Wednesday, August 24, 2005

3M boasts Chinese sales

3M (MMM)hit 52 weeks low yesterday and suddenly Company are talking up their Chinese sales growth +25% for the next 5 years. Hmm, first of all, I would consider the timing fully suspect. Second, MMM still depends on 40% of its sales from domestic operations and Asian operation is about 26%. Now, Chinese operation is only 8% of operation, it immediately throws a red flag in my face as regular readers would know by now company's tricks to obfuscation tactics by steering attention away from potentially slowing main operations (past examples, VIACOM, EBAY etc).

When you have only 8% operation in China at this late stage of the cycle, YOU ARE NOT A CHINESE PLAY period. Plus, Chinese economy has been growing for decades, only now when Joe Investors are finally plowing their hard-earned money in BIDU (BAIDU, Chinese internet portal play) that MMM is finally waking to China? Too Late (read my thoughts on Chinese potentially being the catalyst for a melt down in global economy below). Simply extrapolate linearly for the next 5 years is downright dangerous planning. Think about it, if forecasting are so easy, try to extrapolate crude oil prices when it hit $11 in 2001. It should have gone lower by linear projection.

As I have said many times before, when the fastest growing but smallest part of a company's business is being touted by company executieves, you are forewarned!! RUN FOREST RUN!!

Wednesday, August 17, 2005

Snap shots of receivables growth

They used to say that earnings are easily manipulated through accounting tricks but a sale is a sale. In that line of thinking, earnings growth in the absence of top line growth (sales) will typically not be rewarded. In the era of sales emphasis in order to attract investors' attention, CEOs are scrambling to boost sales. There are good and bad way of increasing sales. The right way is off course the best way when there is a genuine demand for your products and it naturally flows through your top line growth, creating shareholder value. The bad way is to artificially boost it by heavy discounting or give it away (BUY.COM model).

There is a third kind that is called vendor financing. This kind typically won't impact your margins such as heavy discounting would to your P&L. Basically, you give finance to your customers to buy your goods. What it does is that the company will book top line for that product sales and the relevant earnings, so it has a positive impact on the earnings statement. On the cash flow basis, it has a negative impact since the company has not received cash for it.

There are several reasons why a CEO may opt to do this:
1)financing costs are cheap, so why not
2)things may be slowing but I would to book more sales
3)look at that credit default, it's marvelous, who is going to default on me
4)look at that sales number, Wall street don't look at balance sheet data anyway
5)look at the response of my stock price whenever I print huge sales number
6)returns are through the roof, my board and shareholders are going to love me

Having said that, when a company are doing it excessively, it may point to potential problems down the road such as defaults as the portfolio of receivables grow bigger. Suddenly 1% default rate look big on a 1 billion dollar portfolio. In addition, a company may rely on debt as an incentive to continue its growth (sounds familar?).
So what is the metric we should look at in judging a company's financial health. One of the things that I'd look at is the receivables growth rate. If it is greater than sales growth rate, it is a red flag. I'm not predicting that all is bad when that happens but the odds of potential problems down the road is greater than a company that does not rely on receivables to generate growth.

The following is the highlights of several companies that showed receivables growth greater than its sales growth in its latest quarters:

Dell sls +15% rec +23% CSCO sls +11% rec +51% HD sls +12% rec +42%
WMT sls +10% rec +31% UTX sls +16% rec +23% GM sls -2% rec -1%

For GM, I have included their held for sales receivables without which receivables would have declined quite a bit. I figured the total amount of receivable is more appropriate as company do factoring (i.e. sls of receivable) all the time.

Real Estate Prices Will Not crash!!!

Wall Street Journal and a guest on CNBC today both acknowledged that there is a bubble (or overvalued as they put it) in the real estate market but opined that if the bubble does burst, the decline in price will not be great and one of the major assumptions that the guest on CNBC is because:, "...especially if you're bullish on the economy and job creation in 2006 that should keep prices buoyant!". In addition, he mentioned that creative financing such as interest only loans (traditional mortgage payments consist of interest and principal payments while interest only loans is such that principals are rolled into your balance, in effect you have lower monthly payments but your loan amount increases every month, compounding) are adding to the aggregate demand.

Let me explain why this logic is flawed. First, basing your opinion on assumption (such as job creation) is dangerous to say the least. Job lay-off annoucements have spike to the highest level (this is fact according Challenger Gray Consultion firm) and the lamest excuse the general media can base their opinion good job growth to recommend that the housing price will not collapse?

Second, creating financing is equivalent to vendor financing done by the telecom debacles in the late 90s. Vendor financing is financing handed by suppliers to keep sales going (think GMAC, the finance arm of GM that finances all those 0% sales). Eventually everything will stop. This phenomenon is not just limited to the housing sector nowadays. Look at Dell's earnings (which was good by the way albeit short of expectations) for instance, Q2 sales were growing at 15% yoy but RECEIVABLES GROWTH were a whopping 23%. This is a major RED FLAG if you are financial analyst (In fact I will do another post on this).

The other more dangerous sign I have read today is the key word "few economist" think there will be a melt down in real estate prices. The contratrian in me rang a bell so loud that I have to cover my ears. In 1931, before the bottom of the stock market market and deepening of the Great Depression, majority of CEOs and Fed officials were bullish on the economy just as we are today.

Monday, August 08, 2005

Follow up on BAC (Bank of America)

Also see BAC, trading off 10% since peaking in early July. If you're interested, you should read my post on my negative gauge of the stock even before negative sentiment starting to hit the stock since the KRB acquisition. watch this stock, because it is one the biggest component on BKX (bank index) and you know what they say about financials lead the market direction.

FDX follow up

Stock is trading up $.20 following Barron's highlight over the weekend. I may speak early which is often the case but if there is no more follow-thru on the upside, it speaks volume of the tremendous supply of stock coming into the market and may bode well for the bear case in which I laid out in detail yesterday.

Saturday, August 06, 2005

FEDEX is a buy according to Barron's?

Barron's ran a very positive article on FEDEX this weekend. Let me first say that I have a short position on this stock and why I disagree with the assessment.

Barron's first said that the stock is down 16% and it's because of high fuel cost, higher capex and higher competition that weighed down the price.
The crude oil to fedex stock relationship just does not hold water. Why? If this argument will hold water, the negative correlation between the 2 factors will be consistent throughout history. During 2004, while oil was up 100% from $30 to $60, FDX went up by 35%. Immediately, you know that this relationship is not true. In addition, fuel surcharge imposed by FDX is having a positive on their P&L, so again this statement of higher fuel prices causing stock price to head down is downright misleading.

Costs did go up significantly, and that's not just fuel cost. That was the reason margins got crimped despite price increases (which was imposed almost across the board). Now, FDX is a cyclical growth stock, i.e., their cyclicality may not entirely depend on the economy as they do have strong international growth as correctly pointed out by the paper. Having said that, majority of their business is still cyclical and will be at the mercy of the U.S. economy (or global economy for that matter). The key to trading cyclical stocks is to watch margins, when they peak and trend down despite positive revenue growth, time to go. This is the part in which growth manager will overstay their welcome in the stocks.

Capex going up while margins continue to trend will spell trouble if and when things did not turn their way in 2006. That will significantly impact free cash flow and ROE if revenue start to turn down and they can't turn down the cost faucet fast enough.

The international growth story is by far the most telling part of the turning point in FDX. Why? Because typically when a company with significant portion of their business based in the U.S. suddenly EMPHASIZE their international growth proposition, especially having to spend to get there, you know that their are trying to distract investors attention away from the core business and justify slowing U.S. growth with higher international growth (smaller impact on EBITDA but look at the growth rate) in order to justify HIGH valuation. I just don't buy the argument that median of 16x is a bargain. Usage of 5 year median p/e is too short, especially using an expensive stock compared to an even more expensive S&P is a relative valuation game played in 2000 when analyst can't justify the multiples anymore but to compared against even more expensive metric.

There are other issues which I'm not going to go but I'll point out another critical point. Option expensing,if taken into account will crimp EPS this year by 2.5%. For a stock growing at low double digits, how much multiple contraction would we get, another 2-4x?

The paper's assumption of continued growth is flawed and the assumption that p/e will continue to expand is hope. The stock market is a discounting machine, just as it was discounting good 05 earnings during 2004, it well signal that growth is slowing going forward (see my Newspaper Media stocks comment lower). In additional, this stock still tout 75% institutional holding (50% would be consider unloved and worth a look) and put/call ratio and short interest are both low as well. Buy more folks and I'll borrow yours to short.

Friday, August 05, 2005

What Summer Redstone learned from Mel Karmazin

Viacom will be splitting into 2 units by Q1 2006. I bet you didn't know that Viacom's Infinity division was bought and spun out several over its life, making Mel Karmazin, founder and recently left Viacom's CEO, very rich indeed. Should we enrich another CEO that instead of focussing on running its companies (in a rather difficult environment I might add), remain obsessed with driving the stock price up? Summer Redstone is a CEO that would not be shy about touting its company stock when its share price is under pressure (I personally can attest to this as he would repeatedly leave voice messages on my phone reassuring the positive case of its stock whenever there is a negative story that knock down the stock). Financial engineering may be a solution but it is only a solution to short term profiteers such as the investment bankers etc. The stock price would respond if VIA is trading at cheap valuation and/or the environment is getting better, neither of which has happened. Imagine my surprise when I heard Dick Parson of Time Warner chided on CNBC that not all stocks need financial engineering to boost the stock price up, referring to the oft debated case that they should spin off AOL.COM. Kudos to him, we should have more CEOs like and he just elevated his position among my most respected CEOs altar. No wonder Karl Icahn is buying a chunk of TWX, hmm, makes you wonder.