As a young and speculative investor, I bought more shares in U.S. Concrete (RMIX) following their announcement to seek bankruptcy protection (...Are the Warrants Worth It?). That is not the end of the story...
I wonder if hedge funds buy what will be "old" or "potentially cancelled" equity to obtain warrants (when possible) to buy x% of new equity at a set price when such a company emerges from bankruptcy. Under U.S. Concrete's plan, existing shareholders are to receive warrants to acquire 15% of the new equity resulting from its restructuring (fully story here). My logic brings me to initial public offerings. It is likely to assume that hedge funds/other investors might want the opportunity to get in on the offered price of the new equity via warrants again given to the "old" or "potentially cancelled" equity holders if the new equity is assumed to be undervalued or if those hedge funds/other investors see significant upside in the company/industry. The following posts here and here suggest potential upside in U.S. Concrete and the construction/cement industry.
The concern now becomes how to value what will be new equity of a company while it is in bankruptcy? I came across an article here that could suggest how new equity is not valued by a bankruptcy court, but instead by the market - supply and demand. Nonetheless, I look forward to reading comments regarding the matter.
Now if hedge funds/other investors do buy "old" or "potentially cancelled" equity for warrants, does that indicate the new equity will rise in value once the shares become publicly traded? With that said, I presume there will be a bid on April 30 for RMIX stock. That would imply that investors see potential in the company, would it not? If there is no bid, I will follow-up to this article accordingly. On a final note, RMIX will continue operating as it normally would and they do plan to emerge from bankruptcy within 75-90 days. The market saw similar cases with CIT Group as well as other companies.
I leave this post open for discussion.
Full disclosure: Long RMIX at time of writing.
Thursday, April 29, 2010
U.S. Concrete Files for Chapter 11 Protection: Are the Warrants Worth It?
On April 29, 2010, U.S. Concrete (RMIX) filed for Chapter 11 protection in Bankruptcy Court in the District of Delaware. Chapter 7, unlike Chapter 11, is when a company terminates all of its operations and simply goes out of business. U.S. Concrete, through Chapter 11 protection will still operate customer programs and proceed with its employee benefit and wage programs – they will move forward and continue operating as a business.
President and Chief Executive Officer, Michael Harlan, acknowledged that he was content with the support from bondholders to exchange the 8.325% Senior Subordinated Notes due in 2014 for equity in the reorganized company. This will alleviate U.S. Concrete of roughly $272 million in debt resulting in a stronger balance sheet down the road. Consider the following words from Michael Harlan: “As a result of the restructuring, we should be positioned to be a financially strong competitor in our markets.” I still believe with construction spending bottoming (Bottom in Construction), U.S. Concrete, as I suggested to be a long-term (more risky) play, could still work. The company is eagerly trying to expedite the restructuring so in other words, U.S. Concrete should emerge from bankruptcy within 75-90 days.
U.S. Concrete has until September 7, 2010 to reclaim compliance from NASDAQ otherwise the existing (old) shares will be delisted. However, current shareholders would obtain warrants to acquire 15% of the new equity following the restructuring. So I am not entirely sure what the future holds for the existing equity and if NASDAQ’s notice of being delisted to U.S. Concrete is even relevant considering there is new equity as a result from the restructuring. According to the Securities and Exchange Commission, if a public company emerges from bankruptcy (which presumably will happen with RMIX), there can be two types of common stock: old and new. Nonetheless, the old common stock again I assume will be cancelled (which is possible) due to the warrants current shareholders will receive. Refer to the following SEC page about corporate bankruptcies: http://www.sec.gov/investor/pubs/bankrupt.htm. On this page, the SEC confirms that shareholders can participate in the restructuring plan (with warrants) yet substantial dilution is likely – evident with current shareholders receiving 15% of each new share for every old share.
Therefore, it is essential to know what the new equity on a per share basis will be valued at. I will keep my eyes and ears open for any relevant information. Any reader with thoughts or ideas, please comment!
Some final notes: Wallace H. Johnson, a top executive with U.S. Concrete, once held various management positions at W.R. Grace & Co. (GRA). W.R. Grace is a concrete/construction company as well but also has exposure to the chemicals industry and markets abroad. GRA also went through a plan or reorganization in bankruptcy court not too long ago from asbestos lawsuits. GRA emerged from bankruptcy and since, has been trading to the upside. However, following GRA’s bankruptcy reorganization, the ‘old’ shares continued trading. GRA, during its seven years of bankruptcy protection, improved its businesses and almost doubled their sales. GRA also preserved all employee benefits, something that U.S. Concrete stated they will do as well during this restructuring period. The point that I am making is that U.S. Concrete can still grow sales and create long-term value for shareholders. I firmly believe so based on my thesis about Total Construction Spending (Back to U.S. Concrete). Therefore, the warrants current shareholders will receive as a result to this restructuring, I feel are worth it. As I stated earlier, U.S. Concrete is also expediting this process. I plan to keep my readers informed and I will continue to follow this story.
Full disclosure: Long RMIX at time of writing, bought more shares.
President and Chief Executive Officer, Michael Harlan, acknowledged that he was content with the support from bondholders to exchange the 8.325% Senior Subordinated Notes due in 2014 for equity in the reorganized company. This will alleviate U.S. Concrete of roughly $272 million in debt resulting in a stronger balance sheet down the road. Consider the following words from Michael Harlan: “As a result of the restructuring, we should be positioned to be a financially strong competitor in our markets.” I still believe with construction spending bottoming (Bottom in Construction), U.S. Concrete, as I suggested to be a long-term (more risky) play, could still work. The company is eagerly trying to expedite the restructuring so in other words, U.S. Concrete should emerge from bankruptcy within 75-90 days.
U.S. Concrete has until September 7, 2010 to reclaim compliance from NASDAQ otherwise the existing (old) shares will be delisted. However, current shareholders would obtain warrants to acquire 15% of the new equity following the restructuring. So I am not entirely sure what the future holds for the existing equity and if NASDAQ’s notice of being delisted to U.S. Concrete is even relevant considering there is new equity as a result from the restructuring. According to the Securities and Exchange Commission, if a public company emerges from bankruptcy (which presumably will happen with RMIX), there can be two types of common stock: old and new. Nonetheless, the old common stock again I assume will be cancelled (which is possible) due to the warrants current shareholders will receive. Refer to the following SEC page about corporate bankruptcies: http://www.sec.gov/investor/pubs/bankrupt.htm. On this page, the SEC confirms that shareholders can participate in the restructuring plan (with warrants) yet substantial dilution is likely – evident with current shareholders receiving 15% of each new share for every old share.
Therefore, it is essential to know what the new equity on a per share basis will be valued at. I will keep my eyes and ears open for any relevant information. Any reader with thoughts or ideas, please comment!
Some final notes: Wallace H. Johnson, a top executive with U.S. Concrete, once held various management positions at W.R. Grace & Co. (GRA). W.R. Grace is a concrete/construction company as well but also has exposure to the chemicals industry and markets abroad. GRA also went through a plan or reorganization in bankruptcy court not too long ago from asbestos lawsuits. GRA emerged from bankruptcy and since, has been trading to the upside. However, following GRA’s bankruptcy reorganization, the ‘old’ shares continued trading. GRA, during its seven years of bankruptcy protection, improved its businesses and almost doubled their sales. GRA also preserved all employee benefits, something that U.S. Concrete stated they will do as well during this restructuring period. The point that I am making is that U.S. Concrete can still grow sales and create long-term value for shareholders. I firmly believe so based on my thesis about Total Construction Spending (Back to U.S. Concrete). Therefore, the warrants current shareholders will receive as a result to this restructuring, I feel are worth it. As I stated earlier, U.S. Concrete is also expediting this process. I plan to keep my readers informed and I will continue to follow this story.
Full disclosure: Long RMIX at time of writing, bought more shares.
Monday, April 26, 2010
YRC Worldwide: Moving Back Towards a Buck
YRC Worldwide (YRCW) has been trading well below $1.00/ share for roughly three months. The stock was slammed with its restructuring from short sellers who kept shorting YRCW stock to the level where YRCW debt could be swapped for equity, at what I read was near $.34-$.40. Some nice arbitrage position…
Despite shareholder dilution, I do firmly believe that YRC Worldwide, who has been considering a reverse stock split to meet listing requirements, might actually postpone the reverse stock split for several reasons: the company can become profitable sooner than most thought, the stock price will pop above $1.00, and a single-digit stock can entice investors to get in for the long-term.
On April 8, 2010, Chief Executive Bill Zollars stated the following: "With the improved operating momentum we achieved as we exited the seasonally slowest quarter of the year, we have even more confidence in our ability to generate positive EBITDA beginning with the second quarter of 2010." As the economy turns, the trucking industry over the next decade or so will emerge stronger than ever. I should note that UPS came out just the other week with a solid quarter and positive outlook. YRCW’s total shipments per workday have increased month over month from January through March and I suspect we will see the trend continue. The shipment activity is still bluntly weak relative to the same period a year ago, but I firmly believe that if investors wait for the levels to resume back to where they once were, the entire upside movement in the stock will be missed.
YRC Worldwide was derailed from its journey to $1.00 the other week when YRCW president and COO Timothy Wicks resigned. Usually, when an executive resigns without reason, concern is warranted. In this case, Wicks went back to his previous employer, United Healthcare. Wicks’ decision to do so was not a reason to derail the stock 9-10%. Nonetheless, as the market digested the data, the stock began to resume its trend higher, touching $.80 on the morning of April 26, 2010.
YRC Worldwide has until August 30, 2010 to get its shares above $1.00 and keep its bid above that mark for ten consecutive days otherwise the company will be delisted. When YRC reports their data on May 4, I do expect a surprise and cautious, yet positive outlook. The positive outlook alone could provide investors with enough confidence to buy shares. The short interest of the stock is less than 2% of the float potentially because the short sellers already shorted the stock and converted their bonds into equity. YRC Worldwide has been trading on heavy volume recently. I also enjoy how there are 4 hold and 7 strong sell ratings on the stock complimented with no moderate or strong buy ratings.
I should also note that the Jan 11 calls with a strike of $1.00 are only trading at a $.21 - $.22 bid ask spread. The Oct 10 $1.00s are trading at a bid ask spread of $.18 - $.20. If the extra time, theoretically speaking, is only $.01-$.02 more expensive, I would load up on the Jan 11 $1.00s if I hadn't already acquired July calls.
As construction bottoms (consider previous posts) and the economy grows, YRC will prosper. YRC transports a broad array of commercial, industrial, and retail goods. Just today, Caterpillar and Whirlpool announced rising demand for some of their products. Both companies also gave a positive outlook – YRC on May 4, might also do the same.
Full disclosure: Long YRCW calls at time of writing.
Despite shareholder dilution, I do firmly believe that YRC Worldwide, who has been considering a reverse stock split to meet listing requirements, might actually postpone the reverse stock split for several reasons: the company can become profitable sooner than most thought, the stock price will pop above $1.00, and a single-digit stock can entice investors to get in for the long-term.
On April 8, 2010, Chief Executive Bill Zollars stated the following: "With the improved operating momentum we achieved as we exited the seasonally slowest quarter of the year, we have even more confidence in our ability to generate positive EBITDA beginning with the second quarter of 2010." As the economy turns, the trucking industry over the next decade or so will emerge stronger than ever. I should note that UPS came out just the other week with a solid quarter and positive outlook. YRCW’s total shipments per workday have increased month over month from January through March and I suspect we will see the trend continue. The shipment activity is still bluntly weak relative to the same period a year ago, but I firmly believe that if investors wait for the levels to resume back to where they once were, the entire upside movement in the stock will be missed.
YRC Worldwide was derailed from its journey to $1.00 the other week when YRCW president and COO Timothy Wicks resigned. Usually, when an executive resigns without reason, concern is warranted. In this case, Wicks went back to his previous employer, United Healthcare. Wicks’ decision to do so was not a reason to derail the stock 9-10%. Nonetheless, as the market digested the data, the stock began to resume its trend higher, touching $.80 on the morning of April 26, 2010.
YRC Worldwide has until August 30, 2010 to get its shares above $1.00 and keep its bid above that mark for ten consecutive days otherwise the company will be delisted. When YRC reports their data on May 4, I do expect a surprise and cautious, yet positive outlook. The positive outlook alone could provide investors with enough confidence to buy shares. The short interest of the stock is less than 2% of the float potentially because the short sellers already shorted the stock and converted their bonds into equity. YRC Worldwide has been trading on heavy volume recently. I also enjoy how there are 4 hold and 7 strong sell ratings on the stock complimented with no moderate or strong buy ratings.
I should also note that the Jan 11 calls with a strike of $1.00 are only trading at a $.21 - $.22 bid ask spread. The Oct 10 $1.00s are trading at a bid ask spread of $.18 - $.20. If the extra time, theoretically speaking, is only $.01-$.02 more expensive, I would load up on the Jan 11 $1.00s if I hadn't already acquired July calls.
As construction bottoms (consider previous posts) and the economy grows, YRC will prosper. YRC transports a broad array of commercial, industrial, and retail goods. Just today, Caterpillar and Whirlpool announced rising demand for some of their products. Both companies also gave a positive outlook – YRC on May 4, might also do the same.
Full disclosure: Long YRCW calls at time of writing.
Friday, April 23, 2010
Back to U.S. Concrete
The United States Department of Transportation announced a few days ago, on Wednesday, April 21, that there is now $48.8 billion in highway funds available to the states through the Hiring Incentives to Restore Employment (HIRE) Act. This significant sum of money will be disbursed throughout fiscal year 2010. For more information, visit http://www.dot.gov/. It is important to note, however, that a near 85% of the cement industry is controlled by international companies based outside of the United States (Eagle Materials 2009 10K). Regardless, Eagle Materials, Ready Mix, Texas Industries, and of course, U.S. Concrete (ticker RMIX) are among the few that are not headquartered outside of the United States.
In a previous post, I discussed how Total Construction Spending (TCS) either has bottomed or will within the next few months. Breaking down TCS, I touched on highway/street construction and acknowledged how its been rather strong relative to other segments that make up TCS. Arguably, if 85% of cement sales emanate from outside the United States, then 15%, or $7.32 billion (out of the HIRE Act) will be allocated appropriately to the four companies I named above and a pool of about 50 other American, non-public cement companies (I will not even consider that international cement companies lose market share). Average annual revenue for the four public companies I named is about $500 million. The 50 or so other cement companies' annual revenue on average is approximately $200 million. Even if the $7.32 billion was spread evenly among 50-55 cement companies, we are still looking at a near $140 million per company (disregarding other costs for now).
Evidently, U.S. Concrete seems poised to get more from the pie because they have the dynamic force to take on large scale projects in different states unlike some of the 50 other companies who operate solely in one specific area. Also, U.S. Concrete, whose 26% of 2009 revenue came from highway/street construction, worked on such related jobs: New Jersey Route 21, I-580 Emergency Freeway Repair, and the U.S. Census Bureau, the source where I get my construction data - just to name a few. One more interesting fact was that on April 14, 2010, U.S. Concrete was ranked #1 for efficiency measured by Revenue per Employee (RPE), obviously ahead of names like Eagle Materials and Texas Industries. According to IBD, analysts use this metric to compare companies' productivity. So when the HIRE Act funds are put to play, maybe the decision-makers will consider the efficiency measured by RPE data when determining what companies to use.
U.S. Concrete is below $1.00/share therefore making it a candidate for becoming a pink sheet, however, they still have time to get back above $1.00/share. With the HIRE Act coming into play, time on hand to restructure/negotiate debt terms, and TCS near bottoming (or bottomed), I firmly believe that U.S. Concrete again, seems like an amazing opportunity. As matter of fact, I do plan on doubling my position sometime in the weeks ahead. I will assume that U.S. Concrete, when they report on May 3, will give a positive outlook due to the fact that residential construction has bottomed and highway construction season is underway. Consider the following quote: "With spring and summer highway construction seasons just beginning, these funds will help make it easier for states to put people back to work and begin long-term projects.” -Dept. of Transportation Secretary Ray LaHood, April 21, 2010.
As noted, 26% of U.S. Concrete's 2009 revenue derived from highway/street construction. That number comes to about $139 million. When all other data is held constant and I assume that they do get at minimum, half of the $140 million that I earlier mentioned (to compensate for other construction costs), 2010 revenue would rise by roughly 13%. If I keep highway/street revenue constant at 26% of 2010 revenue after including money from the HIRE Act, with some simple algebra, U.S. Concrete's 2010 revenue comes to a near $803 million, a 50% increase compared to 2009 revenue. This assumption is not unlikely considering that the economy has turned the corner. The only worry here is commercial/industrial construction. Nonetheless, I feel that it will bottom very soon (or has at $44.6 million) and when there is that uptick in commercial construction spending from that $44.6 mil (the lowest point on a monthly basis in more than 10 years), I will promptly note it in a response to this post. In the end, if U.S. Concrete remains efficient and controls its costs, profitability could also be reasonable thus allowing the company to pay down debt and increase its equity value sooner than most would have thought.
Full disclosure: Long RMIX at time of writing.
In a previous post, I discussed how Total Construction Spending (TCS) either has bottomed or will within the next few months. Breaking down TCS, I touched on highway/street construction and acknowledged how its been rather strong relative to other segments that make up TCS. Arguably, if 85% of cement sales emanate from outside the United States, then 15%, or $7.32 billion (out of the HIRE Act) will be allocated appropriately to the four companies I named above and a pool of about 50 other American, non-public cement companies (I will not even consider that international cement companies lose market share). Average annual revenue for the four public companies I named is about $500 million. The 50 or so other cement companies' annual revenue on average is approximately $200 million. Even if the $7.32 billion was spread evenly among 50-55 cement companies, we are still looking at a near $140 million per company (disregarding other costs for now).
Evidently, U.S. Concrete seems poised to get more from the pie because they have the dynamic force to take on large scale projects in different states unlike some of the 50 other companies who operate solely in one specific area. Also, U.S. Concrete, whose 26% of 2009 revenue came from highway/street construction, worked on such related jobs: New Jersey Route 21, I-580 Emergency Freeway Repair, and the U.S. Census Bureau, the source where I get my construction data - just to name a few. One more interesting fact was that on April 14, 2010, U.S. Concrete was ranked #1 for efficiency measured by Revenue per Employee (RPE), obviously ahead of names like Eagle Materials and Texas Industries. According to IBD, analysts use this metric to compare companies' productivity. So when the HIRE Act funds are put to play, maybe the decision-makers will consider the efficiency measured by RPE data when determining what companies to use.
U.S. Concrete is below $1.00/share therefore making it a candidate for becoming a pink sheet, however, they still have time to get back above $1.00/share. With the HIRE Act coming into play, time on hand to restructure/negotiate debt terms, and TCS near bottoming (or bottomed), I firmly believe that U.S. Concrete again, seems like an amazing opportunity. As matter of fact, I do plan on doubling my position sometime in the weeks ahead. I will assume that U.S. Concrete, when they report on May 3, will give a positive outlook due to the fact that residential construction has bottomed and highway construction season is underway. Consider the following quote: "With spring and summer highway construction seasons just beginning, these funds will help make it easier for states to put people back to work and begin long-term projects.” -Dept. of Transportation Secretary Ray LaHood, April 21, 2010.
As noted, 26% of U.S. Concrete's 2009 revenue derived from highway/street construction. That number comes to about $139 million. When all other data is held constant and I assume that they do get at minimum, half of the $140 million that I earlier mentioned (to compensate for other construction costs), 2010 revenue would rise by roughly 13%. If I keep highway/street revenue constant at 26% of 2010 revenue after including money from the HIRE Act, with some simple algebra, U.S. Concrete's 2010 revenue comes to a near $803 million, a 50% increase compared to 2009 revenue. This assumption is not unlikely considering that the economy has turned the corner. The only worry here is commercial/industrial construction. Nonetheless, I feel that it will bottom very soon (or has at $44.6 million) and when there is that uptick in commercial construction spending from that $44.6 mil (the lowest point on a monthly basis in more than 10 years), I will promptly note it in a response to this post. In the end, if U.S. Concrete remains efficient and controls its costs, profitability could also be reasonable thus allowing the company to pay down debt and increase its equity value sooner than most would have thought.
Full disclosure: Long RMIX at time of writing.
Wednesday, April 21, 2010
Going Against Apple Cont.
Last night, Apple blew away numbers. Perhaps now would be an appropriate time to establish the first quarter or half of a short position. With my negative long-term outlook on Apple based primarily on investors underestimating the competition factor as well as other qualitative reasoning, I went on to compute a fair value for Apple based on a discounted cash flow analysis. Getting right to the point, my fair value of Apple is approximately $156.00/share. This is roughly a 40% correction from its intraday price of $258.00/share.
What led me to my fair value? I'll go through my calculations step by step. First off, all of the projections range out to 2019. The data has also been adjusted for the adoption of new accounting principles for the relevant time periods. With all items on an annual basis, I will begin with net sales. I assumed a constant 15% net sales growth rate. I did not assume more or less growth for further out years, just a steady 15%. To put this growth rate in perspective, Apple will have $102 billion in sales by 2014. With a growth rate of 25%, by 2014, Apple's annual sales would be about $142.5 billion - that is 2 times Microsoft's 2008 annual revenue and just under 2 times Procter and Gamble's 2007 annual revenue. I do not see that potential especially if unemployment remains high and there is minimal income growth - also keep in mind that Apple products are elastic, meaning the demand for Apple products can change significantly based on several things such as price and substitutes, or what I refer to as competition.
Moving forward, I projected that cost of sales would grow at a near 13.48% which I feel is accurate considering that cost of sales had an average growth rate of 26.97% from 2007 to 2009. R&D, a very important aspect to Apple considering that they are innovators, for my model had 31.01% annual growth. This growth rate was the average from 2007 to 2009. What I intend on doing in the future is comparing R&D growth of Apple to other companies. I will be searching for companies whose R&D is growing at a faster rate than Apple's. When I do find companies whose R&D is growing faster than Apple's, Apple shareholders should become somewhat concerned unless Apple plans on issuing a dividend at some point in the near future. I gave a 23.63% growth rate to selling, general, and admin. expenses. From 2007 to 2009, SGA expenses grew on average, 18.63%. I added a 5% premium to account for new store openings and more store employees.
Capital expenditure, depreciation, current assets, and current liabilities were assigned 2.5%, 49.83%, 5.16%, and 1.28% growth, respectively. For the expected market return, I assumed about 10%, a 1.5 beta, 14.47% for the weighted average cost of capital, and 4% terminal growth. Keep in mind that for WACC, Apple has no debt. A fantastic finance professor of mine always argued that a firm with no debt is not maximizing their enterprise value. Even during the economic turmoil, we saw Microsoft tap the debt markets because it was so cheap to do so! Lastly, a corporate tax rate of 35% seemed accurate. Anyone who has questions regarding my calculations, post your thoughts and I will respond accordingly. So there you have it, $156.00/share. Now I will be straightforward, I do not have a 25 tab excel DCF monster with complex detail that intertwines thousands of cells to spit back a per share value.
On the previous post, I stated how Apple has soared from $80.00/share to its current levels. Excuse me for the correction, but Apple really traded in the mid-100s prior to the crash. So on a percent basis, Apple did not rally as much when looking at a 2 year chart, but that still does not excuse the potential fact that competition can do a number on Apple. In addition, I noticed how Apple's net sales were actually down 14% when compared to fiscal 2010 Q1 net sales. I do realize that during the holiday season, companies generally report stronger earnings. However, I decided to do some more digging... Going back to 1994/95 and comparing Apple's 2nd quarters (Jan-Mar) to its 1st quarters (Oct-Dec), on average, 2nd quarters have declined by 10.75%, which again, is due to the holiday season. 18.75% of the time, 2nd quarters have had positive sales growth compared to 1st quarters. If Apple products today are the best ever, I wonder why we did not see positive sales growth. Holiday season might be strong, but during 2009's holiday season, unemployment was jacked. Apple also had crushed estimates now for the past 21 consecutive quarters, so I personally would have expected at least positive sales growth for Apple in Q2 2010 from Q1 2010, at least a number greater than the negative 10.75%. I understand that the product cycle plays a fine role here, such as when certain products are released, nonetheless, Apple has rapidly come out with interesting devices... I simply cannot see how there is still so much room for the company to run.
I wonder why so many analysts seem to overlook competition when it comes to Apple. Look back less than 10 years ago to PALM’s rise to fame after the dot com bubble burst. PALM stock climbed and traded above $500.00/share for some time. The PDAs were strong and dominated the consumer market. PALM today is just under $5.00/share. Of course everyone says Apple is different and there is a crazy new technology era underway, which yes, might be the case. But when competition is not factored enough into financial models, you get inflated stock prices – and we know where the story goes from there.
Full disclosure: Currently do not have any positions in the companies discussed.
What led me to my fair value? I'll go through my calculations step by step. First off, all of the projections range out to 2019. The data has also been adjusted for the adoption of new accounting principles for the relevant time periods. With all items on an annual basis, I will begin with net sales. I assumed a constant 15% net sales growth rate. I did not assume more or less growth for further out years, just a steady 15%. To put this growth rate in perspective, Apple will have $102 billion in sales by 2014. With a growth rate of 25%, by 2014, Apple's annual sales would be about $142.5 billion - that is 2 times Microsoft's 2008 annual revenue and just under 2 times Procter and Gamble's 2007 annual revenue. I do not see that potential especially if unemployment remains high and there is minimal income growth - also keep in mind that Apple products are elastic, meaning the demand for Apple products can change significantly based on several things such as price and substitutes, or what I refer to as competition.
Moving forward, I projected that cost of sales would grow at a near 13.48% which I feel is accurate considering that cost of sales had an average growth rate of 26.97% from 2007 to 2009. R&D, a very important aspect to Apple considering that they are innovators, for my model had 31.01% annual growth. This growth rate was the average from 2007 to 2009. What I intend on doing in the future is comparing R&D growth of Apple to other companies. I will be searching for companies whose R&D is growing at a faster rate than Apple's. When I do find companies whose R&D is growing faster than Apple's, Apple shareholders should become somewhat concerned unless Apple plans on issuing a dividend at some point in the near future. I gave a 23.63% growth rate to selling, general, and admin. expenses. From 2007 to 2009, SGA expenses grew on average, 18.63%. I added a 5% premium to account for new store openings and more store employees.
Capital expenditure, depreciation, current assets, and current liabilities were assigned 2.5%, 49.83%, 5.16%, and 1.28% growth, respectively. For the expected market return, I assumed about 10%, a 1.5 beta, 14.47% for the weighted average cost of capital, and 4% terminal growth. Keep in mind that for WACC, Apple has no debt. A fantastic finance professor of mine always argued that a firm with no debt is not maximizing their enterprise value. Even during the economic turmoil, we saw Microsoft tap the debt markets because it was so cheap to do so! Lastly, a corporate tax rate of 35% seemed accurate. Anyone who has questions regarding my calculations, post your thoughts and I will respond accordingly. So there you have it, $156.00/share. Now I will be straightforward, I do not have a 25 tab excel DCF monster with complex detail that intertwines thousands of cells to spit back a per share value.
On the previous post, I stated how Apple has soared from $80.00/share to its current levels. Excuse me for the correction, but Apple really traded in the mid-100s prior to the crash. So on a percent basis, Apple did not rally as much when looking at a 2 year chart, but that still does not excuse the potential fact that competition can do a number on Apple. In addition, I noticed how Apple's net sales were actually down 14% when compared to fiscal 2010 Q1 net sales. I do realize that during the holiday season, companies generally report stronger earnings. However, I decided to do some more digging... Going back to 1994/95 and comparing Apple's 2nd quarters (Jan-Mar) to its 1st quarters (Oct-Dec), on average, 2nd quarters have declined by 10.75%, which again, is due to the holiday season. 18.75% of the time, 2nd quarters have had positive sales growth compared to 1st quarters. If Apple products today are the best ever, I wonder why we did not see positive sales growth. Holiday season might be strong, but during 2009's holiday season, unemployment was jacked. Apple also had crushed estimates now for the past 21 consecutive quarters, so I personally would have expected at least positive sales growth for Apple in Q2 2010 from Q1 2010, at least a number greater than the negative 10.75%. I understand that the product cycle plays a fine role here, such as when certain products are released, nonetheless, Apple has rapidly come out with interesting devices... I simply cannot see how there is still so much room for the company to run.
I wonder why so many analysts seem to overlook competition when it comes to Apple. Look back less than 10 years ago to PALM’s rise to fame after the dot com bubble burst. PALM stock climbed and traded above $500.00/share for some time. The PDAs were strong and dominated the consumer market. PALM today is just under $5.00/share. Of course everyone says Apple is different and there is a crazy new technology era underway, which yes, might be the case. But when competition is not factored enough into financial models, you get inflated stock prices – and we know where the story goes from there.
Full disclosure: Currently do not have any positions in the companies discussed.
Tuesday, April 20, 2010
Going Against Apple
Apple has soared over the past two years from roughly $80.00/share to an all time of $251.00 and change/share. Apple has 30 strong buy ratings, 5 moderate buys, 3 holds, and 0 moderate and strong sells. The tech giant has also beat analyst estimates for the last 20 quarters thus partially explaining why the short interest is only 1.12% of its float. No wonder why virtually everyone has jumped on the Apple bandwagon. The other week, I was recommended by a friend to pick up and read Michael Lewis’ “The Big Short.” After reading the prologue in only a few short minuets, I learned of Lewis’ view on how some Wall Street doings, in particular, packaging and selling America’s growing debts was simply unsustainable. My post here is to argue that Apple, and its never ending appreciation, is unsustainable.
In its simplest form, the general public including many traders assumed real estate prices would rise to perpetuity, and if not, the millions at least ignored the existent probability that home prices could correct themselves. Needless to say, I am not writing this post to talk about the housing bubble but rather Apple. Millions of individual and institutional investors have been hyping about Apple. They say that Jobs’ is a genius (which I agree he is definitely the most influential innovator of our time) and that Apple is, and will always be, the leader in technology. I become concerned when I see such bias towards a never ending ruler, Apple that is.
Before I begin my brief analysis, keep in mind that the rating agencies (as I previously discussed) had positive ratings on mortgage related securities leading up to the crash. Downgrading credit after the fact does not really help any investor. So to the 30 analysts who have strong buy ratings on Apple, please, one of you become the outsider and try to downgrade the stock before it has its 50% correction in the coming years. Now Apple is obviously quite different than the credit/housing crisis. Apple has tangible products that are loved by everyone. Its products continually get the oooo’s and aahh’s. But competition, in time, will prevail. That is how a free market works. I became familiar with Buffet’s coined term, economic moat, when I did an internship at Morningstar helping analysts with whatever research they needed help with. Apple does have a strong brand and a lot of power in its space, but as everyone says, technology changes so fast and it is just a matter of time for other companies to start slowly making their way through those barriers Apple has set. When investors underestimate what competition can do to a leader, in this case Apple, they get hurt.
One of several considerations Morningstar uses when determining if a company has a wide economic moat (safe from competition) is high switching costs. Consider the following example: “Medical-device companies Biomet and Stryker benefit from high switching costs because, for example, a surgeon would have to forgo the comfort and familiarity of doing procedures with one artificial joint product. And because the surgeon would have to be trained to use competing products, he or she would also have to contend with lost time and money resulting from not performing as many surgical procedures.” –Morningstar
With smartphones and other communication/entertainment devices, it does not take much for a 16 year old teenager to switch to a new device from Apple’s because the new device is ‘cooler’ and possibly more useful.
Because I studied finance as an undergraduate, I am also well aware that stock prices are priced based on anticipated earnings or events. With Apple, any positive such as ‘blow-out IPAD sales’ seems to me to have been priced in the stock months ago. When Apple sometime in the future does not beat estimates, we will begin to see the depreciation. In theory, if analysts believe that Apple’s profits will level out in one a year, the stock price will begin to show it in only a matter of months. Similar to real-estate, prices kept rising and rising until that one day came around, and look where we are today.
Lastly, I am not a tech guy so I cannot write all day on the research/ development embedded in Apple’s products. But I do question why Apple has not issued a dividend considering that it has one of the largest market caps. Yes, capital is reallocated to its R&D, but I do not see how much there is to it when the ‘new and crazy’ product is really just a physically bigger or smaller version of an older product, plus or minus minimal modifications. Look, there are only so many devices that can come out that provide its users with different ways to e-mail or text message someone.
From an investment perspective, there is no way I would build a long position in Apple. They are reporting after the bell today so aggressive call buying for those traders to capitalize on another surprise does not astonish me. For the long term, I would go against Apple if not for the competition factor, to seek a lower correlation to the market. With the VIX low, investors who are long and EXTREMELY bullish with Apple, do not become complacent like many homeowners did with their property values, buy some protection or starting looking for the exit.
Full disclosure: Currently do not have any positions in the companies discussed.
In its simplest form, the general public including many traders assumed real estate prices would rise to perpetuity, and if not, the millions at least ignored the existent probability that home prices could correct themselves. Needless to say, I am not writing this post to talk about the housing bubble but rather Apple. Millions of individual and institutional investors have been hyping about Apple. They say that Jobs’ is a genius (which I agree he is definitely the most influential innovator of our time) and that Apple is, and will always be, the leader in technology. I become concerned when I see such bias towards a never ending ruler, Apple that is.
Before I begin my brief analysis, keep in mind that the rating agencies (as I previously discussed) had positive ratings on mortgage related securities leading up to the crash. Downgrading credit after the fact does not really help any investor. So to the 30 analysts who have strong buy ratings on Apple, please, one of you become the outsider and try to downgrade the stock before it has its 50% correction in the coming years. Now Apple is obviously quite different than the credit/housing crisis. Apple has tangible products that are loved by everyone. Its products continually get the oooo’s and aahh’s. But competition, in time, will prevail. That is how a free market works. I became familiar with Buffet’s coined term, economic moat, when I did an internship at Morningstar helping analysts with whatever research they needed help with. Apple does have a strong brand and a lot of power in its space, but as everyone says, technology changes so fast and it is just a matter of time for other companies to start slowly making their way through those barriers Apple has set. When investors underestimate what competition can do to a leader, in this case Apple, they get hurt.
One of several considerations Morningstar uses when determining if a company has a wide economic moat (safe from competition) is high switching costs. Consider the following example: “Medical-device companies Biomet and Stryker benefit from high switching costs because, for example, a surgeon would have to forgo the comfort and familiarity of doing procedures with one artificial joint product. And because the surgeon would have to be trained to use competing products, he or she would also have to contend with lost time and money resulting from not performing as many surgical procedures.” –Morningstar
With smartphones and other communication/entertainment devices, it does not take much for a 16 year old teenager to switch to a new device from Apple’s because the new device is ‘cooler’ and possibly more useful.
Because I studied finance as an undergraduate, I am also well aware that stock prices are priced based on anticipated earnings or events. With Apple, any positive such as ‘blow-out IPAD sales’ seems to me to have been priced in the stock months ago. When Apple sometime in the future does not beat estimates, we will begin to see the depreciation. In theory, if analysts believe that Apple’s profits will level out in one a year, the stock price will begin to show it in only a matter of months. Similar to real-estate, prices kept rising and rising until that one day came around, and look where we are today.
Lastly, I am not a tech guy so I cannot write all day on the research/ development embedded in Apple’s products. But I do question why Apple has not issued a dividend considering that it has one of the largest market caps. Yes, capital is reallocated to its R&D, but I do not see how much there is to it when the ‘new and crazy’ product is really just a physically bigger or smaller version of an older product, plus or minus minimal modifications. Look, there are only so many devices that can come out that provide its users with different ways to e-mail or text message someone.
From an investment perspective, there is no way I would build a long position in Apple. They are reporting after the bell today so aggressive call buying for those traders to capitalize on another surprise does not astonish me. For the long term, I would go against Apple if not for the competition factor, to seek a lower correlation to the market. With the VIX low, investors who are long and EXTREMELY bullish with Apple, do not become complacent like many homeowners did with their property values, buy some protection or starting looking for the exit.
Full disclosure: Currently do not have any positions in the companies discussed.
Monday, April 19, 2010
Looking Beyond Goldman to the Rating Agencies
Last Friday, April 16, Goldman Sachs was slammed down by roughly 13% from the announced SEC charges. Sure enough, options expiration also contributed to the exaggerated movement. Nonetheless, I am neither a corporate lawyer nor an investor in collateralized debt obligations, so I am forced to look beyond Goldman's case but use the news from it to help direct me to yet another opportunity that could potentially stem from the SEC and its now-active hunt, thanks to its new leadership, to catch "The Bad Guy."
With the SEC alleging that Goldman Sachs misled investors, it seems appropriate for the rating agencies to be on deck, or at least in the hole. I say that because they too arguably could have 'misled' investors. The issue with the rating agencies is nothing out of the ordinary and the ongoing debate, regarding the business model and the fact that the rating agencies profited generously while few concerns existed about mortgage-related securities prior to the crash, is soon to be refueled. Consider the following statement: "Moody's has already been criticized by lawmakers and regulators for giving top rankings to subprime-mortgage related securities that have tumbled in value as borrower defaults soar to records." -Bloomberg, May 2008
With the spotlight on Goldman Sachs for reasons that occurred a couple years ago, the time to make a move on the rating agencies is now. I worked on a quantitative model today to help me decide which company seems more shrewd to ‘bet against,’ McGraw-Hill (ticker MHP) or Moody’s (ticker MCO). Keep in mind from an investment perspective, if one’s portfolio is overweight equities on the long side, put options and short selling are unique tools, if used correctly and with thought, that can mitigate risk, potentially more than an a broad based US equity mutual fund which is still vulnerable to negative sentiment.
I looked at the January 2011 $22.50 and $17.50 put options for McGraw-Hill and Moody’s, respectively. I chose January 2011 because it can take time for the SEC to move on from Goldman and anyways, the longer the time when waiting for a catalyst, the better. The following strikes assume a near 35% decline in the two equities from their closing price on April 19th, 2010. Take the 13% decline from Goldman, round it to 15% (applying that reaction to the rating agencies if they make it to the plate) and assume another 10% for future allegations and 10% for the market correction everyone is so worried about. There you have it, 35% possible downside for the rating agencies. Also, with the VIX near its 52-week lows indicating low volatility, option prices are deemed discounted.
In conclusion to my analysis, I would go with the put options outlined above for both McGraw-Hill and Moody’s. I would go with McGraw-Hill puts because its average equity return is only .05% less than Moody’s while its option premium is roughly $.45/contract where as Moody’s is about $.84/contract (April 19, 2010 close). More importantly, they are both subject to the same potential allegations/regulations. In addition, McGraw-Hill does not have the generous backing of Buffet’s Berkshire.
Moody’s on the other hand has a 16.19% probability of having a 36.15% (≈35%) decline by January of 2011 when compared to McGraw’s 5.43% probability of having a 34.63% decline by Jan 2011. The short interest for Moody’s is 12.95% of the float relative to only 2.34% of McGraw’s float. With McGraw, that just means sophisticated investors who do agree to my point even in the slightest, have yet to make a move. For the students and others out there thinking that McGraw just publishes textbooks, for 2007, 2008, and 2009, 44.98%, 41.77%, and 43.85% of McGraw's total revenue derived from its Financial Services segment, respectively. That segment operates under the Standard and Poor's brand. All of the calculations were computed as of April 19, 2010.
In the end, betting against a company is just another way to mitigate risk and lower a portfolio's correlation to the market. There is much more to the thought of betting against the rating agencies, but then again, if down the road they are alleged to have misled investors, such an investment would seem warranted, would it not?
I always welcome feedback and other thoughts to my posts. Thanks!
Full disclosure: Currently do not have any positions in the companies discussed.
With the SEC alleging that Goldman Sachs misled investors, it seems appropriate for the rating agencies to be on deck, or at least in the hole. I say that because they too arguably could have 'misled' investors. The issue with the rating agencies is nothing out of the ordinary and the ongoing debate, regarding the business model and the fact that the rating agencies profited generously while few concerns existed about mortgage-related securities prior to the crash, is soon to be refueled. Consider the following statement: "Moody's has already been criticized by lawmakers and regulators for giving top rankings to subprime-mortgage related securities that have tumbled in value as borrower defaults soar to records." -Bloomberg, May 2008
With the spotlight on Goldman Sachs for reasons that occurred a couple years ago, the time to make a move on the rating agencies is now. I worked on a quantitative model today to help me decide which company seems more shrewd to ‘bet against,’ McGraw-Hill (ticker MHP) or Moody’s (ticker MCO). Keep in mind from an investment perspective, if one’s portfolio is overweight equities on the long side, put options and short selling are unique tools, if used correctly and with thought, that can mitigate risk, potentially more than an a broad based US equity mutual fund which is still vulnerable to negative sentiment.
I looked at the January 2011 $22.50 and $17.50 put options for McGraw-Hill and Moody’s, respectively. I chose January 2011 because it can take time for the SEC to move on from Goldman and anyways, the longer the time when waiting for a catalyst, the better. The following strikes assume a near 35% decline in the two equities from their closing price on April 19th, 2010. Take the 13% decline from Goldman, round it to 15% (applying that reaction to the rating agencies if they make it to the plate) and assume another 10% for future allegations and 10% for the market correction everyone is so worried about. There you have it, 35% possible downside for the rating agencies. Also, with the VIX near its 52-week lows indicating low volatility, option prices are deemed discounted.
In conclusion to my analysis, I would go with the put options outlined above for both McGraw-Hill and Moody’s. I would go with McGraw-Hill puts because its average equity return is only .05% less than Moody’s while its option premium is roughly $.45/contract where as Moody’s is about $.84/contract (April 19, 2010 close). More importantly, they are both subject to the same potential allegations/regulations. In addition, McGraw-Hill does not have the generous backing of Buffet’s Berkshire.
Moody’s on the other hand has a 16.19% probability of having a 36.15% (≈35%) decline by January of 2011 when compared to McGraw’s 5.43% probability of having a 34.63% decline by Jan 2011. The short interest for Moody’s is 12.95% of the float relative to only 2.34% of McGraw’s float. With McGraw, that just means sophisticated investors who do agree to my point even in the slightest, have yet to make a move. For the students and others out there thinking that McGraw just publishes textbooks, for 2007, 2008, and 2009, 44.98%, 41.77%, and 43.85% of McGraw's total revenue derived from its Financial Services segment, respectively. That segment operates under the Standard and Poor's brand. All of the calculations were computed as of April 19, 2010.
In the end, betting against a company is just another way to mitigate risk and lower a portfolio's correlation to the market. There is much more to the thought of betting against the rating agencies, but then again, if down the road they are alleged to have misled investors, such an investment would seem warranted, would it not?
I always welcome feedback and other thoughts to my posts. Thanks!
Full disclosure: Currently do not have any positions in the companies discussed.
Sunday, April 18, 2010
Bottom in Construction, Coming Up!
What a return for investors who had bought Las Vegas Sands at $2.00 per share not too long ago. The same goes for a broad range of investors who enthusiastically purchased US equities back in mid 2009. LVS comes to mind specifically because several friends of mine were attracted to the options at the time. Unbelievable. So, what could possibly be next?
I have a strong belief that Total Construction Spending (TCS) has bottomed, or is definitely poised to and over the next decade or so, will emerge stronger than ever. It could have bottomed as of February 2010 but we will have to wait until the beginning of May to see if there is an uptick in TCS for March 2010. With the US equity markets bottoming back in March 2009, most average investors would postulate that they missed the move and that equities have risen too much in too short of a time so there must be some correction soon. Forget that psychology. Instead, consider an area that is potentially in the same spot as the Dow Jones was in March of 2009, construction that is.
Total Construction Spending month over month has still been declining. In September 2007, TCS was just over $1 trillion. In March of 2009 (again, when the US equity markets bottomed), TCS was about $966 million and as of February 2010, $846 million. Nonetheless, Building Permits which are known to economists as a leading indicator and heavily tied to residential construction, bottomed back in April 2009. Most significantly, residential construction, which makes up approximately 45% of TCS, appears to have bottomed as well back in June 2009.
So for the investor, what does this all come to? Consider U.S. Concrete (ticker RMIX), a cement company that sells ready-mixed concrete in bulk and other concrete related products. From their 2009 annual report filed with the SEC, 19% of their sales derived from residential construction and the remainder, 55% and 26% from commercial/industrial and street/highway construction, respectively. I discussed residential construction and the potential fact that it has bottomed. Commercial construction on the contrary, is still in its worst shape. Nonetheless, street/highway construction appears not to really have bottomed, yet from January 2002 to February 2010, on a monthly basis, has had a median of about $68 million and an average of $69 million. For February of 2010, street/highway construction spending was just under $80 million and on average, makes up about 7% of TCS. So despite the fact that TCS is still in its worst form, residential construction appears to have bottomed, highway/street construction seems healthy, but the worries in commercial/industrial construction spending still thrive.
To compensate for the weakness in commercial/industrial construction spending, which is responsible for approximately 7% of TCS, arguably could be offset by Timothy Geithner's recent remarks on "Meet the Press" where he stated that the economy is growing faster than the Obama Administration had anticipated and that existing signs should reimburse Americans with confidence in our economy. So if TCS is at such depressed levels, with everything said, maybe it would be a unique time to consider something like a U.S. Concrete.
On the corporate finance side, U.S. Concrete is buried in debt. That clearly explains why its equity value per share trades under $1.00. In short, majority of that debt does not come due until 2014 thus giving them more options in terms of a restructuring and time to still return to profitability! Consider YRC Worldwide (YRCW). A trucking company that did restructure and was thought by many to have gone under and that profitability was not really deemed accurate for the company in the near term. However, on April 8, 2010, YRCW provided its first quarter update. Total shipments per workday were up month over month from January 2010 and CEO, Bill Zollars acknowledged his confidence in the company's ability to produce positive EBITDA for the second quarter. U.S. Concrete could see a similar case. Now, with TCS at its weakest and not purely from the segments that really matter to U.S. Concrete, perhaps now could be an amazing opportunity.
Clearly, U.S. Concrete is not your typical blue chip and for individual investors considering building a position, your own research and assurance is most warranted. In conclusion, my analysis has led to me believe TCS is at its bottom/near to it and U.S. Concrete is the way to go for the next decade or so. Once TCS has bottomed, profitability for U.S. Concrete can be closer than most would have thought.
Full disclosure: Long RMIX at time of writing
I have a strong belief that Total Construction Spending (TCS) has bottomed, or is definitely poised to and over the next decade or so, will emerge stronger than ever. It could have bottomed as of February 2010 but we will have to wait until the beginning of May to see if there is an uptick in TCS for March 2010. With the US equity markets bottoming back in March 2009, most average investors would postulate that they missed the move and that equities have risen too much in too short of a time so there must be some correction soon. Forget that psychology. Instead, consider an area that is potentially in the same spot as the Dow Jones was in March of 2009, construction that is.
Total Construction Spending month over month has still been declining. In September 2007, TCS was just over $1 trillion. In March of 2009 (again, when the US equity markets bottomed), TCS was about $966 million and as of February 2010, $846 million. Nonetheless, Building Permits which are known to economists as a leading indicator and heavily tied to residential construction, bottomed back in April 2009. Most significantly, residential construction, which makes up approximately 45% of TCS, appears to have bottomed as well back in June 2009.
So for the investor, what does this all come to? Consider U.S. Concrete (ticker RMIX), a cement company that sells ready-mixed concrete in bulk and other concrete related products. From their 2009 annual report filed with the SEC, 19% of their sales derived from residential construction and the remainder, 55% and 26% from commercial/industrial and street/highway construction, respectively. I discussed residential construction and the potential fact that it has bottomed. Commercial construction on the contrary, is still in its worst shape. Nonetheless, street/highway construction appears not to really have bottomed, yet from January 2002 to February 2010, on a monthly basis, has had a median of about $68 million and an average of $69 million. For February of 2010, street/highway construction spending was just under $80 million and on average, makes up about 7% of TCS. So despite the fact that TCS is still in its worst form, residential construction appears to have bottomed, highway/street construction seems healthy, but the worries in commercial/industrial construction spending still thrive.
To compensate for the weakness in commercial/industrial construction spending, which is responsible for approximately 7% of TCS, arguably could be offset by Timothy Geithner's recent remarks on "Meet the Press" where he stated that the economy is growing faster than the Obama Administration had anticipated and that existing signs should reimburse Americans with confidence in our economy. So if TCS is at such depressed levels, with everything said, maybe it would be a unique time to consider something like a U.S. Concrete.
On the corporate finance side, U.S. Concrete is buried in debt. That clearly explains why its equity value per share trades under $1.00. In short, majority of that debt does not come due until 2014 thus giving them more options in terms of a restructuring and time to still return to profitability! Consider YRC Worldwide (YRCW). A trucking company that did restructure and was thought by many to have gone under and that profitability was not really deemed accurate for the company in the near term. However, on April 8, 2010, YRCW provided its first quarter update. Total shipments per workday were up month over month from January 2010 and CEO, Bill Zollars acknowledged his confidence in the company's ability to produce positive EBITDA for the second quarter. U.S. Concrete could see a similar case. Now, with TCS at its weakest and not purely from the segments that really matter to U.S. Concrete, perhaps now could be an amazing opportunity.
Clearly, U.S. Concrete is not your typical blue chip and for individual investors considering building a position, your own research and assurance is most warranted. In conclusion, my analysis has led to me believe TCS is at its bottom/near to it and U.S. Concrete is the way to go for the next decade or so. Once TCS has bottomed, profitability for U.S. Concrete can be closer than most would have thought.
Full disclosure: Long RMIX at time of writing
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