Today's Lunchtime News looked at how the attack on Iraq is affecting oil & airline stocks. We've also got a feature on Sierra Semiconductor's retreat from the modem chipset business.
MF Merlin's Economic News today discusses the Conference Board's release on the composite leading, coincident, and lagging economic indicators for July and the National Association of Purchasing Management's August report on conditions in the manufacturing sector. You'll find the Economic News, as well as all our Special Sections, FoolWires, and earnings reports, on either the Evening News or Stock Research screens. In tonight's Fool on the Hill, MF Templar focuses on defense contractors. Enjoy!
Shares of RAMTRON INTERNATIONAL <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: RMTR)") else Response.Write("(NASDAQ: RMTR)") end if %> flew up $1 11/16 to $7 5/8 after the company announced that Japan-based Rohm Co. will produce Ramtron's new ferroelectric random access memory (FRAM) semiconductor chips. Rohm will market the chips under its own name, and will supply chips to Ramtron for sale under Ramtron's name, as well. FRAM memory is able to read and write data at high speeds, works with low power consumption, and retains data in memory even after power outages. Ramtron has deals in the works with Hitachi, Toshiba and Fujitsu, as well. "The commercialization of our technology represents the most significant development the memory market has seen in more than two decades," said L. David Sikes, Ramtron's chairman and CEO.
A soap opera revolving around fertilizer was staged today, and it left shares of fertilizer and chemical concern ARCADIAN CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: ACA)") else Response.Write("(NYSE: ACA)") end if %> up $2 1/2 to $24 1/2 after the world's largest potash producer, POTASH CORP. OF SASKATCHEWAN <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: POT)") else Response.Write("(NYSE: POT)") end if %> agreed to acquire Arcadian for $1.18 billion. Smith Barney analyst Robert Koort noted that the merger allows Arcadian to ''ride the fertilizer cycle with a bigger, stronger company.'' The two companies have different strengths, with Arcadian specializing in nitrogen, so Potash is expanding its scope with this buy, rather than seeking cost-savings. Meanwhile, phosphate pure-play FREEPORT MCMORAN <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: FTX)") else Response.Write("(NYSE: FTX)") end if %>, which had been in merger talks with Arcadian, is up $2 5/8 to $37, upped by J.P. Morgan from "market perform" to "long-term buy."
Wireless data communication networker METRICOM <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: MCOM)") else Response.Write("(NASDAQ: MCOM)") end if %> saw its shares pop up $2 1/2 to $13 7/8 after mutual fund manager Eric Ryback, who seeks value plays, discussed it in Barron's over the weekend. Ryback mentioned that it might be a takeover play, explaining that, "It's fairly unknown at this point except in San Francisco and Silicon Valley... They have no competition." Regarding when Metricom will generate earnings, he said, "I couldn't tell you... I think they asked the same of Craig McCaw. That didn't stop everybody from making a fortune." Also rising on Ryback's nod was URANIUM RESOURCES <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: URIX)") else Response.Write("(NASDAQ: URIX)") end if %>, up $1 to $12 3/4.
QUICK TAKE: Shares of INDIVIDUAL <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: INDV)") else Response.Write("(NASDAQ: INDV)") end if %> rocketed $1 1/2 to $7 1/2 after the company named Michael Kolowich, formerly of Nets, Inc., as its new President and Chief Executive Officer (CEO).
Power-conversion system developer ADVANCED ENERGY INDUSTRIES <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: AEIS)") else Response.Write("(NASDAQ: AEIS)") end if %> saw its shares lose power today, falling $1 1/2 to $5 1/2. The company announced that due to weakness in the semiconductor industry, it is downsizing its workforce by 7%, taking a $750,000 pretax restructuring charge for severance and facility-consolidation expenses, and employing several cost-cutting initiatives. In addition, senior management has recently cut its own salaries by 10%. Advanced Energy stressed that its other businesses, such as data storage and industrial equipment, are doing well. UBS Securities cut the firm from "buy" to "hold," citing a "sharp decline" in orders from original equipment manufacturers (OEMs).
DECISIONONE HOLDINGS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: DOCI)") else Response.Write("(NASDAQ: DOCI)") end if %>, which provides multivendor computer-maintenance and technology-support services, crashed $3 3/8 to $13 3/8 today on investor worries. The company traded around $20 only last week, but Wall Street is concerned that although DecisionOne has landed several new contracts recently, it has not adequately explained how these deals will affect its bottom line. The company is expected to earn $0.33 per share for its first quarter. Recent contracts have been with NETSCAPE <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: NSCP)") else Response.Write("(NASDAQ: NSCP)") end if %> and COMPAQ <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CMP)") else Response.Write("(NYSE: CMP)") end if %>. J.P. Morgan analyst Daniel Kunstler opined that the stock is "oversold."
Shares of YOUTH SERVICES INTERNATIONAL <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: YSII)") else Response.Write("(NASDAQ: YSII)") end if %> spent the day in detention, tumbling $5 to $14 3/8 after the company issued an earnings warning. Youth Services, which develops and operates programs for youths, particularly juveniles who have committed crimes, said that it sees its fiscal 1996 earnings $0.10 to $0.14 lower than originally expected. Blamed were costs involved in the purchase of Introspect HeathCare Corp. and the attempt to purchase Three Springs Inc., and early conversion of its 7% convertible debt. In fiscal 1995, the company earned $0.40 per share.
Shares of ROTECH MEDICAL <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: ROTC)") else Response.Write("(NASDAQ: ROTC)") end if %> slumped $1 5/8 to $14 5/8 after a Barron's article speculated that lower Medicare reimbursement for oxygen therapy would impact profits. In the same boat, AMERICAN HOME PATIENT <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: AHOM)") else Response.Write("(NASDAQ: AHOM)") end if %> dropped $3 3/8 to $21 1/8, APRIA HEALTHCARE <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: AHG)") else Response.Write("(NYSE: AHG)") end if %> was off $3/4 to $24 1/2 and LINCARE HOLDINGS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: LNCR)") else Response.Write("(NASDAQ: LNCR)") end if %> slid $1 5/16 to $36.
An Investment Opinion
by Randy Befumo (MF Templar)
FOOL ON THE HILL
The Peace Dividend
Shattered irrevocably in 1990, the destruction of the Berlin Wall symbolized the end of the Cold War for many. Erected in 1961 to contain East Germany's fleeing masses, the twelve-foot high edifice extended almost 103 miles before it was finally demolished. Even more deeply ironic was the opportunity that the Wall afforded capitalists after it was knocked down. Enterprising businesspeople quickly snaked in and scooped up the remnants. They would sell the fragments of spray-painted stones to starry-eyed Westerners looking for souvenirs, who would place these rocks on the mantle and sleep a little more soundly with the threat of Communism gone.
Optimism abounded in the early 1990s, particularly with regard to military spending in the United States. With the disappearance of the Wall, the United States could finally trim down its military presence in Europe and use the money saved as a "peace dividend" to put to better purposes. Phrases like "strategic defense initiative," "mutually assured destruction" and "destroy the village to save the village" disappeared from our vocabulary overnight. Robert McNamara, the former auto executive-turned-architect of the Vietnam War, declared it was all a mistake and went back into business after he had expiated his conscience. The world was magically transformed into a better, safer place overnight.
Flash forward to the mid-1990s. Pentagon planners now regularly hunker down over maps of the world, trying to parse out where American interests lie and how to best defend them. Rather than one final cataclysmic battle we can deter with an immense military machine, we have a handful of simmering regional conflicts that ironically could take more troops to contain. Scenarios are drawn out for multi-front wars where two rogue states break free from the constraints of civilized behavior simultaneously, plunging the U.S. military into wars on two separate continents. Logistics, manpower, transportation and tactics would all be stressed to the breaking point. Uniformly, both the Pentagon and Congress turn towards one solution -- technology.
Ironic, isn't it. Those tired old defense contractors you thought were dead in the early '90s have shown an uncanny persistence, consistently winning a bigger and bigger piece of the Federal development pie every year as the weak among them have been killed -- either cast aside on the dustbin of history or consumed by the larger, stronger predators. Whether planes, tanks or missiles, the general theme is the same -- bigger, better and able to do it on automatic. Twenty-seven Patriot missiles smashing into Iraqi air defense compounds is just a fraction of the military hardware we need to deploy at a moment's notice -- the cadre of fighters and bombers that normally follow compromising air defense facilities literally are now waiting in the wings. Now more than ever, the United States needs its defense contractors.
Strangely, being a defense contractor has not exactly meant that your name has been synonymous with "growth" in the investment lexicon. This is an odd feature when you consider the fact that each of these companies has a pretty well-defined franchise. Becoming a defense contractor is not exactly something you can do overnight -- the capital outlay involved in getting the work is so tremendous that virtually no one except the established players can compete. Fool HQ ain't gonna be designing and testing the next generation of tanks anytime soon. Two or three companies share massive worldwide markets, often getting sales with the assistance of a United States government very favorably inclined to foreign powers. With uniformity being one of the military's key norms, a key win can mean billions to a contractor over the life of a product.
Despite the fact that there is a big hurdle to jump to get into the defense contracting business, once you are there are a lot of fixed costs you can leverage off of to generate ample free cash flow. The reason why I think most investors fail to look at the contractors as closely as they should is the multiples to earnings at which they trade. By typical growth stock standards relative to their growth, 16 times earnings for GENERAL DYNAMICS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: GD)") else Response.Write("(NYSE: GD)") end if %> or 15 times earnings for RAYTHEON <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: RTN)") else Response.Write("(NYSE: RTN)") end if %> seems rather pricey when the company is growing at five to ten percent a year. However, if you consider these companies based on the dividend they pay, the free-cash flow they generate, their price-to-sales ratios or their value as franchises to potential acquirers, things start to shift a little. Especially considering that a large portion of the revenues for names like GENERAL ELECTRIC <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: GE)") else Response.Write("(NYSE: GE)") end if %>, ALLIEDSIGNAL <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: ALD)") else Response.Write("(NYSE: ALD)") end if %> and UNITED TECHNOLOGIES <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: UTX)") else Response.Write("(NYSE: UTX)") end if %> comes from defense contracts, you can see that 18 to 20 times earnings is not necessarily exorbitant for a contractor.
Thankfully, I have plenty of good company in staking out this intellectual position. Contrary to popular "We-don't-like-technology" opinion, Warren Buffett's Berkshire Hathaway took a 15% stake in General Dynamics in July of 1992 and still holds a substantial portion of that initial investment. Initially purchased as an arbitrage opportunity for a Dutch auction General Dynamics was holding, Buffett soon realized as he looked at the business that it conformed to many of the franchise criteria he had placed on consumer brand names. Today, with below market multiples, above market dividends and continuing franchises, one could make an excellent case that there is still some remaining value in many of the contractors.
The markets are very segmented and belong to just a few players in each key area. BOEING <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BA)") else Response.Write("(NYSE: BA)") end if %>, NORTHRUP GRUMMAN <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: NOC)") else Response.Write("(NYSE: NOC)") end if %> and MCDONNELL DOUGLAS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MD)") else Response.Write("(NYSE: MD)") end if %> split up almost all of the fixed-wing aircraft, with United Technologies and McDonnell Douglas vying for the helicopter market. LOCKHEED MARTIN <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: LMT)") else Response.Write("(NYSE: LMT)") end if %> remains securely in place as the largest general contractor, making everything from submarines to cruise missiles. Northrup, General Dynamics, AlliedSignal, United Technologies, General Electric, HUGHES ELECTRONICS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: GMH)") else Response.Write("(NYSE: GMH)") end if %> and Raytheon all compete for remaining share, with ROCKWELL INTERNATIONAL <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: ROK)") else Response.Write("(NYSE: ROK)") end if %> holding a significant piece of the defense electronics and semiconductors market.
Any trip through relevant company reports will reveal a heck of a lot of consolidation going on in the industry in the past few years. Whether it was Lockheed and Martin Marietta or Raytheon and E-Systems merging, or events like Northrup Grumman relieving Westinghouse of its defense electronics business, many of these companies will grow revenues through acquiring smaller units or companies with their excess cash flow, and will bring value to shareholders through the gobble-to-grow approach. All in all, the New World Order requires much more integrated and larger defense contractors that form stable monopolies, sharing a market between two or three names. This sort of business configuration is exactly the kind of stable franchise Fools like to look for in consumer names -- simply transplanting it to another industry while maintaining the standards makes perfect sense. Ask Warren.