One Page Annotated WSJ Summary, Friday August 4th

by: David Jackson
David Jackson
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Apple Spots More Options Missteps

  • Summary: Apple Computer, which last month acknowledged 'irregularities' in option grants issued between 1997-2001, has now found 'additional evidence' that will likely require the company to both restate past financial results and delay filing its current quarterly results. A terse press release issued last night did not provide details on the exact nature of the options mishandling, but indicated that an independent counsel investigation that its board initiated has found unaccounted charges for option-related compensation expense. In its June announcement, Apple noted that 'one of the grants in question' was issued to CEO Steve Jobs, but that it was later canceled and 'resulted in no financial gain' to Mr. Jobs. Apple stock dropped in after-hours trading 6.6%.
  • Comment on related stocks/ETFs: Here's the press release from last night; the SEC 8-K filing, warning on the restatement and this quarter's delay, is still not up on the SEC's Apple page. Apple is the highest-profile tech stock among more than 80 to be hit by the options scandal. As noted when the company first acknowledged the issue, the risk is not only for sentiment damage and fines but that Steve Jobs or other key Apple execs could be forced to resign if it's found that they knowingly took options grants at below market prices. Today's Bloomberg piece on the issue notes that shareholder lawsuits are already on file in California alleging Jobs took an improper 7.5 million share grant. The Journal article notes the possibility of Apple facing Nasdaq delisting if this quarter's filing doesn't arrive in time. Jason Wood, meanwhile, brushes aside claims that it's no big deal since 'everyone's doing it.' Our updated options scandal 'scorecard' summarizes the damage to date.

Most Retailers Post Solid July Sales Despite Some Pockets of Weakness

  • Summary: Goldman Sachs' same store sales index rose 3.1% in July (beating a forecasted 2.8%, but below last July's 3.4%), with the gain concentrated in department stores at the expense of discounters. Discounters: The trifecta of high gas prices, rising interest rates and a softening housing market appears to be having a strong effect on the discount sector. While Costco (NASDAQ:COST) led the sector with same store sales up 7%, retail darling Target (NYSE:TGT) posted a same store sales increase of 3.1%, at the low end of its revised forecast of 3%-4% (the previous forecast was 4%-6%). Same store sales increased 2.4% at Wal-Mart (NYSE:WMT) and 1.9% at BJ's Wholesale Club (NYSE:BJ) (including gasoline sales!). Department Stores: July's same store were up 4.9% at JC Penney (NYSE:JCP) , 3.3% at Federated (FD), and 5.3% at Nordstrom (NYSE:JWN). Apparel: Sames store sales in this sector were 7% at American Eagle Outfitters (AEOS) , 3% at Abercrombie & Fitch, with The Gap (NYSE:GPS) bringing up the rear with a 4% decrease. Miscellaneous: Struggling Sharper Image (SHRP) posted a decline in same store sales of 23%.
  • Comment on related stocks/ETFs: Despite a back to school bump Rob Black has concerns with discounters, but is more upbeat on the luxury retail sector. Sharper Image continues its ride into the sunset.

Heat Wave Pushes Power Prices Above U.S. Caps

  • Summary: Spot prices for wholesale electricity surged yesterday throughout the East Coast of the U.S. as another day of sweltering heat and high demand for electricity pushed prices above price caps set by federal regulators. In New York City, Consolidated Edison Inc. paid more than 10 times the average price Thursday afternoon when prices hit as high as $1.33 per kilowatt hour. The federal price cap limits the amount power generation companies can charge utilities and major customers. However they are allowed to charge more if justified by higher costs, but that results in an audit by regulators. Like most utilities, ConEd relies on spot markets during high-demand times and it can pass on costs to customers. High demand this year could spark more plant construction but some experts say time needed to secure permits and equipment could prevent necessary plants from being built fast enough.
  • Comment on related stocks/ETFs: Consolidated Edison (NYSE:ED) seems poised to benefit from the surge in electricity demand and spot prices since it can pass costs on to its customers. The article does mention however, that "Grid operators said they are paying exceptionally high prices only for short bursts of time, unlike during the California energy crisis of 2000-2001." One way of approaching the current situation from an investment standpoint is to consider the equipment and construction companies and also the commodities themselves. Potential stock plays on the construction side include: Halliburton (NYSE:HAL), McDermott International (NYSE:MDR) and Washington Group International (WGII). Resources: ConEd Q2 earnings release, ConEd press releases on the Northwest Queens Outages and it setting a new record for electric usage, Halliburton Q2 earnings conference call transcript, Q2 earnings release (.pdf), McDermott investor relations (earnings August 7 before open, conference call 12:00 p.m. EST), and Washington Group International investor relations (earnings announcement August 7 after close; conference call August 8 1:00 p.m. EST).

Are Frappuccino Woes or Frugality To Blame for Starbucks's Stumble?

  • Summary: Were sales lower due to a combination of longer Frappuccino production times and the abnormal July heat, or are consumers cutting down on trips to Starbucks due to higher gasoline expenses? Starbuck's July 4% same-store sales growth was the lowest in nearly five years, way below previous 8-10% increases. Starbucks' stock was down 8% yesterday on high volume. Management tried to focus attention on the planned rollout of at least 200 more new store openings than previously announced for its current fiscal year ending September 30th, bringing its yearly total to at least 2,000 new stores, and its plans to expand in India and Russia. Starbucks currently operates more than 11,000 stores world-wide with a goal of someday operating 30,000. But expansion into smaller towns, inner cities, and spots off the freeway might be behind the decline in US sales growth, as lower income consumers are more impacted by rising gas prices and credit card bills. Chains such as Applebee's International Inc., Cheesecake Factory Inc. and Yum Brands Inc.'s KFC are blaming weaker sales on consumers cutting back for reasons such as higher gas prices. In contrast, Starbucks CEO Jim Donald calls Starbucks an "affordable luxury" and sees no weakening in his customers' discretionary spending power. Two other potential reasons for a slowdown: (1) increased competition from McDonald's Corp. and Dunkin' Brands Inc.'s Dunkin' Donuts chain; (2) the number of morning coffee drinkers has declined for at least the last 15 years to 37.7% from 48.7% in 1990. Starbucks is implementing changes to speed up preparation time of labor-intensive Frappuccinos and cut lines. CEO Jim Donald also argued that menu expansions are adding to sales, not detracting.
  • Comment on related stocks/ETFs: Investors have every reason to be concerned with a slowdown in sales at Starbucks (NASDAQ:SBUX). As CIBC analyst John Glass said, the restaurant industry is amidst one if its worst downturns in history. Blame it on the heat or higher gas prices, the fact is sales are slowing across the board. So what does this mean for McDonalds, which already operates more than 30,000 locations globally and is introducing upgraded coffee? It actually reported rather strong earnings on July 25th fueled by World Cup Soccer sales in Germany and the sale of Chipotle Mexican Grill (NYSE:CMG) shares. A article reports its same-store sales rose 4.2% in the U.S. in June, extending its streak of increases since April 2003 and notched even higher same-store sales marks globally. Rob Black reports in his Retail Stock Report from Monday that "McDonald's is not seeing signs of economic weakness or consumer skittishness in its U.S. business. He adds, "The underlying strength and growth of breakfast underscore the potential for coffee." Starbucks' smaller rival Peet's Coffee and Tea (NASDAQ:PEET) reported a 30.8% decrease in net profit yesterday causing its shares to also selloff, losing 6.26% in after-hours trading at $25.60 per share. Peet's sales did increase 19.1% on the quarter. Resources: Starbucks Q3 earnings conference call transcript, Mick Weinstein's posts on Starbucks Comments on Frappuccino Wait Times and its Ambitious Growth Plans, and McDonald's Q2 conference call transcript, and Peet's Coffee & Tea Q2 earnings press release.

As Oil Prices Rise, Investors Pour Into Risky Energy Plays

  • Summary: High oil prices have raised the stakes for investing in energy-related endeavors. Billions of dollars are flowing from private-equity, hedge funds, and other professional speculators into unconventional loans, management teams with limited track records, and IPOs on lightly regulated stock markets such as the Pink Sheets and the London Stock Exchange's Alternative Investments Market. Look no further than the ease at which the Carlyle Group and its Riverstone Holdings affiliate raised $5.4 billion in just six weeks this spring to buy or start energy and power companies. As for public companies, look at the huge premiums paid recently in acquisitions: Anadarko Petroleum Corp. paid 40% more than the stock market value of rival Kerr-McGee Corp. and 49% more for Western Gas Resources Inc. "Energy's about as hot right now as tech was in 2000," says Sanford C. Bernstein & Co. analyst Ben Dell. But Jeffrey Currie, head of commodity research at Goldman Sachs in London, points out the risk taking is justified given the energy industry's long underinvestment in new capacity and that supplies have grown extremely light. In October 2004 there were 180 energy-focused hedge funds with assets of $25 billion. As of July 2006 there are 514 funds with assets of 67.4 billion, or an increase of nearly 170%.
  • Comment on related stocks/ETFs: Retail investors may want to pay heed to the SEC's advice mentioned in the article warning investors that "companies quoted in the Pink Sheets can be among the most risky investments" because it is an electronic stock-quote system that lacks any listing requirements.' However, there's no reason to completely shy away from investing in energy-related companies. Refer to SeekingAlpha's coverage of Energy Stocks. Recent articles include: Marc Gerstein's Oil Investing: Stocks vs. ETFs, Dan Carty's Oil Prices: Fundamentals Don't Apply, ETF Securities' Oil Price Driven By Supply Constraints, William Trent's Oil Prices Are All About Supply, Oliver Schwindler's Has Oil Peaked for the Year?, and Rob Black's Energy Stock Report.

Sprint Net Falls Amid Fight for Users

  • Summary: Sprint-Nextel's (NYSE:S) 2.1% turnover rate came back to haunt it, as it reported second quarter earnings of $370mm ($0.12/share), down 38% from $600mm ($0.40/share) it reported for the same period last year. The lower earnings were despite a 10% increase in revenues, to $10 billion. On a net basis, Sprint added 210,000 high-end customers, but existing customers are increasingly moving to lower price plans. Its competitors Cingular (a joint venture between AT&T (NYSE:T) and BellSouth (BLS)) and Verizon (a joint venture between Verizon Communications (NYSE:VZ) and Vodafone (NASDAQ:VOD)) are both signing up more customers (1.5mm and 1.8mm, respectively) and experiencing lower defection rates (1.7% and 1.1%, respectively).
  • Comment on related stocks/ETFs: Sprint's announced $6b share-buyback plan did not prevent its stock from hitting a new 52 week low of $16.88 yesterday. Legg Mason's Bill Miller has been an aggressive buyer of the stock. Resources: press release, conference call transcript & Bloomberg's write-up of the earnings results.

Gateway Posts Loss As Margins Shrink

  • Summary: Gateway Inc., the third largest US PC vendor, reported Q2 results: Revenue up 5.3% to $919 million. Gross margin fell to 5.5% from 10% a year earlier. Net loss of $7.7 million compared to a net gain a year earlier of $17.2 million, which included a $15.1 million payment from a legal settlement with Microsoft. Gateway said it is making progress turning around its direct and professional business.
  • Comment on related stocks/ETFs: Gateway's stock (GTW) fell about 10% in late trading after the results were announced. Gateway's unit shipments of PCs rose by 16% year over year, but revenue was up only 5%. That means that Gateway gained market share on a unit basis, driven by its strategy of partnering with retail stores -- its sold 21% more units into its retail channel year over year. Gateway's core problem is pricing: the US market is maturing and growing slower than international markets where Gateway isn't a player, and Dell and HP are pricing aggresssively. Arguably, Gateway has no niche of its own, an uncompetitive cost structure, and weaker brand than its competitors. Its only advantage is its relationship with retailers. The issue now is how Gateway will fare going forward given Dell's move to "simplify" its pricing. Resources: press release, conference call transcript, excerpts about PC price competition and the company's thoughts on differentiation, Bloomberg's write-up of the earnings results, and Sony's recent results including a comment on strong laptop sales.

IBM to Acquire MRO Software For $740 Million

  • Summary: Continuing the expansion of its higher margin software business, IBM (NYSE:IBM) announced its intent to purchase MRO Software (MROI) for $740mm ($25.80/share). MRO Software provides corprate asset and service management solutions. This is IBM's 37th software company purchase since 2001. Software, with its higher margins, has been playing a more important role at IBM, contributing $16.53 in revenues (19% of total) for the past four quarters. Software now accounts for about one third of IBM's profit
  • Comment on related stocks/ETFs: IBM is not the only big iron maker seeing the software light. Hewlett Packard (NYSE:HPQ) recently announced their $4.5 billion acquisition of Mercury Interactive, which Paul Kedrosky sees as a sign of enterprise harware weakness. For the quarter ending June 30, IBM reported higher profit, but total revenue came in at @21.89 billion, down from last year's $22.27 billion. IBM closed yesterday at $76.33, up a bit from its 52 week low of $72.73 (July 18), but well below its 52 week high of $89.94 set last November. Resources: press release, IBM's second quarter results

Cooper Tire's CEO Dattilo Quits After Report of Wider Net Loss

  • Summary: Cooper Tire & Rubber (NYSE:CTB) CEO Thomas Dattilo resigned to "pursue another opportunity" after the company reported a second quarter loss of $20.7mm ($0.34/share), compared with a $6.9mm ($0.11/share) loss for the same period last year. The increased loss was despite a 22% increase in sales ($624.8mm vs. $510.9mm). Price increases have not kept up with raw material cost increases, and consumers are delaying replacing tires as they shell out more for gas and worry the economy. Cooper still produces most of its tires in the U.S., and it is behind schedule with its plans to move production offshore to China .
  • Comment on related stocks/ETFs: Cooper hit a new 52 week low yesterday of $8.90/share, but it is not alone in its misery. Catablast Media's post on fellow U.S. tire producer Goodyear (NYSE:GT) raises significant concerns about the company. Resources: Earnings press release, CEO resignation press release & Bloomberg's write-up of the earnings results.

CBS's Core Broadcast Revenue Slips

  • Summary: CBS' drop in second quarter revenue added to Wall Street's concern about the future of the legacy broadcast business. Even though CBS has the strongest prime-time TV lineup of the major networks, TV revenue dropped to $2.3 billion, a 1.1% decline. Advertising revenue was flat for the second consecutive quarter, and the $24mm costs of closing the UPN network resulted in operating income dropping by 3%, to $491.9mm. Stung by the loss of Howard Stern to Sirius (NASDAQ:SIRI), CBS radio's ad revenue fell by 8%, to $519.1mm. Radio's operating income came in 20% lower, at $219.6mm.
  • Comment on related stocks/ETFs: Last month, Rob Black noted that advertisers are considering moving more of their dollars to the internet as digital video recorders (which allow users to skip commercials) become more popular. Resources: press release, conference call transcript, and Bloomberg's write-up of the earnings results.

Ford Doubles Reported Loss for Second Quarter and BMW's Earnings Rise 17%; New Competition May Test Sales

  • Summary: Ford Motor Co. reported its second quarter year-over-year loss more than doubled to $254 million, or 14 cents per share, over its earlier earnings report due to increased pension-related losses that are expected to total $1.2 billion, up $200 million from its previous estimate. The pension-related costs include early retirements, enhanced benefits, and recognition of accelerated costs with Ford's U.S. hourly work force. Ford expects to lose 12,000 hourly workers through attrition this year -- more than previously expected. Ford also disclosed that it expects its Premier Automotive Group to be unprofitable in 2006. It has hired long-time investment banker Kenneth Leet to review PAG and find a solution for the loss-making Jaguar brand. Ford spokesman Tom Hoyt said, "There are no new plans to divest our brands or invest in a new alliance." BMW AG reported a 17% rise in second quarter earnings to €787 million ($1.01 billion) but said it could face pressure in meeting sales targets against increased competition in the luxury-car segment by competitors like Toyota Motor Corp. Toyota is said to be targeting BMW on its home turf in Europe with its Lexus brand and Mercedes-Benz is readying for a comeback. BMW hasn't published 2006 sales targets but expects to sell 1.4 million autos in 2007 and 1.6 million by 2010. Revenue rose in Q2 to 8.5% to €13.19 billion. BMW's outgoing CEO Helmut Panke said in a statement that "We have again increased earnings sharply and achieved new record figures for revenues and sales volume." However, BMW acknowledges currency fluctuations and high raw-materials prices have continued to hurt earnings. Mitsubishi Motors Corp reported a narrower Q1 net loss of 15.11 billion yen ($131.9 million) -- from 21.65 billion yen a year earlier -- on improved North American operations and said it is aiming to return to profitability this fiscal year. Mitsubishi is Japan's only auto manufacturer in the red. Its operating loss fell to 6.79 billion yen from 13.78 billion yen as sales were lower by 0.4% to 483.88 billion yen.
  • Comment on related stocks/ETFs: See Mick Weinstein's Ford Mulling Sale of Its Jaguar Unit and Credit Union and Steven Towns' Toyota and Honda Stick it to the U.S. Big-3, in which recent WSJ articles are summarized on the subject of Ford's troubles and Japanese autos rising momentum in grabbing market share in U.S. Big-3 territory. Toyota (NYSE:TM) reported record Q1 profits today; look for an earnings summary forthcoming on SeekingAlpha.

Music You Can See: Warner Plans to Sell Albums on DVDs

  • Summary: Warner Music Group is planning to launch DVD music albums which will contain stereo and surround sound audio tracks plus video footage, song remixes, ringtones, photos and other digital extras. Initial discs will be sold in October, with full launch in early 2007. The new discs will be more expensive than standard CDs, will not be playable on CD players, and will need to contain separate, un-enhanced audio tracks to allow users to load the music on to PCs. Warner is reportedly close to a deal with Apple Computer to use Apple's copyright protection and encoding for the un-enhanced audio tracks.
  • Comment on related stocks/ETFs: A Pali Research media analyst, quoted in the article, says that the new format is unlikely to succed. Other surround-sound formats -- Super-Audio CD, DVD-Audio and DualDisc -- all failed to get traction with customers. However, if the new format does become popular, a number of companies (and stocks) stand to benefit. (1) Music companies Warner Music (NYSE:WMG), EMI and Universal Music, which is owned by Vivendi Universal (NYSE:V). (2) Music retailers Trans World Entertainment (NASDAQ:TWMC), which owns the Coconuts, Wherehouse and FYE chains, and Best Buy (NYSE:BBY) would benefit from higher music revenue. (3) Replacement of CD players by DVD players should benefit the consumer electronics vendors and their suppliers. (4) The spread of surround-sound audio would benefit Dolby Labs (NYSE:DLB) and Digital Theater Systems (NASDAQ:DTSI). (Full disclosure: long DTSI at the time of writing.) However, most of these stocks are more impacted by the rollout of the next generation DVD standard, and are thus suffering from the unresolved standards war between Blu-ray and HD-DVD. On its conference call last night, Dolby issued guidance for single-digit revenue growth and said: "we will be considering the anticipated slow adoption of next generation DVD given the competing formats and high initial price points. Also we are cautious of the fact that in the PC market, OEMs and ISVs are under pricing pressure which may cause them to evaluate whether or not to bundle DVD playback software into base models." If Warner does indeed adopt Apple's proprietary standard for the un-enhanced audio on the discs, that would be incrementally positive for Apple (NASDAQ:AAPL). Resources: Warner Music's Q2 conference call transcript; Dolby's Q2 conference call transcript discusses the outlook for next generation DVD players; Digital Theater Systems' Q1 conference call transcript discusses the surround sound market in cars and other applications.

Total's Net Profit Rises 16% On Increase in Oil Prices

  • Summary: Despite a 9% daily drop (2.29 million barrels/day) in output, French oil company Total SA (NYSE:TOT) reported second quarter profits of $4.4 billion, up 16% from the same period last year. Various maintenance projects, plus production disruptions in Venzuela & Nigeria were blamed for the decline in production. A 35% rise in the price of oil over the same period, averaging $69.90/barrel, more than offset decreased production.
  • Comment on related stocks/ETFs: With yesterday's close of $66.27 below Total's 52 week high of $72.27 (May 11) directly supports Chad Brand's opinion that oil companies appear to be cheap vs. the commodity. Marc Gerstein's recent post investigates the strategy of investing in Oil ETFs.

AHEAD OF THE TAPE: Wage Cost Worries

  • Summary: Today's jobs report from the Labor Department should be a key factor contributing to the Fed's interest rate decision next Tuesday. Futures contracts now put the chance of a quarter-point rate hike at 42%, indicating deep uncertainty among economists on the matter. The key issues are (1) how severe is the current economic slowdown? and (2) how badly is inflation heating up? The key nonfarm payroll figure today is estimated to show 150,000 new jobs in July. A larger number would suggest another rate increase could be absorbed by the national economy. Eyes will also be on the wages figure; in June it showed a 3.9% increase year-over-year, and if that trend continues, it will trigger inflation concerns. A final piece of labor data will arrive just before the Fed meeting on Tuesday -- unit labor costs, which has until now been relatively tame.
  • Comment on related stocks/ETFs: The rate decision will impact the precarious housing market, of course -- Jim Wiandt comments on why most homeowners need not worry just yet about their home values. Eddy Elfenbein argues that the Fed should raise another 25 basis points next week, then stop -- here's why. David Andrew Taylor gives the two reasons why it's hard to predict interest rate shifts.

HEARD ON THE STREET: Ford's Next Step May Be To Shed a Luxury Brand

  • Summary: One or more of Ford Motor's struggling European luxury brands -- Jaguar, Land Rover, Volvo and Aston Martin -- may be put on the block as part of the automaker's turnaround effort. Veteran investment banker Kenneth Leet has been placed in charge of exploring asset sales and alliances for Ford. Additional street buzz suggests some portion of Ford's credit business may be put up for sale. Ford, like GM, is attempting to overcome lowered market share (Toyota just passed Ford in U.S. sales), higher employee costs and borrowing costs, and generally weak financial results. As Ford does not break down sales by division, it's difficult to predict what Jaguar or one of the other brands could fetch; in addition, Jaguar's poor financial results may make it a hard sell, and Ford may be forced to accept less than half of its purchase price of $2.6 billion in 1989. Ford's credit union, on the other hand, has been consistently profitable and may attract more interest.
  • Comment on related stocks/ETFs: With the stock near a ten-year low, sale of the Jaguar unit for, say, $1 billion might do more to enhance investor sentiment than it would to actually bolster Ford's troubled balance sheet. Stephen Brown takes the contrarian bull position on Ford stock, claiming it has 'risen from even deeper abysses than the one it currently finds itself.'

Notable articles on Seeking Alpha today: Today's earnings schedule and estimates. Roger Nusbaum on why the dollar will fall. Long ideas: Wendell Perkins on telecom, Radyne Corp. and Mitcham Industries. Jim Cramer's latest stock picks. Latest conference call transcripts from:
WebMD, Move, United Online, Sabre Holdings, Activision, Pan American Silver, Invitrogen, Gateway, DreamWorks Animation, Gold Fields, Primedia, Barrick Gold, Warner Music Group, Williams Companies, Internet Capital Group, Rio Tinto, CBS, Sprint Nextel, CVS, 24/7 Real Media, Nortel Networks.

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