Leveraged Bailouts

Back to posting!

2010-10-31T19:39:00.000-07:00

I haven't looked at the blog for a while - I was lucky to get an internship at the end of February, and my stock research took a several month hiatus before resuming during the summer in a professional setting. My first foray into pro world of investing was fun, and I'm hoping to jump back into it next year. Now I'm in the muddy waters of recruiting for a full-time position, and back to my blogging board.

The pair trade in the post below (Paychex vs ADP) has worked quite nicely, with ADP outperforming by almost 15%. Now no more, basking in glory, and on to new ideas.

Does US Steel make sense?

2010-02-22T19:00:00.001-08:00

Current TEV, normalized earnings around 1.5B EBIT, although were 3B at the peak. When are the normalized going to come given ~50% current capacity utilization. To me the valuation seems pricey - after all in 2005-2006, presumably better than normal time / average at best the stock was priced ~40, vs 54 right now. Think there's bidding up by investors fishing for recovery that are bound to be disappointed. Thumbs down on this one.

Trade idea: Paychex vs ADP

2010-02-15T05:49:00.000-08:00

Both businesses provide payroll/HR outsourcing services, with PAYX targeting smaller businesses (17 employees on avg) vs ADP's 96. Historically growth rates have been similar at 10-12% revenue, and multiples have been ~20-22x P/E. Now however PAYX is trading much more expensively at 22x P/E while ADP is around 16.5, even cheaper counting in the cash. I think the multiple gap should converge to ~2.5x => PAYX should fall ~15%.

ADP segments include Employer Services, within it basic payroll offering (delivering the checks, tax filing, w2 forms, direct deposit), and beyond payroll (retirement benefits management, insurance services like workers comp, other benefits admin). This segment is ~80% of income and 72% of revs. PEO segment - fully outsourced HR for SMB, not very profitable (5% of PBT, 12% of revs). Dealer services is a back-office solution for 25K auto dealers. ADP has ~600K clients, average retention is 90%.

Historically PAYX has traded at 25% premium to ADP, however believe this might be skewed as ADP used to own Brokerage Services and Travel Clearing business that it divested in 2007 - businesses and growth rates should be more comparable now.

Market dynamic: three top guys (ADP, PAYX, Ceridian) are around 60% of the market. Pricing typically works per employee: say $1 charge per each of 25 pay cycles on the low end, $6 per cycle for smaller firms.

Vulcan Materials - Short or Not?

2010-02-11T16:00:00.000-08:00

Vulcan is produces aggregates, asphalt, and cement businesses. Aggregates (crushed stone, sand and gravel) are 65% of revenues, asphalt and concrete is 32%, with 88% of GP coming from aggregates. Generally a local market - high costs of shipping. 13.5B tons of reserves. Private non-residential is 41%, residential is 17%, highway is 26% of revenues and other public is another 13%. Energy costs are important (10-15% of COGS), with diesel declining, it should provide a nice boost to Gross Margin, but there will be a negative impact from volume decline. Company has a fair debt burden after Florida Rock acquisition in 2007 ($3B).

The stock has run up due to the excitement over the stimulus bill. The jump in spending will be one time increase in U.S. highway expenditures from by $28B from the ARRA (american recovery and reinvestment act), as the spending on highways will increase from annual $40B. Additional hope is the increase in highway spending from $286B allocated over 6 years by previous bill to up to $450-500B in the next 6 years. CBO is only expecting a moderate increase though, and with giant deficits it's hard to see how the larger number would fly. In record year (2006) Vulcan shipped 290M tons of aggregates, while for 2009 only ~150M. For 2009, EBITDA was only 450M, while the current TEV is 8B. At the very top of the cycle in 2006, earnings were 1B.

Need to understand - why has the pricing been strong?

Recent results: shipments down 23%, pricing up 5%. Expect 2010 numbers to be up 0-5 on volume, 2-3% price.
Total revenues for the year were $2.5B, with operating earnings at $150M.
In 2010, management projects public works + highway to be ~50% of the business.

McDonald's - Why Not?

2010-01-28T10:49:00.000-08:00

I'm running a very simple screen - all companies growing EPS at 8% selling at below 25 fwd P/E. And with over $1B in market cap. Rationale being that I don't want to buy businesses that are shrinking, and also don't want to buy stocks are TOO overpriced. One of the top ones on the list - MCD. Surprising that the revenues are only $23B, but that's probably cause the company is mostly franchises - the actual sales of restaurants are much higher. Valuation is reasonable at 15x LTM P/E, and with strong history of expanding profits, I'm a believe they can keep growing at 10% earnings. And there's also 3% dividend, and pretty low beta - MCD hardly lost any value while the stock market tanked completely. I'm somewhat a believer in potential here to generate high risk-adjusted returns, although on absolute basis they might be comparable to the market.

Lab Corp of America

2010-01-26T14:51:00.000-08:00

Not overly expensive at ~15x EPS, with attractive market growth (5-6%) driven by increasing penetration of genomic and other esoteric (don't know exactly what!) testing, with significant opportunity of margin expansion as fixed costs are sizable at ~$1B on revenues of 7B. Second largest lab company in the US after Quest, customer split between managed care, individual patients, some Medicare/Medicaid. Lots of small labs - presumably opportunity to gain share over time, although may be cost competitive eating into margins. Limited risk of being impacted by healthcare bill (that's now toasted anyway), although near-term volume trends are not favorable according to some checks (volume may be flat to down slightly). Pretty low beta stock, I would expect to trade at 18x P/E. Next year's earnings projected to be 5.50, so could get to $100 a share - vs 73 currently.

Resuming... Quanta Services

2010-01-23T10:15:00.001-08:00

Found this one on Fortune Top 10 stocks for 2010. Not sure whether it'd be a top one for me, but the idea is definitely worth exploring: Quanta Services is a contractor servicing electric power lines, gas, telecom, some other minor segments. Electric services include transmission (slight majority) and distribution - they design, maintain and built stuff. Utilities are expected to ramp up their spending, incentivized by the government. Another favorable trend - increasing outsourcing by utilities. Quanta also has a small business constructing wind and solar farms, fast growth here obviously. The struggling segments are gas - with prices down and housing market still in the doldrums (and part of the business is distribution - connecting houses with gas pipes), the market recovery timing is unclear.

Analyst expect very rapid recovery in gas - unclear why. I believe the story on electric power, but with current EPS at ~0.8, and share price at 20, there seem to be better opportunities to invest, especially given the uncertainty on timing of market recovery. Worth keeping an eye on though.

Math Problems at IMF?

2009-04-21T12:09:00.000-07:00

IMF published their new Financial Stability Report, in which they claim that U.S. banks will have $250B drain on equity due to writeoffs in the next two years. The simple math they go through is follows: total write-offs on loans and securities over the cycle for U.S. banks will be $1050B. $500B of that has already been recognized, which leaves $550B remaining. They estimate after-tax pre-provision earnings in 2009-2010 at U.S. banks will be $300B. $550-300B=250B drag on capital. But what happened to applying a tax rate to write-downs, which would presumably reduce net write-down number to 360B, or result in only $60B drag.

This not so well-thought out math only adds fuel to the fire burning the bank stocks and shaking the confidence in the system. Lets hope Fed's stress test is more well-thought out, and somebody actually pays attention, rather than just saying 'they are all bankrupt, I don't care what numbers say', like many people seem to be prone to do these days.

Another "Gem" from WSJ...

2009-04-20T05:52:00.000-07:00

WSJ should really refrain from trying to do any economic analysis of their own. This article claims bank lending keeps dropping, because February loan figures are lower that January ones by 4%, and October ones by 20%. Now, I am not going to dispute that bank lending is dropping - Thank God it is, American consumer needs to delever! But how can you look at February figures - the month, eh, has 10% less days than January? The data in the article is completely meaningless.

What's in Your Wallet - Delinquent Capital One Credit Card

2009-04-15T09:01:00.000-07:00

Capital One charge-offs spiked to 9.3% this month, up 1% from last month. 1% is truly horrendous, but I wouldn't rush to extrapolating to other issuers - COF, vs AXP for example, is much more reliant on 0% ARPs, which once they roll-off from their grace period may turn into delinquents - potentially causing the increase.

Goldman Results - Another Nail in Shorts Coffin?

2009-04-13T14:28:00.000-07:00

At least until the results of stress test come out... GS reported $3.23 EPS and $1.8B net income, and that's despite $2B write-off.

Banks and Fees

2009-04-13T07:52:00.000-07:00

This graphic from WSJ's article on government investigating banks who received TARP funding charging higher fees is entertainingly empty-headed. Are we supposed to infer from it that if you received TARP, you're more likely to be an evil bank sucking your customers dry for every fee you could get. Or, perhaps, that you are a successful bank who has tremendously outgrown your competitors? Ah, those journalists.

Happy Holiday...

2009-04-10T07:50:00.000-07:00

In a day of little news, Bloomberg reports that Fed tells banks to stay quiet about the stress test results (the article also has an awful picture of Geithner). This whole stress test business may be a disaster - just when the markets are getting more optimistic, Treasury will spook them out again by identifying 'weak' banks.

Freaking Out About Helicopters - GS Thinks that Hyperinflation is Unlikely

2009-04-09T12:59:00.001-07:00

Fed's balance sheet expansion to 2TR+ has made many people worried about hyperinflation materializing as soon as this year. GS has recently published a report 'Hyperventilating about Hyperinflation', according to which the worry is hugely overrated. Here's the simple argument:
1. The reason why inflation comes in the first place is "too much money" chasing "too few goods". Inflation tends to lag output gap (potential - actual GDP) by about a year.
2. Output gap will average 7% in 2009 and 2010 according to relatively optimistic economic forecasts - still the worst performance since WWII. To close that gap in a year you'd need 10% growth rate - who thinks we'll be back to even 3% growth anytime soon?

And before the output gap closes, Fed will have plenty of time to unwind it's balance sheet, thus reducing the risk of hyperinflation massively. The key is understanding that most of Fed's facilities are short-term: TAF, CPFF, AMLF have maturities of 90 days and less, and account for $700B of Fed's balance sheet (or 2/3 of 1.1B expansion). Most of other money is in swaps to foreign central banks, that also can be unwound relatively fast if the economy actually starts heating up.

Thus buying double short treasury ETFs (like PST) because you hope for hyperinflation in the next couple of years is not the greatest idea. Hyperinflation will happen only with a) rapid economic recovery b) complete inability by Fed to unwind its facilities. You're much better off with just buying equities that will rally hugely if a) is indeed the case, but don't need b) to come true.

Trade Balance and Claims

2009-04-09T07:59:00.000-07:00

Both trade numbers and claims came out better than expected: -$26B vs -$37B, and 654K vs 660K consensus. Exports actually grew moderately at $2B, while imports declined $8B month-on-month. On unadjusted seasonal basis balance of payments improved from -$44B to -$29B, and of that $11B came from Asian countries (6B from China, 2B from Japan). Chinese better be buying more cars. The claims data is not that interesting - it's basically flat from last week.

Morning Papers...

2009-04-09T05:12:00.000-07:00

CVC close to buying Ishares for $4.4B from Barclays. The article says that the fund will get 2/3 financing from the bank, which implies 1.5B equity check from CVC - quite hefty given their total fund is ~10B euros, including 4B sidecar. Maybe the other chasers of the deal (H&F, Bain), will get a chance to invest after all.

Wells Fargo reported 0.55 EPS for Q1. On the one hand results are very strong, illustrating the earnings power of the franchise. Company's net charge-offs are up to 3.3B from 2.8B in last quarter, while they also added 1.3B to reserve, but the pre-provision earnings at 9B allow them to easily absorb those losses. Hoorah, all bank shares rallying. Two points of caution on the results though: a) NCOs are lowered as Wachovia's impaired 'Pick-a-Pay' loans are not in the charge-off number - they were written down on acquisition, and until losses on them hit the written-off amount, there're no new write-offs on them; b) WFC CEO Kovacevich has recently repeatedly ranted against the stress tests calling them 'asinine'. That makes you question whether WFC needs to raise new capital (their Tier 1 at 7.9% is the lowest among all major banks after all), in which case pre-announcing the earnings will give you a nice share price bump, that would allow to tap existing shareholders for capital with less dilution. We'll wait a couple of weeks to see whether this prediction will pan out...

And more on banks: NYTimes article says after conducting stress tests, officials say that "the banking industry seems to be in better shape than many people think"

China is buying more cars than U.S. for the first time. Long live Wen Jiabao.

And More on BAC - Fox Interview With Ken Lewis

2009-04-08T14:53:00.000-07:00

In the interview with Fox, Lewis presumably (I haven't watched that part of the interview yet) said again that BAC doesn't need more capital. Given the fact that he's in conversations with regulators constantly, I don't understand how he'd make the statement if it wasn't actually true. If it's not true, he'll be given a boot in three weeks, and if it is, BAC is going to 10+ a share very shortly.

Bank of America Needs $36.6 Billion, Oppenheimer Says

2009-04-08T10:58:00.000-07:00

Another analyst came out with their "analysis" of bank capital needs. Oppenheimer claims that Bank of America needs $36.6B of new equity. How do they get to this number? Simply saying that BoFA's TCE should be at 6%, or twice the current level, implying ~50% dilution for existing shareholders. You'd think the point of the stress test conducted now by the regulators is to assess future performance of loan portfolios and see how capital ratios that are already in place (aka Tier 1 - this is what UK regulators were looking at when doing stress test for Barclays). For example projected losses in excess of earnings in the stress case are $20B, and with this you get to 8% Tier 1, and we really want you to have 10%. In any case, if you do believe TCE is the way to go, short Wells Fargo (with their 2.3% TCE ratio including mortgage-servicing rights) and long BoFA if you're feeling lucky, or JPM.

Party Over for Russians Billionaires

2009-04-08T10:46:00.000-07:00

Bloomberg article on deprivations of nouveau riche in Moscow... One of many great quotes: "You just can’t party when others are starving”. Indeed, for there was clearly no one starving in Russia before the crisis began...