Tuesday, July 22, 2014

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Monday, July 21, 2014

Investing in Semiconductor Earnings Growth

The PC industry isn't dead yet.

Intel (INTC - Trend Report) recently posted strong second quarter results, driven in part by strong demand in its core server and PC markets.

Following the Q2 report, analysts revised their estimates significantly higher for both 2014 and 2015. This sent the stock to a Zacks Rank #1 (Strong Buy).

Intel is the world's largest supplier of microprocessors with over 75% of worldwide market share among traditional PCs and servers.

Second Quarter Results

Intel delivered strong second quarter results on July 15. Earnings per share came in at 55 cents, beating the Zacks Consensus Estimate of 52 cents. It was a 41% increase over the same quarter last year.

Net revenue grew 8% year-over-year to $13.831 billion, well ahead of the consensus of $13.622 billion. This was driven by solid demand in its core server and PC markets. Intel's Data Center (server) group saw top-line growth of 19% year-over-year, while its PC Client Group saw revenue growth of 6%.

Gross profit as a percentage of total revenue improved greatly. The gross margin rose from 58.3% to 64.5%. Meanwhile, marketing, general and administrative expenses declined 5% and fell from 16.9% to 14.9% of revenue.

These factors led to a whopping 41% surge in operating income as the operating margin expanded 21.2% to 27.8%.

Earnings Outlook

Following the strong Q2 results, analysts have unanimously raised their estimates for both 2014 and 2015. This has sent the stock to a Zacks Rank #1 (Strong Buy).

Part of the catalyst for the upward revisions was encouraging guidance from management, which stated in the Q2 report that it expects about 5% revenue growth in 2014. That is slightly higher than its previous guidance.

The Zacks Consensus Estimate for 2014 is now $2.14, up from $2.04 before the report. The 2015 consensus is now $2.31, up from $2.18 over the same period.

Intel still faces long-term challenges as it struggles to gain traction in the growing tablet and smartphone markets. But the near-term outlook looks bright for the stock as the PC industry appears to be stabilizing after two years of contraction.


Shares of Intel soared after the Q2 report and have been on a tear this year, rising more than +32%. But the valuation picture still looks reasonable. Shares trade around 16x 12-month forward earnings and about 9x cash flow.

In addition, the company pays a dividend that yields a solid 2.7%.

The Bottom Line

Intel has a dominant position in the microprocessor industry for traditional PCs and servers. And thanks to recent strength in these end markets, along with solid cost controls from the company, earnings growth - and earnings estimates - are soaring for Intel.

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Friday, July 18, 2014

How to Start a Financial Crisis Part 2

How Financial Crises Start, Part 2 by Market Authority

Click Here to Review Part 1

Yesterday, I highlighted the financial panics of the 19th Century (aka bank runs), how they start, and the government’s response to prevent future runs (the Fed and FDIC). As noted, regulators and economists are only able to locate the problems with the engine after the car breaks down.

Today, let’s take a look under the hood of our current financial system to better understand how the economic machine overheated and was left stranded by the side of the road.

Businesses are more profitable than ever with record amounts of cash on balance sheets. The following chart depicts the rise of corporate cash as a % of GDP:

Since this cash must be invested somewhere (usually short-term), Wall Street created the repo and commercial paper markets. This allowed Wall Street to borrow cash from Main Street on a short-term basis. Just like a pawn shop, lenders of cash need some type of collateral that they can liquidate if the borrower doesn’t pay back the cash on time. Wall Street took the borrowed money to finance higher-yielding assets, profiting on the spread between what they paid on the corporate cash versus what they received on the higher-yielding assets.

Historically, the collateral that Wall Street pledged in order to borrow short-term corporate cash was AAA-rated US Treasuries. However, the government surplus of the late 90s mopped up too much Treasury supply. Wall Street needed another asset to use as collateral. And then Wall Street developed a game changer: securitization.

This process moves long-term bank loans off balance sheets by packaging them together and selling them to the capital markets. Securitized loans, also knowns as Asset-Backed Securities (ABS), are backed by mortgages, auto loans, credit card loans, or student loans and now comprise one of the largest markets in the world. A market large enough to provide collateral for the enormous amount of short-term borrowing.

Technology made securitization possible. Software programs can easily package millions of similar loans, something impossible to do by hand. Furthermore, easy-to-obtain credit scores allow lenders to assess the likelihood of default of each individual loan.

Here’s a brief primer on how these loans work:

Let’s say you live in a town called Springfield where 10,000 residents own houses with $200,000 mortgages that are held at the local Citibank. The average resident is paying a 10% rate on their mortgage and they all have 20 years to maturity. Since the bank can expect interest payments totaling $200mm per year (10,000 x $200,000 x 10%), they can create a new special purpose vehicle which separates these payments into different buckets. Because the bank can guarantee that the first $50mm of interest payments will go to the first bucket, the rating agencies give this a higher rating (even though the underlying collateral may be lower rated).

Securitization provided the necessary AAA collateral for Wall Street to borrow from the rest of the private sector.

Now think of this operation like the world’s largest pawn shop. The corporations (with the cash) are the pawnbrokers willing to lend cash to the banks as long as they provide adequate collateral. Typically, the corporations would lend cash at a rate of 1 to 1. So if Wall Street brought in a gold chain (or a AAA ABS) that was valued at $1000, the pawnbroker would lend them $1000 and hold onto the gold chain until Wall Street paid them back.

Wall Street would then take this cash and use it to securitize more loans, which could then be used as more collateral. This process drove the credit super-cycle in a very pyramid-scheme like way.

Tomorrow, I’ll discuss how the system began to crack when the pawnbrokers began requiring more collateral.

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Wednesday, July 16, 2014

How to Start a Financial Crisis

How Financial Crises Start, Part 1 by Market Authority

Today is the start of a multi-part series on the financial crisis: what was the cause and what have we learned.

When I lived overseas, I was the proud owner of a 1982 Toyota FJ40. Designed as an offroad vehicle, this 4-cylinder diesel could climb just about anything. I’m no gearhead, so once the truck started experiencing problems, fixing it was quite the learning experience. Some issues were easy to fix, such as replacing cheap glow plugs with a higher quality set or a worn down hose with a newer one. While I’m still not an expert on diesel engines, I’m now more familiar with how they operate and can diagnose simple problems when they arrive. The universal truth is that nobody really wonders how the engine works until it fails to start in the morning.

And the same principle applies to financial markets. Only when a crisis happens, do we pop open the hood and take a look at the problems with the system. We discover issues that a previous mechanic may have installed incorrectly or parts that need to be entirely replaced due to overuse. Some of these may be quick fixes while others may require a complete rebuild.

Every financial crisis starts with a complete loss of confidence in what’s under the hood. When fear is prevalent, investors sell assets and raise cash. Because of this action, the economy loses the financing necessary to grow and output falls.

The financial crisis of 2008 allowed us to diagnose the problems in our financial system and propose solutions to avoid similar events in the future. This is how economic systems evolve, through a crisis/recovery process leading to a better understanding of how the entire system operates.

For instance, before the Federal Reserve was created in 1914, bank runs were a national pastime. At every peak in the business cycle, depositors would worry that their local bank had underwritten too many bad loans. Fearing their cash was no longer safe, they would line up outside the local bank demanding their money back. This was a powerful signal. If you were walking through town and witnessed your neighbors waiting anxiously (and sometimes angrily) in line, you were likely to inquire what all the fuss was about. When you were told your money was at risk, you would likely join the line, reinforcing the signal. The risk of losing all of your deposit was much greater than the reward earned from keeping it in the bank.

In a fractional reserve banking system, banks never keep enough deposits on hand to pay everyone back at the same time. They don’t need to, unless a crisis occurs and all depositors are suddenly fearful of what might happen to their deposits. The bank run became a self-fulfilling prophecy, with the bank usually closing down, halting withdrawals, and declaring a “bank holiday” while it went about selling assets (in a fire sale) to raise the cash needed to satisfy withdrawals. As a result, the bank would usually close and it would take years for a new bank to repair relations with depositors and get the economy moving again.

This is essentially why the Fed and FDIC insurance were created: to stop bank runs and smooth out the business cycle. The Fed will provide the needed liquidity for the bank (they can borrow at the discount window) and the FDIC gives depositors the peace of mind that their cash will always be protected. If a crisis occurs, there’s no longer a need to withdraw your cash and bury it in the backyard. Thus, the bank runs of the 19th Century are all but extinct.

The Federal reserve as a backstop and FDIC insurance led to what Yale economist Gary Gorton describes as “the Quiet Period” in our economy: the period from 1934 to 2007 when “properly designed bank regulations prevented financial crisis for a significant period of time, until innovation and change necessitated their redesign”. Crisis brought about an evolution in understanding, which allowed for the development of regulatory systems targeted at preventing future crises.

And things got really quiet towards the end of the quiet period during the “great moderation”. Between the mid-1980s and 2007, economic volatility declined dramatically. The Fed had seemingly smoothed out the business cycle.

While economists understood some of the factors causing the great moderation (central bank independence and counter-cyclical economic stabilization), they didn’t foresee the problems under the hood until the 2008 financial crisis occurred.

Tomorrow, we’ll take a look under the hood and discuss the shadow banking system. This will allow us to understand how bank runs can still occur in the 21st Century.

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Monday, July 14, 2014

Investing in Industrial Energy Solutions Earnings Growth

EnerSys (ENS) has powered through the last several quarters producing 11 straight beats of the Zacks Consensus Estimate. Today, ENS is a Zacks Rank #1 (Strong Buy), and it is the Bull of the Day.

Powerful Earnings

Aggressive growth investors appreciate beats. They love them on the bottom line, but they really want to see them on top too. ENS has recorded six straight quarters where the company beat on top and bottom.

Another key metric that aggressive growth investors look for is larger and larger beats of the bottom line. ENS has that too. Over the last three quarts, the positive earnings surprise has increased from 3.5% to 3.9% to 7.3%.

Company Description

EnerSys makes industrial batteries and backup power systems and power related equipment and accessories. EnerSys was founded in 1999 and is headquartered in Reading, Pennsylvania.

Most Recent Quarter

ENS reported a strong 1Q14 beating the Zacks Consensus Estimate of $1.10 by eight cents. The company reported revenues of $665M when the street was calling for $657M in the quarter. The $8M top line beat translated into a 1.2% revenue surprise.

The stock moved higher by 2.5% in the session following the earnings announcement.

Prior To That Beat

Prior to the most recent beat, ENS not only provided a solid beat, they also gave positive guidance. A big beat on the top line drove the company to guide Wall Street to earnings per share between $1.08 and $1.12 for the next quarter when the consensus was calling for $1.05.

Guiding above consensus is a surefire way to please investors, and as a result of the positive guidance, the stock was bid up more than 9% in the session following that release.

ENS Sees Estimates Moving Higher

The Zacks Consensus Estimate for 2014 for ENS has been increasing all year. Starting at $4.00 in October of last year, we saw a nice move higher to $4.24 in November. By February, the estimate had kicked higher to $4.38 and now the Zacks Consensus Estimate is at $4.48.

The 2015 Zacks Consensus Estimate has only been around for a few months. The estimate remains where it started out at $4.84 as analysts have limited visibility at this point, but should release full year 2015 estimates following the next quarter.


The valuation for ENS is very attractive, as the stock trades at a discount the industry average for all the major metrics investors tend to look at. The trailing PE of 17x comes in under the 19x industry average as the the more attractive forward PE of 15x compared to 18x industry average. The price to book shows a healthy discount as well (2.5x vs 3.9x) as does the price to sales multiple (1.4x vs 1.8x).

The company is expected to produce revenue growth of 9% in Fiscal 2015, while the industry average is calling for a decrease of 1% on the top line. Earnings growth of 13% for ENS is above the 8% industry expectation.

In looking for a reason that this stock trades at a discount, the only thing that I could come up with is a lower net margin of 6.1% compared to a 6.8% and a lower pre-tax margin of 6.6% compared to 9.7% for the industry.

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Thursday, July 10, 2014

Short-Term Pullbacks and Long-Term Gains Explained

Why CNBC Wants You To Be Concerned About Your Money by Market Authority

In the days before financial news media broadcasted market information around-the-clock with scrolling pre-market quotes and endless “Breaking News” segments;

In the days before online brokerages marked your net worth up or down with every tick in the S&P 500 while simultaneously pitching products designed to squelch those worries;

In the days before 100s of virtual and real analysts dissected, projected, and connected every data point from presidential poll data to Chinese PMI’s;

In the days before every word, facial tic, hand gesture, and suit color worn by Janet Yellen was scrutinized, humanized, and hypothesized;

In these oft-forgotten days, there was one man and one show that investors turned on and tuned in for their financial news: “Wall $treet Week with Louis Rukeyser”.

This original financial news show aired on PBS from 1970-2002, and hit peak popularity in the mid-80s. Some would argue its appeal led to the launch of CNBC. Rukeyser is best known for his pun-filled humor and attempts to shift investor’s focus from the short-term market gyrations to the long-term. Along with countless awards and recognitions for outstanding journalism, People magazine once named him the “sex symbol of economics”.

Rukeyser sadly departed in 2006 at the age of 73, but many of his broadcasting memories are still alive on YouTube. Here’s a clip from shortly after the October 1987 crash (fast forward to 1:40 mark for Rukeyser’s monologue):

And the money quote:

“Ok, let’s start with what’s really important tonight… It’s just your money, not your life. Everybody who really loved you a week ago still loves you tonight. And that’s a heckuva lot more important than the numbers on a brokerage statement. The robins will sing, the crocuses will bloom, babies will gurgle, and puppies will curl up in your lap and drift happily to sleep- even when the stock market goes temporarily insane! And now that that’s all fully in perspective, let me say Ouch! … and Eeek! … and Medic! Tonight we’re going to try to make sense of mass hysteria, to look behind the crash of ‘87, and most perilously but most important of all, to look ahead.”

If you listened to Rukeyser in 1987 and held on to your stocks, you’ve witnessed a 10-fold increase in the Dow Jones Industrial Average in the past 3 decades. This return outperforms every major asset group. Note, his calmness during the crash contrasts the current state of financial news. While Rukeyser helped investors focus on the long-term, modern financial news wants investors to focus on the short-term.

In the short-term, every piece of news is “Breaking”, significant, meaningful, and market moving. In the long-term, none of these events individually matter. They’re merely noise.

Financial news networks (CNBC, CNNfn, Fox Business, Bloomberg TV) focus on the short-term to create the narrative that you should always be concerned about your money. This narrative is essential for their business model: Concern drives viewership, and viewership sells advertising time- the veritable raison d’ĂȘtre of financial news.

Without concern that a grand piano tethered to a loose string is looming over the market, people would stop watching and the ad dollars would migrate to other channels. Exciting program titles such as “Squawk Box”, “Mad Money”, “Fast Money”, and “Power Lunch”, emphasize your need to be concerned.

Take a look at CNBC’s viewership numbers over the past 17 years:

Viewership spiked at times when investors were concerned: the tech bubble and the financial crisis. Fully cognizant of these numbers, CNBC creates the illusory narrative that a market moving event is lurking around the corner. An event that needs to be closely watched because this event could wreck your portfolio. If CNBC anchors are talking about an upcoming event, the risk is likely priced into the stock market.

Known risks don’t cause unexpected selloffs. Known risks mean that investors are making contingency plans through hedging or selling stocks. Known risks mean that the market is braced for the event and its impact should be muted. Known risks mean that the market is more likely to be higher after the event passes.

For instance, have a look at the 43% rally in the SPY over the past 2 years:

Every little dip along the uptrend represents events that might have derailed the markets, but eventually turned out to be inconsequential. Remember these negative narratives from the past 2 years:

The Fiscal Cliff
Government Shutdown
Debt Ceiling Negotiations
Russia Invades Ukraine
China – Japan Tensions

While each caused short-term pullbacks, none of these events changed the current drivers of stocks: low interest rates, buybacks, strong earnings growth, and a gradually improving economy. These are long-term drivers that are resistant to change once set in motion. If Louis Rukeyser were still around today, he would be humorously highlighting these positive long-term themes, not the negative short-term narratives.

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Monday, July 07, 2014

Investing in Luxury Fashion Earnings Growth

Michael Kors (KORS) is continuing its fabulous run as the leading luxury fashion brand displacing peers like Coach (COH). The company delivered yet another stellar quarterly performance in late May when it reported Q4 EPS of $0.78, beating the consensus by 15% while rising 56% year over year.

Revenues of $917 million beat the consensus by 12% and grew 54% year over year. Further, the company's strong comps gain of 26% made it their 32nd straight quarter of positive same-store sales. In Europe, revenue skyrocketed 125%, with comps launching 63% higher. That's powerful growth for an $18 billion clothier.

And analysts responded across the board by raising earnings estimates and price targets. The current year EPS consensus estimate moved to $3.94 from $3.82, representing 22.5% growth. Next year was lifted to $4.70 from $4.56 indicating potential year over year growth of 19%.

Most price targets were moved slightly higher into a range of $105 to $115. Reportedly, Goldman Sachs was the outlier with a bump from $120 to $134, but I have not seen that report.

But investor reaction has been mixed as Wall Street digested information about declining gross margins. It seems there were questions about the available runway for this growth story and if investors were willing to pay more than 20X for EPS growth that might be leveling off to 20%.

A Long Bias for KORS

I think the KORS craze and market penetration globally is far from over. Especially when they work so hard to have so many fashion accessories at so many price points. Their "accessible luxury" strategy speaks to, and opens the wallets and purses of, more than the affluent.

I have traded KORS stock twice in the past year for my FTM portfolio, first buying last July at $63 and bagging 25%. Then we bought again in December in anticipation of a great holiday quarter. We were not disappointed as we caught the big February pop to new highs above $90 and grabbed 12% gains.

Though I am a big fan of the Michael Kors company, its products, and its marketing strategies and global growth opportunities, I rely on the retail analysts who focus on the industry to sort out the real potential of the stock as an investment.

What Do the Analysts See in KORS?

What made me buy the stock again in June, besides the core growth story still being strong, is that I liked the commentary from several analysts. Here's a sampling...

JPMorgan analysts revisited KORS in last June after British handbag retailer Mulberry reported dismal sales efforts in high-end bags. They raised estimates, even introducing their FY16 EPS number of $4.80 (we are currently in Q2 of KORS FY15 which ends next March). They also raised their PT from $100 to $104 based on 25-26X their FY15 estimate of $4.00, or 21-22X their FY16.

Europe, Men's, and jewelry markets/categories are considered "$1 billion opportunities" for the company by the JPM analysts and these areas will drive growth beyond women's handbags. Though the bears here could still force a test of $86 and lower, I am confident this stock will be approaching $100 again in the next six months.

Deutsche Bank analysts raised their price target from $105 to $110 and had this to say in response to the gross margin concerns...

"While there are many moving parts to this increasingly complex global company, the bottom line we believe is that Kors once again delivered on both results & guidance. Though FY15 plan came in at least in-line with expectation, even so, we believe management is being conservative. Primarily, we note that plan calls for gross margin normalization, but management made it clear that hasn’t happened yet (and we don't think that back-half of 1Q compares get more difficult)."

Piper Jaffray analyst Erinn Murphy met with management recently and had many good things to say about their plans and solid execution. She reiterated her Overweight rating and $115 price target.

"Management was bullish not only on near-term trends but also on the multi-category opportunity for further market share gains over time. We believe Q1 comps are tracking above 20% globally. The company is investing behind e-com, product, supply chain, stores and people as sales continue to grow in the range of $1B/year. We expect operating margins in the 29% range for the next two years. Our recent European checks confirm that the brand is taking significant 'white space' that exists below high-end luxury."

The big take away for me was that these analysts and others are as bullish on KORS for the longer-term as I am. They see the international opportunity as still being in the early innings and they view the handbag wars (which KORS is still winning) as only one battlefield they excel on.

The Global Opportunity

The $75 billion accessories category of the global luxury goods markets is the fastest-growing sub-sector of apparel. And this is 85% of KORS current sales.

Management sees the potential for 700 stores internationally, including 400 in North America (currently 288), 200 in Europe (80), and 100 in Japan (37), with potential to eventually acquire licensed Asian geographies. KORS plans to add 110 stores in F2015, including 45 in North America, 55 in Europe, and 10 in Japan.

According to GuruFocus.com, "KORS opened 7 stores in the Asia-Pacific region, bringing the total count to 94 stores, including a new flagship store in China. Management expects around 200 retail locations in the Asia-Pacific region. Kors also opened two stores in Brazil, expanding its presence in Latin America. The company currently has seven locations in Latin America and expects it can support 40 retail locations over the next several years."

To solidify their Asia strategy, the company created a new leadership position and filled it with some key talent. Stephane Lafay has been named to the newly created role of President of Asia, reporting to John D. Idol, the company’s Chairman and CEO. From the company's June 30 press release...

Mr. Lafay’s appointment, effective July 28th, 2014, reflects the brand’s powerful momentum in the region and its sustained focus on growth. "This is a pivotal moment for the brand as we continue to invest and work to build a strategic roadmap for the Asia region," says Mr. Idol. "Stephane has a long history of building luxury businesses in Asia. His skills and experience will be a tremendous asset for us going forward."

Mr. Lafay was most recently at Tiffany & Co., where he held the position of Senior Vice President, Asia Pacific and Japan. Lauded for his leadership and in-depth knowledge of the region, he led the brand to consistently strong results.

"The Asian market is an important region for us to develop as we continue to grow our global luxury brand," says Mr. Idol. "We’re excited to take advantage of the momentum our brand has recently generated. In the past two years we’ve been able to double our store count to over 100 locations in the region. Stephane’s experience and leadership will help enable us to capitalize on our momentum in the region."

"I’m delighted to be joining Michael Kors at such an exciting moment in the brand’s development," says Mr. Lafay. "Having worked in Asia for 25 years, and spent nearly two decades building brands in the region, it’s clear to me that there is enormous opportunity for Michael Kors there. I look forward to being part of the team that turns this potential into reality."

It sounds like they picked the right guy for that "enormous opportunity."

Multi-Channel Excellence

According to Baird Equity Research, "KORS utilizes several marketing avenues to project its 'jet-set' image, including print (three 40-page catalogs per year), increasingly online/social media, fashion shows, and editorial (strong relationships with press)." Baird analysts have a $114 price target on KORS.

Obviously, Michael Kors the man now carries the cache of a Ralph Lauren (RL) with global fashion consumers after his celebrity run on the hit show "Project Runway."

What makes KORS above-and-beyond the average retailer is their global reach and brand appeal, their diverse "accessible luxury" lines that attract middle class fashionistas too, and their multi-channel marketing strategies in retail and wholesale. The company strategy is not hit-or-miss like many retailers. They are going for the jugular as THE all-encompassing and innovative lifestyle brand for more than the jetset.

And that's why it was nice to see Steve Mandel of Lone Pine Capital increasing his stake in Q2 by 25% to 11.3 million shares, probably on those dips below $90 in April. He's a conservative fundamentally-driven investor with a long-term view and he's clearly not done watching the KORS growth story take his investment higher.

Neither am I. And that's why I was buying the dips below $90 in June and it's a Zacks Rank #1 (Strong Buy).

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