Wall Street Breakfast for December 20, 2006
MACRO AND HOUSING
New Home Construction Rises, But Inventory Levels Still High
New home construction rebounded 6.7% in November following October's 13.7% monthly drop, which leaves overall housing starts down 25.5% from a year ago. Permits for new building fell 3% to a nine-year low, suggesting ongoing weakness in the new home market that may pressure the overall economy for at least the next quarter. Yet the slowdown in building hasn't depleted unsold inventory: the Commerce Dept. reports the glut of unsold homes remains equivalent to a 7-month supply, up from 4.5 months a year ago. Meanwhile, builder Hovanian Enterprises on Monday reported its cancellation rate jumped to 35% in its most recent quarter. Most economists don't expect the housing weakness to require the Fed to cut interest rates in the near term, however, given ongoing inflationary concerns exacerbated by yesterday's PPI report.
• Sources: Commerce Department release (.pdf), Wall St. Journal, Washington Post, Associated Press
• Related commentary: How Long Can Consumer Confidence, Earnings Weather the Housing Bust?, Housing Bubble and Real Estate Market Tracker, How Far Will Housing Drag Down The Economy?
• Potentially impacted stocks and ETFs: Hovanian Enterprises (HOV), Toll Brothers Inc. (TOL), Beazer Homes USA Inc. (BZH), Lennar Corporation (LEN), Centex Corp (CTX), KB Home (KBH). ETFs: iShares Dow Jones US Home Construction (ITB), SPDR Homebuilders (XHB).
Inflation Unleashed?
The Labor Department today announced that the producer price index [PPI] leapt by 2% in November, the highest rate since November 1974. The core PPI, which excludes food and energy, rose 1.3%, the highest rates since July 1980. That followed a drop of 1.6% in October, when the core PPI also fell 0.9%. Economist had expected the PPI to rise by only 0.5% and the core PPI by 0.2%, according to a Bloomberg survey. Noteworthy components: raw materials up 15.7% month-over-month, gasoline up 17.9%, natural gas up 5.9%. Meanwhile, the Consumer Price Index [CPI] was flat for November, as was the core CPI, which excludes food and energy.
• Sources: Labor Department PPI Press Release, Labor Department CPI Summary, WSJ, Bloomberg, AP.
• Related commentary: PPI Jumps Fully 2% - A Closer Look, Fed Leaves Short-Term Rates at 5.25%, Dollar Glut: Why the Bears Are Wrong, 'Goldilocks' Scenario in Danger.
• Potentially impacted stocks and ETFs: iShares Lehman 1-3 Year Treasury Bond ETF • iShares Lehman 7-10 Year Treasury ETF • iShares Lehman 20+ Year Treasury Bond ETF • iShares Lehman TIPS Bond ETF, iShares GS $ InvesTop Corp Bond ETF.
Foreclosure Threat Ominous for Subprime Borrowers
The Center for Responsible Lending, a nonprofit organization based in North Carolina, has released a study indicating that 2.2 million subprime housing loans, or 15% of the total, will end in foreclosure. The loans were issued over the period between 1998, when the housing boom began, and today, as the sector settles into a slump. The study blames lenders for making subprime loans without adequately assessing whether the borrowers would be able to pay them off once rates went up, and for failing to check the veracity of the borrowers' income declarations. In 1998, subprime loans represented 24% of the total, but today, they account for 62%. The excessive distribution of subprime loans has created a dangerous scenario: borrowers won't be able to make higher monthly payments, won't be able to refinance since the value of their homes will have declined, and won't be able to sell, since they will owe more on the houses than they are worth. These problems could lead to a hard landing for the housing sector, which could, in a worst-case scenario, contribute to an overall recession. The Mortgage Bankers Association considers the Center for Responsible Lending's study to be excessively pessimistic, maintaining that housing prices are unlikely to fall precipitously in 2007.
• Sources: Wall Street Journal, New York Sun, Business Week, The Sacramento Bee
• Related commentary: Treasury Sets New Guidelines to Stem Rising Delinquency Threat, Mortgage Applications Perking Up
• Potentially impacted ETFs: iShares S&P Global Financials (IXG), Vanguard Financials ETF (VFH), streetTRACKS KBW Bank ETF (KBE), Regional Bank HOLDRs Trust Regional Bank HOLDRs Trust (RKH)
Hovnanian Enterprises Suffers Gruesome Fourth Quarter
Luxury homebuilder Hovnanian Enterprises has posted a huge Q4 loss, dampening the ray of optimism cast by yesterday's report of a 6.7% jump in new-home construction in November. The company reported a 1.5% drop in revenues for the quarter, to $1.7 billion, and a loss of $117.9 million ($1.88 per share). This loss, which is the result of steep inventory impairment charges and land write-offs, stands in stark contrast to the company's $165.4 million, or $2.53 per share, profit in the same quarter last year. Investors responded to the news by selling
across the sector, bringing Hovnanian down 1.9% and the S&P Homebuilding Index 1.5%. The sector is suffering from high cancellation rates and high inventories, which have sent prices plummeting. Hovnanian's guidance for fiscal 2007 EPS is $1.50-2.00, provided conditions do not deteriorate much further. Hovnanian's CFO, J. Larry Sorsby, expects the sector to bottom in H1 2007, but also expects the market to "bounce along the bottom for several quarters before pricing and sales [improve]."
• Sources: Business Week, Newsday, TheStreet.com, Reuters
• Related commentary: Assessing the Homebuilder Stocks, How to Short Homebuilders: Look for the Fastest Growers, How Long Can Consumer Confidence, Earnings Weather the Housing Bust?, How Far Will Housing Drag Down The Economy?, James Grant's Investment Strategies for the Housing Predicament, Homebuilders Lower Forecasts on Weak Demand and Cancellations
• Potentially impacted stocks and ETFs: Hovnanian Enterprises (HOV), DR Horton (DHI), KB Home (KBH), Centex (CTX), Toll Brothers (TOL), streetTRACKS SPDR Homebuilders ETF (XHB), iShares Lehman 1-3 Year Treasury Bond Fund (SHY)
TECHNOLOGY AND INTERNET
Palm Earnings Drop on Treo Delay, Onslaught of Competition
Palm Inc. reported a sharp drop in fiscal Q2 profits and revenues after yesterday's close, while beating Street projections. Its Q3 forecast fell short of analyst expectations. Profits were $0.12/share ($12.8m), compared with $0.17/share in Q2 2006 (after discounting a one-time tax-related gain). Revenues were down 12% to $390m. Despite the drop in profits, Treo unit sales came in at a record high of 617,000, up 42% y/y. Palm said the much lamented delay of
its Treo 750 was due to carrier certification issues out of its control. But in its earnings conference call CEO Ed Colligan candidly told UBS's Maynard Um, "If we had gotten [the 750] out a little earlier for the holiday season, I think this quarter would have been significantly better and we would be much more excited about the results... The sell-through y/y was up 42%, so you can imagine what that number would have been if we put that one on the market. Look, no excuses there, we have to do better and we have to hit those dates." He said the 750 U.S. launch remains on track for the current quarter and would boost sales, and admitted that the onslaught of new competition (from rivals like Motorola, Nokia, and Samsung) hurt its numbers. For fiscal Q3 Palm said it expects revenues of $400-$410m and with earnings of $0.08-$0.10/share. Shares dropped to a new 52-week low of $13.41 before closing at $13.70 (-$0.30), and fell 9 cents in after-hours trading following the report.
• Sources: Palm Inc. Fiscal Q2 2007 Earnings Conference Call Transcript, CBS/AP, MarketWatch
• Related commentary: Palm Meets Reduced Guidance; Outlook Weaker Than Expected, Palm Treo 750 Delays May Be Worse Than Expected, Palm Slaps Investors in the Face - Shares Respond in Kind, Palm's Warning, Delay May Increase Its Takeover Likelihood, Palm Warns - Stock Down 4% After Hours, Palm: A Gift for Value Investors
• Potentially impacted stocks and ETFs: Palm Inc. (PALM). Competitors: Motorola Inc. (MOT), Nokia Corp. (NOK), Research In Motion Ltd. (RIMM)
Ericsson Buying Redback To Fend Off Cisco In IPTV Equipment
Swedish telecom giant Ericsson will acquire Silicon Valley's Redback Networks, which produces routing equipment, for $25 a share - an 18% premium over Redback's closing price on Tuesday. With the growth of multimedia over broadband internet creating new demand for networking hardware, the combined company hopes to compete more aggressively against larger rivals Cisco and Juniper. Redback filed for bankruptcy in 2003 after its telecom boom expansion left it saddled with excessive debt; in late 2004 its stock traded for less than $3, but the company staged an impressive comeback following cost-cutting and layoffs of more than 1000 employees. Ericsson's acquisition of Marconi last year spurred broader consolidation in the industry, and this acquisition should help Ericsson in its effort to beat out Cisco in becoming the number two supplier of IPTV infrastructure following Alcatel.
• Sources: Ericsson news release, Associated Press, Bloomberg, Reuters, Wall St. Journal,
• Related commentary: Ericsson Buying Redback Networks; More Telecom Equip Takeovers Likely?, Om Malik: Ericsson buys Redback, Good Move?, Sony Ericsson Sees Opportunity in Mobile TV, Intel and Ericsson: IMS Laptops or Phones?, Qualcomm's Empire Is Under Siege Conference call transcript: LM Ericsson Q3 2006
• Potentially impacted stocks and ETFs: L.M. Ericsson Telephone Co. ADS (ERIC), Redback Networks Inc. (RBAK) Competitors: Cisco Systems Inc. (CSCO), Juniper Networks (JNPR), Alcatel (ALU) ETFs: iShares Goldman Sachs Networking (AMEX: IGN), PowerShares Dynamic Networking (PXQ)
MEDIA
Harrah's Accepts Private Equity Offer of $90 Per Share
Harrah's Entertainment has approved the $17.1 billion buyout offer from Apollo Management LP and Texas Pacific Group. The is the fourth largest private equity buyout ever. The company announced that shareholders will receive $90
per share. The deal includes the assumption of $10.7 billion in debt, bringing the transaction total to $27.8 billion. Two months ago, the buyout firms initially offered $15.1 billion or $81 per share. The current deal is a 35% premium over the share price at the end of September, before the deal was announced. Harrah's had $1.08 billion in earnings through September, almost double its 2005 earnings. Harrah's CEO Gary Loveman said he doesn't expect any major changes in corporate strategy or operations. Harrah's operates 46 casinos in the U.S. and 11 overseas. Shares of Harrah's climbed 14 cents to $82.32 yesterday.
• Sources: Bloomberg, WSJ, Reuters
• Related commentary: Who Will Acquire Harrah's This Time?, Valuing the Casino Industry: Are There More Harrah's Out There?, Harrah's Seems Underwhelmed by Buyout Offer, Harrah's Receives Yet Another (Better) Buyout Offer
• Potentially impacted stocks and ETFs: Harrah's Entertainment, Inc. (HET) Competitors: Penn National Gaming Inc. (PENN), Wynn Resorts (WYNN), Boyd Gaming Corporation (BYD), MGM MIRAGE (MGM), Las Vegas Sands Corp. (LVS), Trump Entertainment Resorts (TRMP).
RETAIL
The Latest Flat Panel TV Casualty: Circuit City
Ciruit City's stock fell 18% after it announced a net loss for the quarter ending November 30th of 9 cents a share, versus the analyst consensus of (positive) 5 cents, and reduced its projection for full year 2007 sales growth to 8-9% from 9-11%. Revenue for the quarter rose 6.9% to $3.1 billion, in line with estimates, with same store sales up 5.1%. But gross margin fell to 22.2% versus the consensus expectation of 24%. CEO Philip Schoonover said "the most significant variance from plan was in the flat panel television category. The pace of the decline in
flat panel television prices accelerated during the quarter as manufacturers and retailers competed aggressively for market share, and prices fell to unanticipated levels." Of note: Web-originated sales grew 67%, call center sales grew 84% and services revenues grew 72%. Circuit City's earnings miss follows Best Buy's last week, also due to weak flat panel TV margins, but the extent of Circuit City's loss was a surprise.
• Sources: Circuit City Press Release, WSJ, Bloomberg, Reuters.
• Related commentary: Best Buy Misses on Consumer Electronics Price Pressure, Circuit City: Flat Panel TV Prices Falling Even Faster Than Expected, Full Seeking Alpha Flat Panel Coverage. Conference call transcripts: Circuit City Earnings Call Transcript, Best Buy F3Q07 Earnings Call Transcript.
• Potentially impacted stocks and ETFs: Circuit City (CC). Competitors: Best Buy (BBY), Radio Shack (RSH), Wal-Mart (WMT). ETFs: Retail HOLDRs (RTH), Consumer Discretionary SPDR (XLY)
FINANCIAL
Mack Taking Care of Business at Morgan: Q4 Profit Up, Talks of Discover Spinoff
Morgan Stanley turned in a record Q4, aided by a tax benefit, but still reported a 26% increase in profit ($2.2b) from continuing operations. Also, CEO John Mack has changed his mind and decided to spinoff Discover, saying it will maximize value for both Morgan and Discover shareholders. Q4 Diluted EPS was $2.08/share, versus $1.64 last year -- excluding an income tax benefit it was $1.81/share, which still beat the $1.78 average estimate of analysts surveyed by Bloomberg.
Q4 net income was off 11% due to a $700 million asset sale gain last year. Q4 revenues grew 24% to $8.6b. For its fiscal year-ended Nov. 30, net income from continuing operations increased 44% to $7.5b, or $7.09/share, versus $4.81 last year, on record net revenues up 26% to $33.9b. ROE grew 23.6%, compared to 19.0% last year. Morgan reported strength in trading, fixed-income sales, M&A, real estate and in its Discover unit, while there was weakness in equity underwriting and asset management. Discover's Q4 pretax profit totaled $199m, more than triple last year. Although it is a smaller player in the credit industry, some analysts say that could bring a premium to its shares as a potential takeover target. The spinoff is expected to be completed in Q3'07, with Discover valued as high as $13b. Morgan's shares traded up 1.7% yesterday to close at $81.70.
• Sources: Earnings release, Bloomberg, The Wall Street Journal
• Related commentary: Goldman Posts Its Best Quarter (and Year) Ever, Lehman and Bear Stearns Report Impressive Q4 Numbers, But Overshadowed By Goldman
• Potentially impacted stocks and ETFs: Morgan Stanley (MS). Competitors: Bear Stearns (BSC), Goldman Sachs (GS), Lehman Brothers (LEH), Merrill Lynch (MER), UBS AG (UBS), MasterCard (MA), American Express (AXP). ETFs:
iShares DJ US Broker-Dealers (IAI), streetTRACKS KBW Capital Markets (KCE), Financial Select Sector SPDR (XLF)
HEALTHCARE
Northfield Labs Shares Go Deep Red on Weak, Confusing Test Results
Northfield Laboratories Inc. said yesterday that preliminary results of a late-stage trial of its PolyHeme red blood cell substitute showed it failed to meet the primary goals of the study. PolyHeme is used to treat patients who need blood where it is not available, such as accident victims. PolyHeme failed to show clinical superiority to a salt/water placebo, as
well exceeding its 'noninferiority' threshold. The company countered that after removing patients who violated study protocol the treatment came in under the inferiority threshold, and it hopes the FDA would be amenable to a review that focuses on that data. Northfield also said it discovered discrepancies in initial data received from an outside contract research organization [CRO] which will necessitate unlocking and correcting the study's database before finalizing statistical analyses. For the past 25 years Northfield and others have unsuccessfully sought to improve upon red blood cells, which carry oxygen from the lungs to the rest of the body. PolyHeme is a solution of chemically modified human hemoglobin which Northfield says is compatible with all blood types and has a shelf life of more than 12 months. Northfield shares were down $2.90 (20%) to $11.42 in regular trading Tuesday, and shed another $5.74 (50%) to $5.68 after hours.
• Sources: Press release, TheStreet.com, MSN.com, Reuters
• Related commentary: Do Northfield Labs Options Have Too Much Premium to Sell?, Jim Cramer's Take on NFLD
• Potentially impacted stocks and ETFs: Northfield Laboratories Inc. (NFLD). Competitors: Biopure Corp. (BPUR)
GlaxoSmithKline Grabs HuMax-CD20, Genmab's Promising New Cancer Drug
GlaxoSmithKline plc will boost its oncology drug roster by developing and selling HuMax-CD20, a new blood-cancer and rheumatoid arthritis drug discovered by Danish biotech company Genmab AS. The agreement, according to which Glaxo will pay $357 million for a 10.1% stake in Genmab as well as a $102 million licensing fee, is the company's third deal in eleven days. The size of the deal surprised analysts and may make Genmab profitable as early as next year. HuMax-CD20 is now in Phase III clinical trials for chronic lymphocytic leukemia and non-Hodgkin's lymphoma and Phase II trials for rheumatoid arthritis. If it reaches the market, the drug will compete with Roche Holdings' Rituxan, which is sold by Genentech. The drug's target market is estimated at $5 billion.
• Sources: Wall Street Journal, TheStreet.com, MarketWatch, Bloomberg
• Related commentary: Eye On GlaxoSmithKline, Genentech, Biogen, Elan and PML Disease, Biogen Idec & Genentech Down on Rituxan Related Deaths, Walgreen Co. and Genentech: Two Ways to Play the Drug Sector
• Potentially impacted stocks and ETFs: GlaxoSmithKline plc (GSK) Competitors: Genentech Inc. (DNA), Biogen (BIIB) ETFs: Europe 2001 HOLDRs (EKH), BLDRS Europe 100 ADR Index (ADRU), iShares MSCI EAFE Growth Index (EFG), WisdomTree DIEFA High-Yielding Equity (DTH)
INTERNATIONAL
Thai Flip-Flop -- Asian Stocks Rebound
Yesterday Asian stocks had their biggest fall in a month, led by Thailand's now flip-flopped decision on implementation of capital controls, which today, resulted in broad rally. Thai stocks rebounded 11%, after the SET Index plunged 15% yesterday for its worst one-day drop in 16 years. Malaysia, said it has no intention to intervene in currency trading, which helped the Kuala Lumpur Composite gain back 1.5% after yesterday's 2% fall.
Sustained weakness in the yen attracted more buyers to Japan's blue-chip exporters, sending the Nikkei 225 to its highest close in more than 7 months. Analysts meanwhile, have mixed opinions on investing in Thailand, with some saying "beware," while others suggest it is a buying opportunity. An ABN Amro executive in Singapore is in the latter camp, commenting, "The Thai central bank may now resort to an interest rate cut to rein in the baht, which could benefit banking stocks." Templeton's emerging market guru Mark Mobius' comments were mostly positive, noting the Thai government is showing flexibility, and the market's reaction is a warning signal to other countries. Also, Mobius says the drop "definitely" presented a buying opportunity, adding that "our guys are out there looking for opportunities constantly."
• Sources: Bloomberg [I, II, III]
• Related commentary: Thai Fiasco: The Downside of Emerging Markets, Investing in Thailand Amid Political Crisis, Emerging Markets ETF: A Volatile SPY?, Global Markets: Currency Imbalances and Trade Are Driving Forces
• Potentially impacted stocks and ETFs: ETFs: iShares: Pacific ex-Japan Index (EPP), Hong Kong (EWH), Japan (EWJ), Malaysia (EWM), Singapore (EWS), S. Korea (EWY), Australia (EWA). CEFs: Thai Capital Fund (TF), The Thai Fund (TTF)
MUST-READS ON SEEKING ALPHA TODAY
U.S. Markets: How Long Can Consumer Confidence, Earnings Weather the Housing Bust?
Housing: First-Ever International Real Estate ETF Launched
Long Idea: Liquid Coal: Four Stocks To Watch
Short Idea: Newpark Resources: Disappointing Investors for the Past Five Years
Internet: Ask.com: The Little Search Engine That Could (Topple Google?)
Telecom: The 'Duh' Of The Year Award Goes To KPMG
Hardware: Apple Stock: Capture The MacWorld Effect
Software: Might Be Time To Sell Adobe
Consumer Electronics: 2007 May Be Rough For Video Game Stocks
Media: Time Warner’s AOL: To Sell or Not to Sell?
Healthcare: Hemispherx Biopharma Is Worth The Risk
Retail: PetMeds Is a Bargain for Consumers and Investors
Transport: Ship Finance International: The Big Boats Are Thriving
Gold: Why Gold? Using Roman Monetary History To Better Understand Inflation
Energy: Newpark Resources: Disappointing Investors for the Past Five Years
Financial: Trouble In the Private Equity Business?
Asia: Fuwei Film IPO: Solid Growth, Reasonable Multiple
ETFs: Canadian Royalty Trusts That Trade in the U.S.
Small-Caps: Japan's Small Cap Weakness a Warning Sign for Global Small Caps?
IPO Analysis: Double-Take Software: Solid Smallcap Software IPO
Sound Money Tips: What To Do With a Broken iPod
Jim Cramer: Latest stock picks
Earnings Conference Call Transcripts: Palm Inc. Fiscal Q2 2007
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