The Motley Fool, 8/22/97: The Evening News

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SMART MODULAR TECHNOLOGIES <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: SMOD)") else Response.Write("(Nasdaq: SMOD)") end if %> gained $9 5/16 to $59 on ringing up 3Q EPS of $0.57, blowing away the Street's expectations of $0.46. Smart Modular is a contract manufacturer that offers over 500 products under the "SMART" and "Apex Data" brand names to leading OEMs and distribution channels in the computer, networking, and telecommunications industries. The entire contract manufacturing segment has seen a dramatic rise over the last year. Analysts see 1998 earnings of $2.15 per share, up 22% from trailing EPS of $1.76, which is quite a premium to its trailing PE ratio of 33. This PEG ratio of 1.5 is in stark contrast to industry valuations just eight months ago. What has prompted the valuation shift? Average five-year industry operating margins of 23% combined with robust asset turnover provide some clues.

Casino and hotel operator BOYD GAMING CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BYD)") else Response.Write("(NYSE: BYD)") end if %> rolled $1 7/16 higher to $8 11/16 on the strength of a Deutsche Morgan Grenfell upgrade from "hold" to "buy." Boyd benefits from having a diverse property base that prevents the company from relying solely on Las Vegas, which has seen considerable additions to supply over the last year. Boyd recently reported Q4 EPS of $0.12 ($0.06 after a charge), a 100% increase the prior year quarter. The company indicated that upon completion of its Treasure Chest Casino acquisition, it will have will have four strong cash flow properties in its central region, essential in keeping the momentum going. For further information check out the Gaming Industry message board.

QUICK TAKES: JILIN CHEMICAL INDUSTRIAL CO. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: JCC)") else Response.Write("(NYSE: JCC)") end if %> apparently wasn't reacting to J.P. Morgan's "market underperform" rating granted today, as the Chinese petrochemical concern moved higher $2 7/8 to $36 7/8... Chip maker CYPRESS SEMICONDUCTOR <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CY)") else Response.Write("(NYSE: CY)") end if %> climbed $1 to $16 1/2 after Morgan Stanley initiated coverage of the company with a "strong buy"... Morgan Stanley analyst Bruce Missett reiterated his "strong buy" rating on the shares of retailer KMART CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: KM)") else Response.Write("(NYSE: KM)") end if %> after meeting with Kmart Chief Executive Floyd Hall, helping Kmart shares gain $3/4 to $14 1/16... Gaming powerhouse CIRCUS CIRCUS ENTERPRISES <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CIR)") else Response.Write("(NYSE: CIR)") end if %> had the odds in its favor today, rising $1 5/16 to $24 3/8 after reporting Q2 EPS of $0.26, still short of estimates... Client/server customer interaction software firm VERSATILITY INC. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: VERS)") else Response.Write("(Nasdaq: VERS)") end if %> rose $1 1/4 to $9 5/8 on posting Q1 EPS of $0.01, versus $0.04 in last year's Q4... Shares of initial public offering KENDLE INTERNATIONAL <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: KNDL)") else Response.Write("(Nasdaq: KNDL)") end if %> gained $2 from its offering price of $14 as the contract research organization closed the day at $16... After announcing that it would bring caller ID to the Japanese market, shares of CIDCO INC. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: CDCO)") else Response.Write("(Nasdaq: CDCO)") end if %>, a supplier of Caller ID and other intelligent telephone equipment, rang up a gain of $1 3/4 to $17 3/8... Last night IOMEGA CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: IOM)") else Response.Write("(NYSE: IOM)") end if %> said it is expanding its Zip products with the introduction of the ZipPlus, which zipped the stock up $1 1/6 to $23 11/16 today.

RETIREMENT CARE ASSOCIATES <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: RCA)") else Response.Write("(NYSE: RCA)") end if %> was hit for a $1 11/16 loss to $9 15/16 after agreeing to accept fewer shares in its merger agreement with long-term care and sub-acute care provider SUN HEALTHCARE GROUP <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SHG)") else Response.Write("(NYSE: SHG)") end if %>. Under the old agreement, Retirement Care holders would have received 0.68265 Sun shares for each Retirement Care share. That agreement has been changed to 0.52 shares of Sun for each Retirement Care share. Healthcare industry consolidation looms large in this week's Industry Snapshot on hospitals.

Chip maker INTEL <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: INTC)") else Response.Write("(Nasdaq: INTC)") end if %> lost $2 1/4 to $96 1/8 after Merrill Lynch analyst Tom Kurlak lowered his rating on the company to "near-term neutral" from "buy." Kurlak did not really identify anything wrong with Intel, but he's hypothesizing an industry slowdown. Like a good deal of industry analysts who have called for a slowdown in PC demand, Kurlak might be in be setting himself up for a personal replay of Waiting for Godot. In the face of Information Technology (IT) managers going toward multi-Pentium servers to drive NT networks and Intel's lock-down on the rest of the PC market, a short-term call on Intel seems silly for Merrill's retail investor clients. Maybe Kurlak should identify which calls are for institutional clients, which calls are for his all-star analyst rating, and which are for investors.

The war between MCAFEE ASSOCIATES <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: MCAF)") else Response.Write("(Nasdaq: MCAF)") end if %> and SYMANTEC <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: SYMC)") else Response.Write("(Nasdaq: SYMC)") end if %> looks more and more like the ongoing squabble between CADENCE DESIGN <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CDN)") else Response.Write("(NYSE: CDN)") end if %> and AVANT! <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: AVNT)") else Response.Write("(Nasdaq: AVNT)") end if %> every day. This morning Symantec issued a press release claiming that McAfee had copped to "misappropriating" some of Symantec's software code. McAfee now says that it did nothing of the kind, with General Manager Zach Nelson commenting this morning, "It would certainly be a novel approach for McAfee to admit something through a Symantec press release... [a]nd it should have been your first clue that the statement is completely inaccurate." McAfee says the 100 lines of allegedly nonfunctional code to support the NEC9800 in Japan are absolutely irrelevant to the VirusScan product. Certainly the publicity Symantec has generated has hurt shares of McAfee, down $4 1/4 to $55 today, while shares of Symantec have risen nicely in the past few weeks. Although this ongoing battle leaves a lot of open questions, this update courtesy of Mr. Nelson helps clarify today's Fool Plate Special in the Lunchtime News.

QUICK CUTS: SYSTEMSOFT CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: SYSF)") else Response.Write("(Nasdaq: SYSF)") end if %> fell $3 1/8 to $9 1/16 after the utilities software company reported a 50% decline in Q2 EPS. The company also forecast weak results for the rest of the year... TEXAS INSTRUMENTS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: TXN)") else Response.Write("(NYSE: TXN)") end if %> fell $6 1/4 to $118 3/4 under the rating downgrade axe of Merrill Lynch today, which lowered its opinion on the DRAM and DSP chip maker to "near-term neutral" from "near-term accumulate"... PEERLESS GROUP <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: PLSS)") else Response.Write("(Nasdaq: PLSS)") end if %> lost $1 1/8 to $5 1/8 after the financial information systems provider said it will not meet Q3 EPS estimates of $0.13 to $0.14 because of a disappointing sales performance... CONSO PRODUCTS <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: CNSO)") else Response.Write("(Nasdaq: CNSO)") end if %> unraveled $3 to $11 1/4 today after the maker of decorative trimmings warned that fourth quarter earnings could be as a low as $0.16 per share due to an inventory adjustment at its British Trimmings unit... British specialty publisher M.A.I.D. PLC <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: MAIDY)") else Response.Write("(Nasdaq: MAIDY)") end if %> lost $1 1/8 to $13 1/2 after the company said yesterday that it is in talks regarding the possible purchase of the Knight Ridder Information unit of KNIGHT RIDDER INC. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: KRI)") else Response.Write("(NYSE: KRI)") end if %>.

Don't invest in capital intensive businesses. This little aphorism is one of the premiere bits of wisdom passed around among modern investors. What is meant by "capital intensive" is never really clarified, but these investors know the names of the usual suspects. INTERNATIONAL PAPER <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: IP)") else Response.Write("(NYSE: IP)") end if %>, ALCOA <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: AA)") else Response.Write("(NYSE: AA)") end if %>, INTEL CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: INTC)") else Response.Write("(Nasdaq: INTC)") end if %>, and DELL COMPUTER <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: DELL)") else Response.Write("(Nasdaq: DELL)") end if %> for starters. Investors also know the names of the companies that are not capital intensive, those that run "light" businesses like COCA-COLA <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: KO)") else Response.Write("(NYSE: KO)") end if %>, WRIGLEY <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: WWY)") else Response.Write("(NYSE: WWY)") end if %>, PROCTER & GAMBLE <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: PG)") else Response.Write("(NYSE: PG)") end if %>, and KELLOGG <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: K)") else Response.Write("(NYSE: K)") end if %>.

"Capital intensity" is a measure of how much money relative to a company's stream of income that it has to spend on hard assets like plant, property, and equipment in order to keep the business running. People see pulp, alumina, semiconductor chips, and personal computers and they imagine massive factories maintained at exorbitant costs. They then imagine flavored syrup, chewing gum, liquid detergent, and boxed cereal and they smile, knowing it cannot cost that much to put together such a tiny package. Obviously one can just look at a company's products and assess how capital intensive the business is. Or they can they?

One objective way to assess the capital intensity of a business is to measure the capital expenditures disclosed in the Cash Flows from Financing section of the Statement of Cash Flows and compare this to the company's earnings before interest, taxes, depreciation, and amortization (EBITDA), also known as gross cash flow. Capital expenditures are the actual money the company is spending on the expensive, cash-sucking machinery instead of having leftover cash to pay dividends, repurchase shares, and buy shareholders birthday cards.

As for the gross cash flow, the reason you want to compare the capital expenditures (cap ex) to earnings before interest, taxes, depreciation, and amortization is because you want to assess all the cash a company has at its disposal, not just what the accountant calls "earnings." You back out interest income because it does not come from operations, taxes because they are only paid if there are earnings left after the cap-ex, depreciation because this is a non-cash charge against earnings made to spread the cost of hard assets over time instead of recognizing them all at once, and amortization because this is typically goodwill relating from an acquisition charge that is also spread out over a long period to even out earnings. As for interest expense, if there is any, for the purposes of our examination, we will leave this deducted from the earnings.

To figure out the cap ex to EBITDA ratio for the eight lovelies mentioned above, I took a quick jaunt over to www.edgar-online.com and looked at each company's last 10-K filing for the full year. You can also get the same information from www.freeedgar.com and www.sec.gov. I looked up the last 10-K for each in order to make calculating the gross cash flow easy (as cash flow is cumulative and not broken out quarterly). Cap ex is found on the Statement of Cash Flows, as mentioned above. EBITDA is a little more difficult, but not impossible. Interest and taxes are on the Income Statement, while depreciation and amortization are on the Statement of Cash Flows in the Cash Flows from Operations section.

Any bets on which one of these companies is the most capital intensive and which is the least? Here they are in order of how much of their cash flow is consumed to keep the operational furnaces burning.

      
Company             CapEx  EBITDA    %  

Int'l Paper       $1,394   $1,827   76.3%
Alcoa               $996   $1,846   54.0%
Procter & Gamble  $2,179   $6,027   36.2%
Intel Corp.       $3,024   $9,797   30.9%
Kellogg             $307   $1,111   27.6%
Wrigley's           $102   $406     25.1%
Coca-Cola           $909   $4,837   18.8%
Dell Computer       $114   $761     15.0%

International Paper and Alcoa, spending more than half of their gross cash flow on new equipment, certainly fit the picture of capital intensity we have been trained to anticipate. International Paper in particular had an awful year in 1996 as paper prices unexpectedly fell while some kinds of pulp used to make paper actually rose in price. These are obviously not enterprises with much cash left after buying the necessary equipment to keep things going.

While most of the companies play out as one might have expected, the conventional wisdom defies expectations in a few regards. The much-ballyhooed capital intensity of Intel only outmatches the "light" Kellogg by a few degrees. Capital-intensive Dell Computer, toiling in the trenches manufacturing commodity PCs, somehow manages to run a "lighter" business than Coca-Cola, defying all conventional wisdom. Brand-king Procter & Gamble chews through more capital making toilet paper and potato chips than Intel does making network interface cards (NICs) and semiconductor chips.

Although there are certainly other lessons to draw from this exercise and definitely other ways to assess capital intensity, the most important thing an investor should keep in mind is that things are not always as everyone believes. This is particularly true in matters of investing where far too many are quick to assume what is true and only bother to check the actual facts much later, if at all. For those souls buying Procter & Gamble over Intel because Procter & Gamble is less capital intensive, perhaps another glance at the balance sheet might assist them immeasurably.

HEWLETT-PACKARD <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: HWP)") else Response.Write("(NYSE: HWP)") end if %>
(800) 633-8284 (code: 2857062) -- replay through 8/22

HOME DEPOT <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: HD)") else Response.Write("(NYSE: HD)") end if %>
(402) 220-3005 -- replay through 8/22

ROSS STORES <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ROST)") else Response.Write("(Nasdaq: ROST)") end if %>
(402) 222-9936 -- replay through 8/26

ACE CASH EXPRESS INC <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq:AACE)") else Response.Write("(Nasdaq:AACE)") end if %>
(800) 642-1687 (give last name and confirmation #566078) -- relay through 8/27

DELL COMPUTER <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: DELL)") else Response.Write("(Nasdaq: DELL)") end if %> Call
HEWLETT-PACKARD <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: HWP)") else Response.Write("(NYSE: HWP)") end if %> Call

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