Thursday, January 11, 1996
MARKET CLOSE
INDEX:
I. Market News: Despite Budget Battle, Markets Recover Some Ground
II. Heroes: APAC, ATML, EMC, TDW, NWK, IRF, OMX, MIR
III. Goats: DNA, ABSI, LEA, SBO, LEAF, WLM, LECH, NMG, STUA, PWIR
IV. Investment Perspective: Rick Whittington Feature, Part One
V. Calendar: Friday's Economic Events
MARKET CLOSE
DJIA: 5065.10, +32.16 (+0.64%)
S&P 500: 602.69, +4.21 (+0.70%)
NASDAQ: 1011.10, +20.89 (+2.11%)
MARKET NEWS
After two days of complete thrashing, the stock markets pushed higher today, recovering a portion of its recent losses in heavy trading and a somewhat volatile session. The biggest gainers were in the technology sector (see Investment Perspective below) as earnings season begins to separate the recent winners from losers.
HEROES
Are markets efficient? In order to be efficient, information needs to be disseminated to all market participants in a reasonable manner. When Investor's Business Daily rehashed last week's news that APAC Teleservices <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:APAC)") else Response.Write("(NASDAQ:APAC)") end if %> planned to open ten new call centers, it was enough to cause the shares to rally $5 1/4 to $32 1/2. APAC is a recent IPO that allows companies to outsource their customer relations needs. Events like this only go to prove that information about a company is not equally disseminated to all investors, even when made public through normal channels, highlighting the fact that, yes, Virginia, the market is inefficient. This type of inefficiency is actually a boon to the small investor who can hone in and do research on fast-growing companies before they come to the attention of the Street. Another chipmaker, Atmel <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:ATML)") else Response.Write("(NASDAQ:ATML)") end if %>, rose $4 1/4 to $23 5/8 today not on earnings hopes but because of a lawsuit it filed today against its competitor, Silicon Storage for "willful infringement of patents." The suit seeks an injunction prohibiting Silicon Storage from making or selling the products in question.
Some analyst changes in the last 24 hours sent two stocks skyrocketing today. EMC Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:EMC)") else Response.Write("(NYSE:EMC)") end if %> , up $1 5/8 to $17 1/1, was raised to "strong buy" by Salomon after its competitor Seagate <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:SEG)") else Response.Write("(NYSE:SEG)") end if %> beat earnings estimates yesterday. "Our industry contacts indicate EMC continues to do very well in the marketplace," Salomon said in its report. In another industry entirely, Tidewater <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:TDW)") else Response.Write("(NYSE:TDW)") end if %> was raised to "buy focus" from "hold" by Rauscher Pierce Refsnes oil analyst James Wicklund. His opinion that higher utilization of vessels in operating theaters will translate into higher earnings translated into a higher stock price today as shares climbed $2 3/8 to $32 5/8.
Some earnings surprises pushed stocks up today as well. Network Equipment <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:NWK)") else Response.Write("(NYSE:NWK)") end if %>, which makes, off all things, networking equipment, beat consensus by a penny, which was enough to send shares up $1 7/8 to $25 1/2. Specialty chip maker International Rectifier <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:IRF)") else Response.Write("(NYSE:IRF)") end if %> beat estimates by 10%, climbing $3 5/8 to $23 7/8 today. What is a "specialty chip" maker? Read the Investment Perspective column below for details.
A management shake-up at OfficeMax <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:OMX)") else Response.Write("(NASDAQ:OMX)") end if %> caused investors to bid up the shares $1 3/4 to $19 1/2. George Mrkonic, vice chairman and president of Border's Group <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:BGP)") else Response.Write("(NYSE:BGP)") end if %> was pushed off the board today. Mrkonic had originally served as KMart's <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:KM)") else Response.Write("(NYSE:KM)") end if %> representative on the board when KMart still owned 25% of the company---a stake the ailing retailer bought back in July. This move signals OfficeMax's intransigence toward its former parent corporation and KMart's demands that OfficeMax ante up to cover a portion of KMart's massive debt.
The news has been all good for shares of Mirage <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:MIR)") else Response.Write("(NYSE:MIR)") end if %> recently. The stock rose $2 1/2 to $38 3/4 today when the U.S. Bankruptcy Court of Louisiana allowed the company to pick up bankrupt Capital Gaming for $55 million plus the assumption of liabilities of up to $6.5 million---apparently a steal. In an interview last week, a Mirage official quoted quarterly numbers $0.05 a share higher than the current consensus, citing record holiday attendance.
GOATS
It was up to Dan Dorfman today to say that the "Emperor had no clothes." The CNBC "financial correspondent" gave a bearish overview of Diana Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:DNA)") else Response.Write("(NYSE:DNA)") end if %>, a networking company springing full-grown from the forehead of a food distribution concern. Shares of Diana fell $3 to $15 1/8 today after Dorfman quoted a pro who said something the Evening News has maintained throughout the stock's torrid rise; the new networking business is a big unknown and may not be successful. Dorfman also mumbled something or other about a lot of competition and declining margins in the telecommunications equipment industry, but he failed to follow through with any details.
ABS Industries <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:ABSI)") else Response.Write("(NASDAQ:ABSI)") end if %> fell $3 to $3 3/4 today after the company stated that it would revise downward its first-, second- and third-quarter earnings. It characterized its recognition of some revenues in those quarters as "premature." The company also now expects to post a loss in the fourth quarter that will be greater than the current estimates. As a result, the company is not in compliance with certain covenants under a $40 million credit facility and could be driven into bankruptcy. The company is in discussion with lenders and plans to complete the previously announced acquisitions of Mercer Forge and A&M Machining for 1.6 million shares of stock---bargain basement at the moment. The company supplies cold and warm forged parts to automakers. Lear Seating <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:LEA)") else Response.Write("(NYSE:LEA)") end if %>, another automotive company supplier, was off $1 1/4 to $25 3/4 on no news, perhaps in sympathy.
Showboat <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:SBO)") else Response.Write("(NYSE:SBO)") end if %> traded downward today even as most gambling stocks made headway, losing $2 3/8 to $22 3/4. C.J. Lawrence slashed its 1996 estimates 16% to $1.40 a share in part to reflect Showboat's higher-than-expected depreciation cost of its Sydney, Australia casino. The Sydney casino is currently operating in a temporary facility while a permanent site is constructed, which explains why the depreciation expenses are out of whack. C.J. Lawrence claimed the permanent facility would open in October of 1997, ahead of the company's April 1998 projections. It is interesting that increased depreciation has hurt the stock so much since it does nothing to change cash flow or Earnings Before Taxes, Internet, Depreciation and Amortization---a popular tool to value companies.
Bad news on the future earnings front led two companies lower today. Interleaf <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:LEAF)") else Response.Write("(NASDAQ:LEAF)") end if %> floated down $1 11/16 to $7 9/16 after it told the Street revenues would only be $21 million for its third quarter and profits a mere $0.01 to $0.03 a share, compared to expectations of $0.06. Interleaf makes software to create and manage documents much like recent casualty Adobe Systems <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:ADBE)") else Response.Write("(NASDAQ:ADBE)") end if %>. Welman <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:WLM)") else Response.Write("(NYSE:WLM)") end if %> also got hosed for $3 1/8 to $20 1/8 when it said that fourth-quarter 1995 and full-year 1996 earnings would be "significantly below" the respective year-ago periods because of "recent deterioration of business conditions" in the worldwide fiber industry.
Shares of kitchen retailer Lechter's <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:LECH)") else Response.Write("(NASDAQ:LECH)") end if %> tumbled $1 1/8 to $5 1/2 today when the CEO, brought in last year to turn the company around, resigned. The Street took this as a capitulation that his 500-day plan to right the company wasn't going to happen and the shares were punished as a result. The bankruptcy of upscale fashion retailer Barney's did nothing to help matters; the bankruptcy of chain stores was very much on investors' minds today. Neiman Marcus <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:NMG)") else Response.Write("(NYSE:NMG)") end if %>, a competitor of Barney's, wilted $1 to $19 1/4 under the heat today.
Stuart Entertainment <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:STUA)") else Response.Write("(NASDAQ:STUA)") end if %> canceled merger talks with Gaming Lottery Corp. today, which caused investors to cancel the recent advance in its stock, pushing it down $1 1/8 to $6 7/8. In unrelated investment banking news, Palmer Wireless <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:PWIR)") else Response.Write("(NASDAQ:PWIR)") end if %> got hit for $2 to close at $17 3/4 when it announced the issue of 5 million more shares, mostly to pay down debt.
INVESTMENT PERSPECTIVE: Part One of Three
When the Chips Are Down, Or Rick Whittington: Not a Chip Off the Old Block, but the Old Block Itself
Part I. A Tale of Two Companies
Semiconductor and semiconductor equipment shares have been slaughtered in the days since analyst Rick Whittington issued a round of "sell" ratings on many high-profile companies. Theorizing that the semiconductor companies would enjoy "profitless prosperity" in the next year as revenues increased but profits did not, Whittington changed his estimated range for semiconductor growth from a 15%-20% clip to 0%-10% growth. Whittington believes that as profits dry up for semiconductor manufacturers, ambitious capital expansion plans will be curtailed as well, prompting him to downgrade the semiconductor equipment stocks as well.
Whittington based his conclusions in part on the dramatic shift in the DRAM market which caused shares of Micron Technology <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:MU)") else Response.Write("(NYSE:MU)") end if %> and Texas Instruments <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:TXN)") else Response.Write("(NYSE:TXN)") end if %> to tumble in recent weeks. The other crutch to his view is a 25% downturn in orders at National Semiconductor <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:NSM)") else Response.Write("(NYSE:NSM)") end if %> in the month of December. National Semiconductor makes more than 5,000 types of simple integrated circuits, with 60% of its product mix focused on analog and mixed-signal chips rather than higher-margin digital products. In generalizing from these two companies to the broader semiconductor market, however, Whittington has unfortunately failed to distinguish between two classes of semiconductors in his outlook---commodity chips and specialty chips.
In classic cyclical industries, analysts recognize a difference between companies that produce an easily replicated product and companies that employ commodity materials to make either a proprietary product or utilize a proprietary process to manufacture a semi-proprietary product. The chemical industry, for instance, has two classes of companies---companies like Rexene <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:RXN)") else Response.Write("(NYSE:RXN)") end if %> which produce raw materials and companies like Hercules <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:HPC)") else Response.Write("(NYSE:HPC)") end if %> which take those raw materials and make resins and polymers. Investors can expect consistent long-term growth in specialty chemicals manufacturers even though they can fluctuate from year to year. They can't expect the same sort of growth from the commodity companies. Hercules, for example, has grown earnings at a rate of 22.5% over the last five years; Rexene has seen earnings shrink an average of 56.4% per year over the last five years---an indication of how wide a difference in performance there can be between a commodity and specialty company.
The difference between the specialty and the commodity semiconductors that Whittington glosses is just as significant, as can be witnessed today. Xilinx <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ:XLNX)") else Response.Write("(NASDAQ:XLNX)") end if %> reported earnings per share of $0.41 a share today compared to $0.21 in the same quarter last year, even as Advanced Micro Devices <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:AMD)") else Response.Write("(NYSE:AMD)") end if %> reported earnings of $0.52 versus $0.52 in the same quarter a year ago. One company doubled its net earnings in the same period the other company's earnings remained flat. One of these companies is a commodity chip company and one of them is a specialty chip company; can you tell which is which? I thought you could.
Xilinx rose $3 9/16 to $31 13/16 today on the strength of its earnings, meeting expectations for the fourth quarter of $0.41. The strength of the Street's response is explained by the fact that it was reporting *THIRD* quarter earnings, where the consensus estimate was $0.39. Xilinx is a quarter ahead of the business plan and will probably have earnings projections upgraded over the coming days as a result. The company improved gross margins by 3% to 64% from 61% a year ago. I believe that analysts were probably guided toward a lower number by the company which is why their quarterly estimate was off by 4%. Cowen & Co. has already upgraded the shares to "trading buy" from "hold" based on the unexpected jump in those numbers---no doubt helping the shares today.
Xilinx offers customers a package deal---device architecture with complimentary programmable logic devices (PLDs) and related development software. What this means is that it creates significant relationships with the companies it supplies and it is very difficult for any low-cost Asian manufacturing facility to come in and steal their market share overnight. This is a stark difference from DRAM, SRAM and x486 chips which all can be duplicated easily by idle Taiwanese fabs, particularly given the fact that many companies will run DRAM fabs even if they make no money because it's excellent practice for building more sophisticated chips.
Speaking of easily duplicated chips, we have Advanced Micro Devices <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:AMD)") else Response.Write("(NYSE:AMD)") end if %> reporting flat earnings, up $1/4 to $17 7/8 today. On the surface it looks like the company beat estimates by $0.05 a share, making $0.52 EPS and analysts had expected $0.47. A closer look reveals that the company told analysts recently that earnings would fall short of last year's level, meaning the company did not really beat estimates but guided them lower by giving analysts very understated expectations. Revenues only increased 9% as gross margins declined a whopping 13% to 39%.
x486 chips account for about 50% of Advanced Micro Devices revenues, with flash memory accounting for another significant chunk. Buried are some nice products like PLDs and imbedded microprocessors, but they are not a significant enough part of the product mix to ward off the deleterious effect of the commodity chips they make. With Intel already on the x686 and Apple-Motorola-IBM still pumping out RISC-based PowerPC chips, the x486 has gone the way of the dodo, taking margins with it.
Is this just a fluke? I don't think so. The difference between the commodity company and the specialty company is massive; a specialty company can construct a "moat" around its core business that allows it to maintain generous gross margins. It is difficult to prove this with the same power that one can demonstrate that Hercules makes more sense than Rexene based on past EPS growth because the x486 has only become a commodity product with the introduction of the Pentium. The last fiscal year says a lot, however. Advanced Micro Device's earnings are off 17% year-over-year while Xilinx has boosted its earnings by 75%. In the past three years, a shareholder of Advanced Micro would have lost 2.6% a year while shareholders of Xilinx would have been rewarded with 56.3% a year.
But that is the past---what about tomorrow? Analysts expect the difference between this year and next year to be a repeat, with Advanced Micro making 15% less while Xilinx brings in 43%. Xilinx is expected to make $1.40 a share this year (which ends in another quarter) and $2.01 next year. Even after today's rally the shares trade at 16 times forward earnings. For a company that will grow about 40% next year, it can only be overvalued if you believe that this and the five-year growth estimates of 27.9% are completely bogus. This means a PEG of 0.64 and a YPEG/5PEG of 0.57 based on Xilinx's $32 price.
Compare now Advanced Micro Devices, which made $2.84 a share in fiscal 1995 and is estimated to make all of $2.17 next year, $3.55 the year after. In two years, earnings will increase 25%, an annualized rate of 12%, quite a bit below the 17% five-year growth rate analysts are quoting. Even though seemingly undervalued on a long-term basis, the ugly short-term where earnings will decrease 24% is what preoccupies investors.
Whittington's basing his views of the entire semiconductor and semiconductor equipment industry on commodity chip companies like Advanced Micro Devices, National Semiconductor and Micron Technology is the same as if chemicals analysts were only to look at Rexene in order to forecast the entire chemical industry and related capital equipment required to manufacture their products. It is the conflation of commodity with specialty that makes indicators like the book-to-bill ratio questionable and analogies based on a sole kind of company nothing short of stupidity. Despite the fact that Whittington's overall logic here is desperately flawed and that the "profitless prosperity" prediction only makes sense for commodity companies, the stocks have been hit across the board---none worse than the semiconductor equipment shares.
In Part II of our series tomorrow, we will examine the connections between the semiconductor and semiconductor equipment industry, attempting to filter through the flurry of information provided by the companies and analysts like Whittington in recent weeks. In the meantime, you can check out our Semiconductors folder in the Investment Research area, hosted by MF Chips, or Infrastructure on the Web (http//:www.infras.com) for information on both semiconductor and semiconductor equipment companies, not to mention some sparkling commentary.
CALENDAR: Thursday's Economic Events
---December Atlanta Federal Reserve Bank Economic Survey (10:00)
---Weekly Commercial/Industrial Loans (4:15)
Byline: Randy Befumo (MF Templar)