John Dessauer's  Instablog

When asked about the huge federal deficits Secretary of the Treasury Geithner answers: “growth first, then the deficit.” What he should have as his number one priority is jobs. The “jobless recovery” is an oxymoron. Without a substantial increase in the number of jobs the recovery will either slip away or be anemic. The President and his advisors know that the labor market is on life support. In response the President is holding a summit meeting to find solutions to the jobs tragedy. And make no mistake the unemployment mess is national tragedy. The economy has lost 7.3 million jobs since the recession began. Unemployment benefits run 99 weeks, a national record. Still there are few jobs available when benefits run out. Nationally there are six applicants for every job opening. In construction the ratio is 25 to 1.The ranks of the homeless are growing. Democrats and Republicans know as do both the left and right that we must start creating jobs soon or we face a dismal future. They also should know what it takes to create jobs. Sadly the evidence is growing that too many political leaders are bent on following policies and creating laws that are job killers.

 

            The Cap & Trade legislation that passed in the House of Representatives is a job killer. It alone would impose a record tax hike, estimated to cost every household $6,800 a year. That is in addition to higher electricity costs. The President visited China. There he had a clear view of how to create jobs and how to avoid the job killers. Officials in Beijing have said no to the proposed climate change rules. They understand that their economies cannot afford the high price of such policies. China has long faced a critical need for jobs. For the last few decades skeptics have warned that the Chinese miracle was going to flounder because of high unemployment and a lack of new jobs. The skeptics have been wrong. Beijing has focused on policies that stimulate the private sector. Even the recent Chinese stimulus package was focused on projects that support the private sector. And the money was spent quickly, giving China’s economy a real boost. Now skeptics worry that China’s economy might be growing so fast as to overheat. If only we could move in that direction. Central bankers know what to do to stop overheating and control inflation. Getting the economy growing after a deep recession is the greater challenge.

 

            Here in the United States we are going down a different path. One look at the House version of Cap and Trade makes you wonder what on earth they are thinking. There is a lot in that bill. Consider one aspect, homes. Under that bill you would need permission from the EPA to sell your home. To get that permission you would have to have the energy efficiency of your house measured, at an estimated cost of $200. Next the EPA will tell you if your house meets the new energy and water efficiency requirements. If it doesn’t you will have to upgrade your home, replace windows, buy a new heating system, etc. at your own cost. Next you get the house measured again for another $200 fee. When you finally get your home up to the current standard you will get a “label” that must be prominently displayed. If you don’t follow these regulations you will not be able to sell your house. The EPA would raise the standards every year. If this ever passed into law the housing market would be crushed. The cost of new construction would rise. Fewer new homes would be built. Existing house prices would take another nosedive. And there is much, much more nasty, anti jobs material in the bill. Take a look: http://www.govtrack.us/congres/bill.xpd?bill=h111-2454. 

 

            Are the members of the House who voted for this bill completely out of touch with the reality of an economy weighed down by double digit unemployment? You might think so until you read the New York Times and articles from the Economic Policy Institute. Bob Herbert writing for the New York Times this month said he has long believed the private sector cannot create the millions of jobs we need. He says we need to rethink our entire approach to unemployment. By that he means instead of the Federal Reserve and federal government spending trillions of dollars to stimulate the private economy the government should create jobs directly. Herbert points to writings by Ross Eisenbrey of the Economic Policy Institute. Eisenbrey says the private sector by itself cannot create the number of jobs needed to bring the unemployment rate down. Like Herbert he wants government to step up job creating efforts by help the states and launching large infrastructure projects. Keep in mind that roughly 25 million Americans work for state, local and federal governments. Where does the money come from for those paychecks? It comes from taxes collected from the private sector. Tax collections have collapsed under the weight of the recession. State and local governments have frozen hiring. Some are being forced to reduce the number of employees. Editorial writers like Herbert and think tank members like Eisenbrey do not tell us where they would get the money to pay for their policies. Likewise the members of the House do not say where homeowners would get the funds to comply with the Cap & Grade rules and regulations. They simply assume the money will arrive and therefore new jobs in the home remodeling industry will multiply. It does not require a degree in economics to understand they are totally wrong. Hopefully this bill will die in the Senate. If not we will likely see a political revolution at the polls a year from now. Americans are not used to double digit unemployment. Every one of the 108 million who have private sector jobs worries that they might be next to get the pink slip. None will relax and resume spending and investing until they see hundreds of thousands of new jobs being created every month. Politicians who do not grasp that reality will likely get the boot and be out of a job a year from now. The bottom line for investors is that the jobs situation is still very serious. As can be seen from the stock market’s recovery there is opportunity. But this time opportunity comes along with unprecedented risk. The best strategy is to diversify, think globally and do your own due diligence.

November 2009

        

            On November 4, 2009 Walt Disney Co., NYSE, DIS, $29.06, said Chinese government officials have approved a plan to build a theme park in Shanghai. I believe this is the beginning of a new and enormous growth opportunity for Disney. The cost is estimated at $4 billion, which would rank among the biggest foreign investments in China to date. Disney already has a theme park in Hong Kong. Located on Lantau Island on the route to Hong Kong’s new airport, Hong Kong Disneyland is Disney’s smallest park.  It got off to a rocky start after opening in September 2005. Changes have been made and attendance has improved. Now Disney will be able to take experience from Hong Kong and apply it to a much larger theme park in Shanghai. The plan is to locate the park in the Pudong district. Pudong is right across the Huangpu River from the famous Bund section of Shanghai. Pudong is an area about the size of Singapore. It was rice fields until 1990. The Chinese government launched a plan to develop Pudong into a world class business district. Today there is a deep water port, a new airport, a high speed train connecting Shanghai and the airport, an industrial park, a financial district and the Oriental Pearl Tower. The tower supports radio and TV antennas but is also a major tourist attraction.

 

            When I first visited Shanghai in the early 1990s the tower did not exist. Pudong was struggling. Critics said the whole idea of developing Pudong would not work. For a while the critics looked correct. New office buildings had trouble attracting tenants. Rents had to be slashed. But by the time the Oriental Pearl Tower opened in 1995 Pudong was on its way to success. Over the last decade or so the atmosphere in Shanghai has changed dramatically. There were lots of tourists strolling along the river in the Bund during my first visit to Shanghai. But most of the tourists were foreigners, not Chinese. On my last visit in April 2008, the tourists with digital cameras taking pictures of the Oriental Pearl Tower were Chinese. The same was true in the tourist sections of Southern China. China’s economic success has lifted tens of millions of Chinese up to the middle class. They now have the money to travel and see the sights of their own country. Shanghai has been a tourist attraction for a very long time. The addition of a large major Disney theme park will add dramatically to Shanghai’s attraction as a destination for Chinese tourists.

 

            Mainland Chinese have to get visas and special permission to visit Hong Kong. That is not the case for Shanghai. The Pudong Disney theme park will open the door to the hundreds of millions of Chinese who have the means to travel to Shanghai. As China’s economy continues to grow millions more will climb up the economic ladder and be able to visit Shanghai and the Disney theme park.

 

            I am not sure how many Americans know that most Chinese admire us. My first visit to mainland China was in 1994. The year before I had been in Hong Kong and took a tourist three day Swire Pacific tour to Beijing. That tiny glimpse of mainland China convinced me that I needed to know a lot more about China. Not the usual government-commercial China that investment bankers see. I wanted to visit rural China and see cities that most business people at the time did not see. I found a way to do that. By sheer luck I found China Span and Keren Su. Keren is a very successful professional photographer. He takes small groups of people to visit China. In February 1994 I was off to Hangzhou to join a small group led by Keren. It is cold in that part of China in February. But outside the city the motels had no heat. Businesses and schools also had no heat. People dressed warmly and stayed that way while they worked in a silk factory or other business. I was impressed that the Chinese smiled and were cheerful in spite of the cold.

 

            I was surprised by the attitudes of the Chinese people we met in towns and villages. They like Americans. In one small village outside Hangzhou the village elder asked us to stay for tea. Every one in the village came to see us. They had never met Americans before. Our local city guide in Hangzhou spoke perfect English. She sounded like she came from Wisconsin. But in fact she had never been outside China and learned English at a school in Hangzhou. In schools all across China they teach English, American English. We are admired in China. They see us as role models as they try to achieve their three goals, work hard, get rich and live a long time.

 

            During my many trips to China I saw Donald Duck and Mickey Mouse dolls and paraphernalia in shops and kiosks in cities large and small. I am sure they were not properly licensed from Disney. But they told me that Chinese children also like Mickey Mouse and company. When I put these pieces from my personal experience together they tell me that Disney in Pudong will be a tremendous hit and source of profits for Walt Disney Co. Of course it will take time to select the land and construct the park. The profits won’t start rolling in until the park actually opens for business. But this move to Shanghai will likely be Disney’s biggest opportunity since Walt first created Mickey & Minnie.

 

            If you invested $1,000 in Disney stock in the fall of 1971 when Disney World, opened near Orlando your shares would be worth $33,195 today. And that is after the disastrous 1970s stock market and the worst recession since the great depression. Accumulating shares in Disney between now and when Disneyland Shanghai opens will most likely also produce a huge long term capital gain.

 

Disclosure: Long Disney

 

Philips Electronics, NYSE, PHG, $27.17, shocked analysts by reporting an outstanding third quarter. Profits were $256 million or $0.19 a share. That was more than three times last year’s third quarter of $0.06 a share. Analysts were expecting a loss. Sales were down 11%, showing that Philips is not immune from the downward drag of the global recession. Philips’ lighting division was hit hard by the slump in housing and commercial real estate. The consumer-lifestyle division which makes everything from coffee makers to flat panel television sets was hit hard by the rising tide of unemployment and consumer retrenchment. Even the health care division saw sales decline (4%). The big surprise was that in the face of a sinking top line an aggressive cost cutting and restructuring program significantly improved profits. Adjusted operating profit margins were 6.8% in the third quarter up from 5.4% in the third quarter of 2008. This quarter’s profit margin is one of the best ever for Philips. Philips is an example of how a well managed business can do more than survive a deep global recession. Not only has management kept the company profitable they have increased free cash flow to $519 million and accumulated a cash hoard of more than $5 billion. Management is cautious about the immediate outlook for sales. In commenting about the third quarter the CFO said “the recession is not over.” But there are signs that the recession is winding down. Some economies, such as China and India, are growing nicely again. The International Monetary Fund (IMF) has raised its forecast for the global economy next year. In July the IMF said growth next year would run at a 2.5% pace. Now they see that rising to 3.1% and that is subject to further upward revision. Historically, a global economic growth rate of 3.1% is very good for business. The 2007 global growth rate of 5.2% was considered above average and a threat to inflation. An optimum non-inflationary rate is more like 4%-4.5%. But coming out of the worst recession in decades a 3.1% rate is welcome. Philips will see a rise in sales and a jump in profits if the IMF is even close to right about growth in 2010.

 

            The long term outlook is very bright for Philips. Technology is revolutionizing lighting. No, I am not talking about the problematic fluorescent bulbs with poisonous mercury. I am talking about solid state lighting, or light-emitting diodes (LED).  Philips has spent $5 billion for acquisitions in that last five years. Unlike the competition Philips covers the whole market, making the bulbs, fixtures, controls and systems. I know when you see or hear LED you think of small electronics or computer screens. LED for business and household use is still in the future. An LED bulb can cost $30-$50. That is far more than the $0.70 for an incandescent bulb or around $14 for a fluorescent fixture and bulb. But LED technology is developing fast and the cost will come down.

 

            The U.S. Energy Department is holding a contest with a $20 million prize to encourage development of affordable LED lighting. On September 24, Philips was the first to submit an entry. According to the Energy Department there are 425 million 60-watt incandescent bulbs sold each year in the United States. Replacing them with LED bulbs would save enough electricity to power 17.4 million homes.

 

            Say goodbye to the traditional incandescent light bulb. It is highly inefficient, converting only about the first 5% of electricity into light. As of September 1, the European Union banned most incandescent bulbs. The U.S. will follow suit starting with California in 2011 and the rest of the country a year later. As incandescent bulbs are phased out, new technology will develop and grow quickly. The end of incandescent bulbs will mean a rise in sales of all energy efficient lighting including fluorescent. But LED lighting has advantages over fluorescent. Philips’ CFO says the pricing premium for LED over fluorescent will become very modest over the next few years. LED is a small piece of the total lighting market, but it is already the fastest growing. The industry is expected to grow 5% a year through 2012. But the LED market is predicted to grow 28% a year over the same period.

 

            Philips is a financially strong, well managed company with above average growth potential both during the recovery and for the longer term. The question is what to pay for the stock. There is a dividend. It is paid once a year in June. But it is a profit sharing dividend. Management targets the dividend at 40%-50% of continuing net income. The current yield is 3.5%. The stock fell to $13.98 at the market’s March low. It is now back close to the level before the collapse of Lehman Brothers. The high was $45.90 in 2007. The long run average P/E is 20. Based on third quarter results it looks like Philips will be able to earn $1.00 a share or better in 2010. The long term average P/E makes the stock look on the high side at 27. But cost cutting and restructuring have significantly improved Philips’ operating leverage. Phillips can earn $2.00 a share in earnings long before the global economy manages a full recovery. Other measures of value are book value and sales per share. At $27 the stock trades at 110% of book value and 79% of sales. In 2007 at the low, the multiples were 129% of book value and 110% of sales. The current multiples are less than at the 2007 low indicating the stock is not over valued. But it is always a good idea to get the best entry point possible. Before the announcement of third quarter results the stock traded below $25. There is a risk of a broad market correction. If the market comes down Phillips would likely follow. Therefore my advice is to be patient, buy Philips below $25.

 

Full disclosure: Long PHG