INDEX:
I. Market News: Another Drab Down Day
II. Heroes: Sallie Mae, Harley Davidson, Ibis Tech, Fresh Choice, Intermet
III. Goats: Charming Shoppes, Movie Gallery, Acordia, Charles Schwab, Landmark Graphics
IV. Investment News: Movie Rental Chains: Bargain or Bane?
MARKET CLOSE
DJIA: 4761.26, down 27.82
S&P 500: 581.72, down 3.94
NASDAQ: 1027.60, down 15.94
MARKET NEWS
Economic news suggesting a slowdown and perhaps a rate cut pushed bonds up throughout the day. More third quarter warnings put a decidedly negative spin on the stock market, as investors reconsidered whether or not that growth they were paying up for was really there.
HEROES
The Student Loan Marketing Association <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:SLM)") else Response.Write("(NYSE:SLM)") end if %>, better known to investors the world around as Sallie Mae, rose $2 1/4 to $56 today after the Board of Directors approved restructuring its service operations into a wholly owned unit after the market closed on Friday. Sallie Mae has been under pressure for most of the year due to the fact that the Republican Congress wants to privatize the quasi-government entity and end the direct financing of student loans by the United States Government, one of Clinton's programs. Apparently, investors believe that this latest development bodes well for Sallie Mae. Federal Home Loan <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:FRE)") else Response.Write("(NYSE:FRE)") end if %>, or Freddie Mac, and Federal National Mortgage <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:FNM)") else Response.Write("(NYSE:FNM)") end if %>, or Fannie Mae, have both been privatized with great success.
Harley Davidson <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:HDI)") else Response.Write("(NYSE:HDI)") end if %> recovered some of its losses today, rising $1 1/8 to $25 1/2, when Interstate/Johnson Lane initiated coverage with a "buy" rating. Analyst Lee Wilder believes that the recent pullback related to warnings of a disappointing third quarter represent a great time to get involved with a "solid, long-term growth story." The estimates the firm gives are for $1.40 in 1995 and $1.70 in 1996, which would give the stock a PEG of 1.31 and a 5PEG (which uses the five year growth rate multiplied by the 1996 estimates to get a fair price) of 0.79. Harley Davidson's third quarter loss is as a result of lower sales of parts and accessories than analysts had expected due to the dour retail environment.
Ibis Technology <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:IBIS)") else Response.Write("(NASDAQ:IBIS)") end if %> rose $2 5/8 to $7 7/8 today after the company signed a deal with blue-chip Motorola <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:MOT)") else Response.Write("(NYSE:MOT)") end if %> to expand its capacity to produce "separation by implamantion of oxygen," or SIMOX, wafers to meet Motorola's needs. Motorola wants the chips so badly it is financing the development of Ibis's next generation of SIMOX equipment. Motorola and Ibis also plan on collaborating to produce the SIMOX chips in mass quantities. Ibis recently reported a loss of $0.26 EPS versus earning $0.48 EPS in the year-ago period.
Narrowing losses at Fresh Choice <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:SALD)") else Response.Write("(NASDAQ:SALD)") end if %> boasted the stock price by $1 13/16 to close at $7 13/14 today. Fresh Choice reported today that it only lost $0.04 EPS in its third quarter, compared to consensus expectations of a loss of $0.17 EPS. The company has cut executive staff by 30% over the past six months and expects to have a new CEO shortly. Fresh Choice, which operates a chain of restaurants focused on salad and soup scatter-bars, has been hurting recently due to poor results caused by decreases in same-store sales and high store-opening costs. With a new CEO, the companies suicidal strategy of opening new units close to current ones, resulting in cannibalization of sales, might end.
Intermet <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:INMT)") else Response.Write("(NASDAQ:INMT)") end if %> popped up $1 7/8 to $13 1/8 today when it received an unsolicited offer to acquire the whole company for $13 1/2 per share in cash. GWM, Inc. and Kelso & Company submitted their offer on Sunday. Intermet provides precision iron parts to automotive and industrial customers in North America and Europe. The company has 25 million shares outstanding, bringing the entire price tag to $337.5 million. Intermet's Board says it will think the offer over.
GOATS
Charming Shoppes <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:CHRS)") else Response.Write("(NASDAQ:CHRS)") end if %> was the latest in a string of pre-announced "lower than expected third quarter losses" to hit the Goats column, down $1 9/32 to $3 7/32 today. Charming Shoppes, which stated that it would lose $0.20 to $0.30 EPS per share in the third quarter, opposed to consensus expectations of a loss of $0.02 EPS, is in trouble. The company is in talks with lenders to defer payments on its debts, will suspend cash dividends indefinitely and will need to restructure all of its commercial bank pacts in order to avoid bankruptcy. Dan Dorfman called this one, actually, stating on Friday that the company is experiencing "extreme" financial difficulty. Love him or not, gotta give him credit when he does make the call.
Growing fast, but not fast enough! Movie Gallery <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:MOVI)") else Response.Write("(NASDAQ:MOVI)") end if %> lost $7 15/16 to $34 13/16 after it reported to investors that revenues would triple for the third quarter ... but earnings would still not be up to snuff. The video rental chain was the latest high-flyer in this line of business to collapse. Hollywood Entertainment <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:HLYW)") else Response.Write("(NASDAQ:HLYW)") end if %> was hit had last week, coming off its 52-week high of $35 to its current level of $21 5/16 in a few hairy days. Video Updates <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:VUPDA)") else Response.Write("(NASDAQ:VUPDA)") end if %> has been hurting as well, down from its high of $13 set back in June. The news has been bad enough to force Movie Gallery to shelve a proposed 2.8 million share offering that had been previous announced.
Acordia <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:ACO)") else Response.Write("(NYSE:ACO)") end if %> killed insurance companies today when it reported, guess what, slack third quarter earnings coming up. Down $2 7/8 to $24 5/8, Acordia blamed its woes on a highly competitive California market, where softening rates in worker's compensation and managed care killed the bottom line. A slowdown in construction did not assist Acordia's construction insurance business either. Merrill Lynch and Alex. Brown exacerbated the sell-off by cutting their ratings on the company. Acordia sees a net of $0.20 EPS versus $0.42 EPS in the same quarter a year ago.
"Moderate Outperform" was not good enough for Charles Schwab <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:SCH)") else Response.Write("(NYSE:SCH)") end if %> shareholders today, as the company's shares sold off $ to close at $ when Goldman Sachs initiated coverage. Looking for 1996 net income of $1.18 EPS, Goldman Sachs analyst Richard Strauss actually was substantially above the existing consensus of $1.03 EPS and topped the highest previous estimate by $0.08 EPS. Strauss conceives of Schwab as an asset management company and not simply a discount brokerage. Schwab's mutual fund business, which accounts for 35% of revenues currently, is seen in Strauss's models to increase to 40% next year.
Landmark Graphics <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:LMRK)") else Response.Write("(NASDAQ:LMRK)") end if %> reported that it would not meet analyst revenue targets, dropping $2 to close at $27 today. Landmark will report $39.4 million rather than the $39.5 million to $42.5 million that had been anticipated. The real problem was lower than expected software revenues, $1.7 million below the $16.3 million that had been expected. Landmark Graphics supplies information systems to petroleum companies. The company will take a previously announced $3.1 million charge for "restructuring." This quarter, which is already going to be bad, represents an optimum moment for Landmark to pack all of the bad news into the balance sheet, which explains the size of the charge.
INVESTING NEWS -- More Market Movie Madness
Another slew of warnings about third quarter earnings eroded the markets poise and has sent us spinning lower. If you have not updated your portfolio today, brace yourself for what more than likely is going to be a string of negative numbers. Whereas the Dow Jones Industrials and the S&P 500 have basically been flat for most of the month, the Nasdaq Composite, full of those technology companies that Fools seem to love best, is almost down 5% off of its early September highs.
Understandably, the third quarter profit warnings would serve to spook the most shaky of money. But the extent of the sell-off in some cases goes beyond logic. Today I wanted to focus on two of the most recent whipping boys, Hollywood Entertainment <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:HLYW)") else Response.Write("(NASDAQ:HLYW)") end if %> and Movie Gallery <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:MOVI)") else Response.Write("(NASDAQ:MOVI)") end if %>, whose individual losses have detailed in previous Heroes & Goats columns.
Hollywood Entertainment and Movie Gallery both operate in the video retail business, a fast growing industry with consolidation contributing to profits through economies of scale. You can think back just a few years and recall when most of the purveyors of video rentals in your town were Mom & Pop shops run by locals. Now you head on out to Blockbuster Video (owned by Viacom) or one of the other corporate chains that is taking America by storm. (Viacoms's $2 1/2 point decline over the last two days has been linked to the news from Hollywood and Movie Gallery.)
Why are the corporate video rental places displacing the hometown heroes? Basically, it comes down to cash. Cash to buy inventory with, cash to buy enough inventory with to allow more generous rental terms as the industry moves toward the three day rental from the previous overnight position. Anyone who switched to Blockbuster or one of its 80-some cousins from the local places knows why the did -- a larger selection, you could keep the movies longer, you did not have to pay as much, you could get into frequent rental clubs, you had nationwide access to movies no matter where you were.
So if the industry is so great, which have Hollywood Entertainment and Movie Gallery, two of the largest publicly owned video rental chains, been hurting so much lately? Well, there really have not been a lot of hit movies that people have been coming out in droves to rent (along with an extra two or five as long as they are there). This summer and the previous spring have just not generated the big hits that most renters flock to stores to see. Also, with more and more rental dollars coming from video games and not just videos, the industry-wide contortions in the video game area translate over to the video rental industry. Without one dominant platform and a number of new platforms moving toward prominence, video rental stores are left with a lot of outdated video games they cannot rent and have to get rid of.
Hollywood announced on Thursday, September 28th, that is same store sales would be down 3-4% for September and its revenues in the third quarter would be 6% to 7% below consensus expectations. However, the company was still anticipating revenues increasing somewhere in the 77% range, fueled by the consolidation that has made these chains profitable. The stock fell further on Friday, September 29th, when Alex. Brown got out the scissors and cut their rating on the stock to buy.
Movie Gallery got hit today because the company said its revenue would increase only around 227% rather than the 236% that analysts were expecting. The reason why this small revenue difference matters a lot is because the fixed costs of running a video store are not altered that much by increased revenues, meaning that the 9% or so lost comes right out of the bottom line. Earnings will still increase 94.4% though, according to the companies estimates, rather than the 127% that analysts were expecting.
Even with a 7% downward adjustment to the estimates to account for the lost revenues, Hollywood Entertainment has a PEG of around 0.70 and a 5PEG of 0.47, with analysts estimating a 50% five year growth rate. Movie Gallery looks even more attractive after an 8% decrease in FY '96 estimates, PEGging at 0.58 with a 5PEG of 0.42. Granted, PEG valuations of a companies stock tend to get ridiculous the faster a company is growing, but with earnings of around $2.00 expected for Movie Gallery in 1996, it is currently trading at only 17 or 18 times that number -- quite a break from the near 100% earnings increases that it has been churning out of late.
An analyst took the opportunity of Hollywood's Friday decline to call the entire industry "cyclical" and "overvalued." Perhaps the Daily News is a little bit old-fashioned, but cyclical businesses are normally commodity oriented or prone to waves of technological innovation. Granted, Sony tried to sell the Betamax as a major technological improvement, but video rentals seem about as boom or bust as the movie industry -- meaning that it is dependent on hits and swings as a result, but does not have the characteristics of a true cyclical issue.
A quick glance at Movie Gallery's balance sheet (which I happen to have in my overburdened file cabinet) shows that cashflow has been nothing short of explosive, as the new stores generate high depreciation and amortization. With more stores coming on line, this cash flow supports the rapid growth by supplying the money to keep 'em running. As the movie rental business is a cash business, primarily, there are not accounts receivable to stay up at night worrying about, either.
The "gotcha" here, of course, is the terrible cash position that Movie Gallery is in, despite its great cash flow. Current assets only amount to $7 million according to the most recent financial statements, while current liabilities are $13 million and long term debt is around $5 million. One misstep in the expansion trail and the resultant cash squeeze could bring ruin upon the corporate heads. Hollywood, with current assets of around $56 million and liabilities of $28 million looks to be sounder than its twin.
Byline: Befumo/Sheard (MF Templar/MF DowMan)