Chris Lau's Instablog

Profit from "Green Shoots" Scenario by Buying Family Department Stores

Mon, 10 Aug 2009 22:15:07 -0400

The One-Liner:
Family Department Stores is benefiting from the "best of both worlds." It is positioned to grow in both negative recessionary and positive recession-"less" scenarios.

Detailed Summary:
Family Department is in this "win-win" situation because its earnings is again benefiting from any government stimulus initiatives. While earnings growth from "food stamps" may be morally questionable to some, an investor would be prudent to take advantage of this. Finally, FDO is opening stores, upgrading existing ones, and updating product mix. All of these activities will make it a more attractive place to shop as the recession eases.

3rd Quarter Results
Positives for most recent quarter:
* $0.62 per diluted share versus $0.46 per diluted share (a 35% increase compared to last year)
* 1.843B in Net sales compared to $1.702 billion (up 8.3%)
* 1.2M shares acquired at an average cost of $32.00

Negatives for most recent quarter:
* SG&A (Selling, general and administrative expenses) up $528.2 million, or 8.3%, due to higher incentive compensation and insurance premium costs (this cost is higher despite leverage of costs against higher sales)
* Inventory up $1.035 billion, or 3%

Outlook for next Quarter (Q4)
According to management, net sales are expected to increase between 4% and 6%. Comparable store sales are expected to increase 2% to 4%.

Management provided an EPS forecast of $0.39-$0.43 (compared to $0.38 Q4/2008) a potential 13% growth in earnings from a quarterly results comparison.

Outlook for 2009

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.

Company Valuation (Intrinsic Value):
A fair value for FDO is $31.04. This was calculated using its average EPS from 2000-2008 of $1.35 and an average growth rate in that same period of 7.2%. This value is also supported by the company's ability to generate over 323M in operating cash flow, pay $103M in CapEx, and $54 in dividend payments in its most recent quarter.

Assumption: FDO is able to maintain a minimum earnings growth rate of 7.2%.

Target Price:
Removing negative earnings growth values from calculations last 8 years (to simulate a "best of both worlds" scenario ascribed in my investment thesis), I arrive at the following range of target prices:

Margin of safety   Target Price
50%                    $23.24
25%                    $34.85
20%      $37.18
10%                    $41.82

Note: The margin of safety was applied to a best-case average EPS of $1.37 and a growth rate of 12.71%.

I arrive at a baseline target price of $32.53 (by averaging worst-case and best-case prices) and an upside target price of $37.18.

This target price represents an upside of 22% as of the closing price on Aug 10 2009, a forward P/E of 18, and an average PEG of 1.42. Short-term, the target price is conservative, since the PEG is 0.72 when a 1-year growth rate is used (2008 to 2009).

Support/Entry Price - Portfolio Management:
FDO is attractive at current prices, and even more attractive at prices below $25. At that level, investors gain a 50% margin of safety against past and forecast growth rates for which my target price is based.

Reasons supporting Target Price:

1. Company is investing in a chain-wide store technology to capitalize on the government stimulus package initiative of food stamps. This is achieved by supporting the acceptance of credit cards and food stamps.

2. Initiative to replace old Look and Feel with a more intuitive one (by improving in-store signage and merchandise adjacencies in ways that make more sense)

3. As of March, 2009 approximately 15M households relied on food stamps (up 19% year-over-year for the same period).
This year’s stimulus program is effectively about 13% higher for the FDO customer. Management noted food stamp
transactions increased from April 2009.

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.

Risks:
1. Change in product mix may impact gross margins negatively and a poor execution may result in higher costs.
2. Recession eases significantly enough that consumers shop instead at up-scale competitor stores.
3. Market risks (general decline in appetite for risk results in investors paying less than assumed P/E levels.

Source:
3rd Qtr conference call as posted on seekingalpha.com.

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.

"Quality is Job #1" Slogan is Key to Ford's Comeback Strategy

Thu, 18 Jun 2009 22:40:00 -0400

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:

Investing in the automotive sector is likely more suicidal to a portfolio than it is money-making. Yet Ford is defying the odds. It is run by ex-Boeing execs, and most critically, it refused to obtain government support when its competitors took the bait. Where is GM now? Where is Chrysler now? Ford is building a dominant position against both domestic and foreign auto makers, namely Honda and Toyota Motors.

In the past, Ford played the consumer "incentives" game to keep sales going, eroding earnings and margins. It can no longer do that. In fact, no car company can. The industry shrank suddenly, and all companies need to shrink accordingly to survive.

In my analysis, I will illustrate that Ford is on track to build market share at the expense of its competitors.

Balance Sheet Analysis:

From a financial balance sheet analysis, Ford would fail as a healthy investment. Graham/Dodd would probably not have taken a second look at this company. Its debt/equity is poor; it reported negative income since 2006 (it was last profitable in the year ending December 31, 2005!); the automobile industry is assumed by all to be virtually non-existant.

To coin a phrase that supported the March-June 2009 40% global stock market rally, Ford is doing "less worse" than what the market thought. In fact, it is doing better than its competitors.

GM and Chrysler, as it emerges from bankruptcy, will be distracted from making bold and key decisions. Investors who have written off Ford also believe that these bankrupt companies will undercut product pricing. People thought this too, before the bankruptcy. The thing is, it never really happened. At that point, the fate of the other "big two" was sealed. Now, GM and Chrysler have too many owners and it is under government intervention and supervision.

In reviewing Ford's most recent results, let me now compare the revenue generation against both ongoing and permanent cost reductions.

Cost Reductions:

* Reduced automotive structural costs by $1.9 billion vs $1.3 billion in 2008
* Reduced automotive debt obligations by $10.1 billion
* Lowered annual cash interest payments by over $500 million (note that this is negligible since management indicated credit facility negates net benefit of this expense)

* Lowered annual U.S. labor costs by $500 million
* Manufacturing and engineering costs were over $800 million lower
* Spending related costs improved by about $200 million (lower depreciation)
* Pension and retiree health care expenses were $300 million lower
* Overhead costs were over $300 million lower (achieved via layoffs)
* Advertising and sales promotions were about $300 million lower

Total cost reduction as reported by management: $1.9B. The company forecasts a full-year structural cost reduction of over $4 billion.

Product Supply:

Supply for Q2 (Compared to year-ago period):

North America: 435,000 units (36% decrease)
Europe: 385,000 units (32% decrease)
Volvo: 82,000 units (27% decrease)

Product Demand:

Management indicated a 20% increase in production from Q1 to Q2 for this year. This is bullish. Not only did Ford maintain its price levels, it expects demand to increase.

(All above unit and cost figures provided by seekingalpha.com, April 2009)

Analysis:

There is adequate cash flow to support corporate debt obligations. However, this was achieved by obtaining a ~$10B credit facility. Ford recently issued shares to improve its balance sheet. The market has improved to allow the company to do this again if required.

Still, its debt is too large. My bullish outlook for Ford depends on the company improving its balance sheet through cost reductions, growing demand on all of its key products, and working down inventory.

Past Quarterly Results Q1/2009:

* Revenue was $24.8 billion, a drop of $14.4 billion
Reasons: Lower volume and unfavorable exchange partly offset by higher net pricing.

* Operating loss (excl. special items) was $2 billion
* Net loss $1.4 billion (includes pre-tax special charge gain of $362 million)
* Cash: $21.3 billion of cash, down ~$7.4 billion year-over-year
* Pre-tax loss: $637M
* Cash flow was -$3.2B
* Receivables was 106B ($42B lower than last year)

Analysis and Comments: Weak cash flow was expected, as overall demand plummeted for the industry. However, Ford has reported declining receivables. The company expects to pare this down to $85-$95B this year.

Beating The Competition:

On Improving Quality:

Ford…wait for it…beat Honda and tied Toyota in quality by improving this level by 5% (figures are from the latest Global Quality Research Systems study). The benefits of this are obvious: warranty costs would decrease, and demand would improve (in the latter case, customer satisfaction figures are improving for Ford).

On Increasing Market Share:

Ford has 13.9% of the U.S. market. Its European market share is 9.4%. How was this even possible? It surprised even me as I prepared this analysis that Ford achieved this last quarter. It is clear that management is running the company very well, and, even with the weak auto industry and global economic health, Ford can grow by capturing greater market share.

Analysis:

Japanese auto makers are not growing market share at the expense of U.S. automakers, as everyone had thought. Toyota (TM) and Honda Motors (HM) are not performing in a way everyone expected. All in all, I believe that Ford has it right from the management of the company all the way to having the right product mix.

There is already strong evidence that the Ford Fusion and the Ford Fiesta are going to be a winning combo globally. Reviews have been good, and "green initiatives" often refer to Ford's hybrid offerings. As I stated previously, Ford's product prices are not falling, suggesting demand is expected to be healthy.

Any media buzz talk about green initiatives will benefit Ford, because ford has its bases covered with hybrid vehicle offerings.

Early indications suggest strength for the Fusion in the North American market, and the Fiesta for the European, Chinese, Australian, New Zealand and South African markets.

Financial Ratios:

* Price / Sales: 0.14
* Market Cap: 17.99B
* ROA, ROI, operating margin, profit margin values are all negative. This is a company in transition so these values should be flagged as poor. For my forecast (below), I will not be applying this to assessing company value.

(All figures from finviz.com)

Company Valuation: I will use the following input values to calculate company value: 1) Margin Improvements to Determine Margin of Safety in Price Target: Ford average margin per vehicle was about $5,700. Historically, the company made somewhere between $8,000 to $10,000, a 47% drop. While product mix, competition, and costs impact this, let me still use the 47% margin decline (round to 50%) in my margin of safety calculation. Note that the absence of “incentives” suggests that the lowered margin is sustainable and should not decline further.

Revenue Forecast (Provided by Management):

Ford is confident it can ramp up sales in the U.S. I agree. I am bullish on its new product line and apply a management-supplied sales growth figure of 25% for North America (435,000 units) and 13% sales growth in Europe (385,000 units).

Cost Reduction: $4 billion for 2009 is achievable by Ford (it already saved $1.9 billion in the first quarter alone). The to-date cost reduction does not even include a rationalization of the supply-side distribution system.

Ford was last profitable for the full year in 2005. It earned $0.50. It is not meaningful to review average EPS for Ford in the past 10 years, since the industry has been completely decimated by shrinking demand. My valuation calculations are therefore dependent on cost cut figures and sales figures in the past year. Ford is also running like a different company, with a solid product line not seen since the 1990's when it exceed all estimates with its "homerun product" the Ford Taurus.

Since I expect earnings to be negative for this year and next (due to ongoing costs exceeding a ramp up in product demand), my company valuation is therefore based on a single estimated EPS for 2011, and applying a margin of error of 50% . This also aligns with management forecast for a breakeven or profitable earnings in 2011.

2010 EPS Estimate: ~ -$0.50
2011 EPS Estimate: ~ +$0.50

Assuming a 10% revenue growth rate, a 50% margin of error applied to the stock target price (forecasting 2 years out is bound to have sufficient inaccuracies), and a 2011 EPS of $0.50 yields a 2011 company value of $7.00.

Price Target and Conclusion:

When Ford stuck a deal with the UAW, the option of a stock payment with a strike price of $2 was issued. This cannot be ignored in determining a basement stock price. I therefore use this as a guide for my “support price” for the stock.

My price target is $7.00, a 23% return from current prices. My strategy will be to accumulate Ford at lower prices, and to buy aggressively if the stock falls to the $2-4 range. Ford will not exceed 5% of my portfolio.

My upper-range price target would fall within a forward P/E in the range of 10x - 15x @14x P/E.

"Quality is Job #1" may have been a slogan for Ford in the past, but from this point forward, it is a key strategy to its survival.

Risks to Price Target:

Increasing auto loan delinquencies (eg: trans union noted a 28% increase in delinquencies >60days), unsustainable discounting by competitors, resumption of incentives spending by competitors, pension funding shortfall, failure by company to meet $4B cost reductions, competitor successful launch of "home run" products, excessive share issuance diluting current shareholders.

Disclosure: Author holds a LONG position in Ford on his KaChing virtual portfolio (a site with over 375,000 registered users). This portfolio is also followed by nearly 400 users.

Author blog is broadcast on twitter.com/chrispycrunch

First Solar Vulnerable to a Big Selloff

Sun, 14 Jun 2009 09:28:53 -0400

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:

First Solar is the number one solar energy company in the world. Calling for a short-sell/"sell&... recommendation on the top player in any industry would seem to be both risky and foolish. However, FSLR is a "new"-commodity company in an industry that is too richly valued. Its declining cost-management supply business model, while unique and impressive, is not sufficient to justify a high multiple. A high trailing P/E was justified by lower product pricing, healthy customer demand, and government policies resulting in a net 10-fold revenue growth. Past results don't justify future results. In this research report, I will illustrate why investors should SHORT FSLR at current prices.

Balance Sheet Analysis:

Earnings Per Share - 5 Year Period

2008 2007 ... 2006 2005 2004 ... 2003

$4.24 $2.03 $ 0.07 $ (0.13) $ (0.39) $ (0.78)

Analysis: EPS sky rocketed in 2007 and in 2008 alongside impressive growth in revenue. Compared to 2006, revenue rose almost 500% in 2007, and almost 10,000% in 2008. This was achieved when FSLR lowered reached a critical $/megawatt. The issue now is that its competitors are making the same achievements, decreasing the competitive advantage the company has in this industry.

The average EPS for the 5-year period is $1.01. This is calculated to estimate the company value so that it may be compared against the current market share price. Next, applying a a variety of forecast growth rates we arrive at a range of values:

Growth &... Company Value:

200% growth   $412.585
100% growth   $210.585
75% growth  &... $160.085
50% growth  &... $109.585

Note that the company is still nascent as a public company, so these estimates have minimal reliability.

At a current share price in the ~$180's, if the company disappoints by failing to meet projected growth, the downside 2009 valuation for FSLR is $109.69 - $160. This downside is greater if market discounting is applied. Historically speaking, the green initiative/movement by the government (especially with Obama) added to this "market premium" on the stock price. See the chart and the stock price around the time of the U.S. election:

http://stockcharts.com...

Conversely, FSLR could be worth $412 if it produced 200% returns indefinitely and in a current and future economic environment equivalent to that of 2007-2008. How can any investor assume a 200% growth rate when PV prices are falling and new demand is waning? Note that FSLR has an impressive backlog in orders, but as it will be discussed, 10-15% of those orders face credit risk.

To put it succinctly, FSLR is at best at fair valuation (a market assumption for 100% growth indefinitely) and at worst has more downside than upside.

Company Forecast (Key Figures):

1) Net sales guidance range of $1.9 billion to $2 billion.
2) GAAP operating margin between 31% - 33% (expenses for OptiSolar acquisition is factored in this)

Source: seekingalpha.com

The "street" is forecasting an EPS for 2009 is $5.66 and for next year it is $8.91.

I plotted the EPS estimates for 2009 and 2010 against past earnings from 2003. The forecast figures were obtained from finviz.com: it was a proportionately straight line! That's right. I used an exclamation point in this research report.

If forecasting was this easy, then I would cast the EPS estimates for FSLR, and its current share price, in doubt. The forecasts likely assume recurring revenue and margins are constant, a scenario that needs to be questioned. There is clearly more downside remaining with FSLR.

Let us now dig deeper on to the facts to put into question the validity of the future earnings estimates.

Financial Ratios:

The Good:

Debt/Equity: 0.14

EPS This Year: 5.66

Market Cap: 15.77B

ROE: 32.64%

Insider Ownership: 42.94%

Sales past 5 Years: 229.48%

The Forecast:

EPS Next Year: 8.91

Fwd P/E: 20.96

The Bad:

Book Value/Shr: 20.84

P/E: 32.99

Figures from finviz.com

Discussion of Forecast

In its most recent conference call, management repeated many times that it would need to cut costs and improve margins to meet this consensus growth already priced in by the market.

Are the forecast earnings this achievable? This is questionable for two reasons. The questions lie in two general areas: (1) recent quarterly results and (2) fundamental analysis. I will not detail a balance sheet analysis since the metrics are healthy.

(1) Quarterly Results

Briefly, in its most recent quarter, revenue was $418.2M, translating to a diluted EPS of $1.99. These were solid results.

Remember that the key metric in this industry is production amount (megawatts). For FSLR, the company generated 26% more @220 megawatts. That's up 26% quarter-over-quarter. Capacity/line was up 49 megawatts, up 4% quarter-over-quarter.

The company signed up 479 megawatts in new volumes, with gross margins at 56.3% (up 2.4%). In its conference call (posted on seekingalpha.com), gross margins were sustained by the use of foreign exchange hedges.

Investors need to be aware that these hedges are for 2009 only, and therefore earnings will fluctuate with the Euro. While I am not bullish on the Euro ( stockcharts.com/charts... ), investors will need to watch more closely the gross margins with FX affects stripped out.

Finally, cash flow @ $63.7M sounded healthy. Still, management indicated an increase in accounts receivable and in inventory. If customer accounts show signs of strain, it will further solidify my view on FSLR. For example: year over year, receivables are up ten-fold, and inventory is nearly double. For now, however, it is not a major negative concern in my bearish view for the company since these values are large in percent change, but small in absolute dollar terms.

Investors will need to monitor changes in these two lines on the accounting sheet.

Fundamental Analysis

The PV-specific pricing trend is worrisome for this industry. It is not unnatural for new sectors who experience lower sale price for products due to competition, supply increase, and technological improvements in manufacturing. However, just how much of demand was due to subsidies from "green" initiatives? FSLR benefited from this in European markets, and is currently pushing into the Americas. More specifically it is pushing into California...this is the State with government facing massive deficits, problems in its cash flow, and severe problems in the housing market.

To establish a position in the U.S., FSLR needs to 1) obtain incentive from the federal government (subsidies) and 2) natural gas prices must rise.
Geographically, there are constraints. Just where will transmission lines be placed?
Is it possible to develop conventional power projects alongside solar power ones? There aren't even any guidelines or rules established for this. How long is this going to take? That will add to uncertainty to the stock price, if U.S.-based growth is priced into the stock.

Another worry for FSLR is its EXISTING customers. The company is seeing up to 10-15% defaults. Therefore, the market price of FSLR is dependent on the perceived health of the economy and the banking/credit system. Any more bad new in these areas (which I believe will be coming - see my blog) will push FSLR stock price down. So, if management is cautious with its customers, why are shareholders rewarding FSLR with a rich current P/E of ~30x ?

One thing I like about the company is that it manages its forecasts assuming declining polycrystalline silicon costs. the company compares it to its own cost reduction road-map. That way the company can manage its margins against cost advantages. No wonder FSLR is #1 (the company sees a manufacturing cost at ~$0.65 a watt by 2012, translating to a 35-55% cost advantage).

Another "positive" for FSLR is high natural gas prices. Right now it is low (relative to oil prices). I believe that oil prices are up only due to currency/money flow, and not due to demand/consumption dynamics. Therefore, natural gas prices will remain low. This is negative for FSLR.

http://www.wtrg.com/da...

Conclusion:

I am skeptical that the company will be able to achieve 200% sales and earnings growth for the next 5 years, while maintaining margins in the absence of currency hedges beyond 2010. My price target is $110, based on a projected growth rate that is 4-fold less than the street view.

This is a 40% decrease from current levels. I plan to increase my SHORT position by up to 10% as political, economic, and fundamental changes prove my investment thesis correct.

Risks to Price Target:

Due to positive correlation to commodity pricing, especially oil, commodity strength is a risk. Risk exists for competitor polysilicon prices to fall, undermining FSLR's low-cost production advantage.

Disclaimer: SHORT position on FSLR on a KaChing virtual portfolio (a site with over 370,000 registered users). This portfolio is also followed by nearly 400 users. My personal blog is twittered to twitter.com/chrispycrunch

Short the Pound to Play the Bullish Rebound on the US Dollar

Fri, 12 Jun 2009 23:16:50 -0400

Summary:
=========
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:
===============
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:
================
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:
===================
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:
===================
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:
========
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:
==========
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:
====
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.

Disclaimer: SHORT position on FXB on a KaChing virtual portfolio (a site with over 370,000 registered users). This portfolio is also followed by nearly 400 users.

Why Investors Should Sell FedEx

Sat, 06 Jun 2009 08:45:54 -0400

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.

Twitter users may track my blog here.

Time to Hedge the Bear Market Rally with TLT

Wed, 03 Jun 2009 17:49:48 -0400

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.

Disclosure:
I have a long position in my kaChing virtual portfolio. My kaChing portfolio is being followed by ~350 users. Note also that the 'Intelligent Investing' group that I moderate has 380 members.