Back to posting!

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?

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

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?

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?

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

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

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.