portfolio by short-selling the British  pound currency ETFs. This is an investment hedge. This report is not a suggestion to make a large calculated trade as Soros most famously did so on Sep 16, 1992 How great was it to make a 1.1B return for one's firm and to have a "Black Wednesday" named after a trader?.

Detailed Analysis:
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The purpose of shorting the pound was due to a macro-economic "top-down" analysis of the world markets. This research will illustrate why a strategy would be an effective means to guard against a rise in the U.S. dollar, and a drop in commodities.

I am entering a short position in the Pound because I am becoming less negative on the U.S. dollar and U.S.-denominated assets relative to all other currencies. I am also becoming more negative on commodity prices, after its bullish run that began in March 2009 - present. Even though the media continues to report that a global economic recovery is underway and will begin Q4/2009, and that a recession "bottom" was reached recently or will be reached soon, I am unconvinced.

As a footnote, Teck Corp (TCK), for example, rose almost a fourfold. AA is up a twofold. Gold and silver are both up at more reasonable levels (I am long on both to position the portfolio an inflation hedge). Oil is nearly double. Why should any of this matter in short-selling England?

A long U.S. Treasury (30-year), long U.S.D., and short Pound are the players in my packaged hedge. I am essentially betting that the U.S. will continue to aggravate the world with its experimental quantitative easing. Therefore, the idea of higher interest rates, higher energy prices, and inflation are all symptoms of net-saving countries (China, Japan) trying to move away from the American currency. THAT is where the problem lies.

The net-saving nations are simply not in a position to cause inflation via higher commodities. They WANT their own currency to remain low, because that will improve net exports for these nations. If the U.S. currency remains depressed for too long, that imports inflation. As a result, the U.S. will WANT their currency to be stronger. Investors will seek the "least worst" of the options. Fundamentally speaking, the U.S. is in the least worst position if compared to England and Europe.

England and Europe (and the Euro) are both in poorer shape than that of the U.S. in economic terms. As the U.S. housing "crisis" moderates, this will not likely be the case for England. British banks, and government figures have still not been quantified by the markets due to poor and incomplete reporting. Conversely, the U.S. "stress test" (I am still skeptical about just how stressful it is, due to assumptions used as inputs to its forecast model) added additional transparency to the U.S. banks.

It also worked.

Think about that for a moment: the relief rally resulting from this test enabled banks to raise capital from the markets, at a time when the credit markets were completely frozen.

Economic Analysis:
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Look at this phrase reported by Reuters:

"A weaker U.S. dollar helped push U.S. crude oil futures up more than $1 a barrel to top $71, a new seven-month high, after data Tuesday showed a steep drop in U.S. crude inventories, and lifted commodity prices like copper and gold."

Currency valuation is inter-connected to commodities. Commodity values are speculative and are based on incorrect forecasts for a resumption in global economic growth.

Let's say that the trend for an interest rates rise continues globally. London has no choice but to raise rates as well. The mortgage rise will reduces the sales of foreclosures and homes in general. Here's a headline that was published in London's papers today: "Nationwide hits buyers with mortgage rate rise." Swap rates have also been rising. The net effect will be that the country may be paralyzed from taking any action to reduce rates for the purposes of stimulating demand for homes.

On the U.S. side, the situation is the same. So if two countries face the same economic challenges, which country do you put your money in? The question is that of relative strength, and that strength does not exist right now in the U.K. Let's analyze the fundamentals.

Fundamental Analysis:
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Several points need to be made in my bearishness in Britain relative to the U.S.:
1) The housing market bust is substantial. This has greatly impacted the British Government's balance sheet. (see Markit’s services index regularly)
2) The question of government competence and collapse of support for the UK's Labour Party in the European election (as illustrated in the recent scandal and actions by the Prime Minister) will continue to destabilize the Pound against the American dollar
3) Economic fundamentals remain poor (some improvements were reported but one month does not justify a positive trend)
4) The cost for saving British banks has impacted the British government balance sheet significantly.
5) Quantitative easing (125 billion pounds) and the BoE interest rate cut (currently 0.5 percent) makes the Pound unattractive as opposed to speculative headlines that the U.S. may have to raise interest rates.

Bank of England Forecast: UK GDP to fall by -3.4% for 2009. Source: www.marketoracle.co.uk...

United States Forecast: Real GDP is forecast to contract by 3.2% in 2009.  Source: Country Forecast @ www.economist.com/coun...

Comments: GDP forecasts are negative for both countries, but remember that British debt was downgraded. This has not yet happened to the debt for the U.S.

Portfolio Management:
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To profit from this scenario, I am placing an incremental short position on the Pound to 5%. I will increase my position to up to 10%. This short position will be balanced with LONG position on TLT (30-year U.S. Treasury).

Price Target:
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My price target is $140-155. This is based on a target for the U.S. dollar strengthening by about 10% from current levels. The price target represents a 5% to 14% return from current levels. Combined with a TLT long position (and a target return of up to 15%), the net return on this trade is a maximum of 30%.

Conclusion:
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I am not convinced that the 70% consumption rate is sustainable for the U.S. Savings is up and will not fall to levels of the past. What this means is that the U.S. economy will suffer, but it will suffer less than other nations. The U.S. was the first to be more transparent and accountable (to a relative degree, of course). England did not take such a position. It is lagging in getting its house in order by at least a few months as compared to the U.S. Even though the Prime Minister "crisis" may put into question any rally for the Sterling, the weakness on the Sterling overall will be a result of the fundamental weaknesses discussed.

The way things may play out in the currency market is that funds will flow to the strongest nations. This needs to be accompanied by lower commodities, low interest rates, and a weak Pound.

On the currency demand side, savers globally will look away from the weaker nations. On this forecast list for weaker nations, England is on the top of it.

Risks:
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Unexpected strength in U.K. housing, manufacturing/services, unexpected recovery from recession, and/or under-capitalization of U.S. Federal Reserve, continued weakness in U.S. Dollar. To mitigate portfolio loss, apply a stop loss of 10-15% on this position.

By all (balance sheet) accounts, FedEx is a healthy company. Its assets more than cover liabilities, even when goodwill and intangibles are excluded. It has more than enough cash ($2.7B as of Feb/28 2009) to pay off its debt ($1.9B as of the same period). Even its expenses are well-contained, and is approximately proportional to its change in revenue.

Therein lies my problem with FedEx, and hence the focus of this research to illustrate a taking a bearish/sell position on the company. It is the historical cash flow that was poor and will only get worse due to persistant weakness in the world economy, unless significant steps are taken to improve it. At this time, investors should not be paying such a hefty premium for deteriorating cash flow. My analysis for future FCF for FDX is not optimistic.

FDX should therefore should be sold/short-sold at current levels.

Balance Sheet Analysis:
CapEx is ~ $2.9B/Yr, resulting in a negative cash flow in 3 of the 4 past years. Despite the bold-font red on its balance sheet, this is not my main reason for being negative on FDX. After all, UPS also has similar CapEx levels on an absolute basis. However, UPS also has roughly double the revenue generated compared to FDX, so on a relative level, UPS is a more attractive company.

Relative comparison - 4-year average Net Income:
UPS = $2.86B/yr
FDX = $1.60B/yr

From these figures, UPS has the advantage of being a bigger company with larger revenues that can look for ways to cut expenses to maintain or increase EBITDA and to justify its current P/E. FDX may not do so. These are the critical metrics for FDX (from finviz.com)

P/FCF: 28.05
Profit Margin: 1.95%

Forecast:
Forecast for EPS next year: 3.38 (a 44.4% increase over this year's EPS)
Forward P/E $16.66

Current:
Current EPS: 2.34
Current P/E: 24.06

My problem about FDX share price is that it is not justified. Investors are paying 24x earnings on expectations for a nearly 2x PEG (P/E vs growth). That is a high expectation. The market is saying that combined net earnings from increased package shipments and cost reductions (which I mentioned would be difficult to achieve relative to competitors) will be up over 40%. Investors are paying far too much for low FCF (28x).

That is unjustifiable. This is too generous to its current share price.

Fundamental Analysis:
FDX is the first indicator for an improving economy. Shipments will increase because small business transactions depend on the Transports sector (DJTA). Guys like EBAY depend on package shippers to complete the deals.

But...here's the thing. Investors have added market risks to FDX stock by pricing this already frothy outlook. The outlook is based on mainstream media reporting "less bad unemployment." They completely skip past incredibly low GDP numbers for Q1. Q2 is NOT going to be any better.

It is my view that shipments will be flat to marginally higher (5% shipment growth at best for 2009). The risk/reward is clearly on the downside.

On the cost side, let's assume that there is indeed economic growth. Oil prices will rise. Energy costs will be a problem for FDX even if shipments rise. FDX will therefore need to improve its profit margin (currently at a paltry 2%) to benefit from the so-called elusive "economic recovery of 2009."

FedEx is not asleep on these problems. It bought Kinko to provide some kind of end-to-end solution for customers. The problem was that Kinko's culture and business model had no real fit to FDX's package shipment business.

Here are some of the latest headlines to illustrate this poor business acquisition:
"FedEx expects to take $1.2B in fiscal 4Q charges"
Source: www.reuters.com/articl...

Market Price, Company Value, and Price Forecast:
In examining the EPS for the past 10 years, the average EPS is $3.32. The average growth rate was 13%. Using those figures, the value range for FDX are dependent on the range of values for a Margin of safety. The stock price range is $42 - $71:

Margin of Safety / Stock Price / % from Current Stock price

37.5%    $42    -26.69% <--This is where FDX stock should be, by reducing 2010 growth rates by 5/8th against its past 10-year average.
50%       $48    -16.22%
0%         $71     23.93% <-- no margin of safety applied to stock price
The above calculations use a stock price of: $57.29.  

I therefore assign a company value for FDX in the range of $42 - $71. Given my argument that FDX is too richly valued at current market price, my target price is closer to the downside in the low $40's.

Top-down Analysis:
At the time of writing, the media reported slower increase in unemployment. Listen, the unemployment in the U.S. is now 9.2%. Most of those jobs are in manufacturing and won't come back. Has the market adjusted to the lower revenue expectations? Has FDX cut enough in its costs to adjust for a 10% unemployment rate for 2009? Even the U.S. postal service has cut its level of service to cope with the economic deleveraging and reduced capacity utilization.

Conclusion and Risks to Target:
My target price is FDX in the low $40's.

Risks to my stock price target are: unexpected strength in economy, "green shoots" is an actual reality and not a myth, consumption in demand from China, Emerging markets greater than anticipated (thereby benefiting shipment growth).

Disclosure: Short position on my kaChing virtual portfolio. This portfolio is tracked by over 350 users in a community with over 370,000 registered users.

Summary:
Prices in the US 30-Year Treasury collapsed significantly enough and relatively large against the shorter-term government debt securities. Both the 3-month rally and the dumping of the US currency are strong reasons to place a long position with TLT. Note that TLT is on the kaChing insight page and is listed as a 77th recommendation as a SHORT. This recommendation is therefore a contrarian position against the kaChing user community (a virtual portfolio manager site with over 350,000 users worldwide).

Note: When I refer to TLT, I will be referring to the underlying 30-year Treasury bond.

Top-Down Analysis:
When the government announced that it was going to essentially print money to pay for its own debt, 30-year treasuries corrected slightly. During that time, it was revealed that China was reducing its holdings in USD currency and began/continued to accumulate commodities. It may be a political move to make the statement that China will not tolerate the increasing debt load of the US (thereby depreciating the value of US-denominated assets). There is too much speculation required to decipher China/US dynamics, so let me get to the kicker:

Investors need to note the momentum shift that occurred in the last two weeks between the 2- 5-, and 10-year bonds versus the 30-year bonds. Rates rose significantly for the shorter-term debts as compared to the 30-year. The impact to the economic policy is significant: The Fed does not have the control we all assumed was there in controlling interest rates.

Banks limited the mortgage renewal terms, especially for the longer-term ones.

So what? Why should US debt prices move up from here?

Remember that when the markets were in free-fall, TLT was in a state of a “mini-bubble.&am... Since it has sold off and is at ~ $90, what is needed for TLT to rise again are the following:

1)   &a... Flow of assets out of commodities (gold, copper, silver) and into a currency (U.S. Dollar).

*** Comments: See point #3 about China. The problem I see about gold as a “safe haven” against the US Dollar is that a country will still need to convert the holding to some currency before spending it. What currency will it use?

What currency is strongest relative to every other currency?

It is certainly not the Euro (London, Spain, Eastern Europe is far weaker than that of the U.S.).

Canadian dollar? It’s too dependent on resources.

Counter-argument: Yuen or Yen? Maybe.

2)   &a... Stock market correction and investors seeking for “safety.”

*** Comments: The stock market rallied almost 40% in just 3 months. True, stocks were undervalued and the bank crisis was a crisis until it was “fixed.” But now we need to get in the mind of the herd. The herd is thinking “profit taking.” As such, we need to get ahead of the curve and accumulate “safety.”

3)   &a... Realization that inflation does not exist

*** Comments: Oil has risen 80%. Ditto for gold and silver. This is all because of markets thinking “the worst is behind us,” and therefore we should immediately expect some kind of major inflation. You know what? This is not going to happen. “Bailout” funds have all be diverted to the banks and little of it has actually reached the economy. Even the housing bailout reaching out to consumers barely impacts more than 55,000 or so homeowners.

Counter-argument: If China is accumulating commodities because long-term demand for it exists, then this argument will be weakened.

Some Relative Figures:
As of June 3 2009 (versus last month)
2-year - 0.91%
5-year - 2.42% vs 2.02%
10-year - 3.54% vs 3.73%
30-year - 4.44% vs 4.05%

Analysis:

Treasury offering tomorrow may pressure TLT. Use this as a buying opportunity.

More Reading and Additional thoughts:
Here is a great summary posted by another blog:

"Regardless why the yield curve is steepening, Bernanke's belief that he can control both the long and short end of the curve is seriously misguided. The fact is he cannot really control either, at least for long" - http://globaleconomica...

Economic fundamentals are the headwinds against the U.S. monetary policy. It further supports my long position on TLT.

Conclusion:
Long TLT. Target price is just over $100 (9% return). $105 is possible (14% return). Downside stop-loss is in the low $80’s (10% loss).

Risks:
Downside would occur if the stock market continues to rally, if the USD continues a spectacular decline, or if China’s continued stimulus program results in extended strength for commodities. Do not fight this trend. Take the loss to preserve capital.

Portfolio Management:
I have an initial 2% asset allocation in my kaChing portfolio, and intend on adding somewhere between 5-10% or more as the global events unfold and an established trend is identified.