WRFest 30Dec07(Business): Fragilities, Exposures & Soundness
Well here are the interesting stories on business for the week for industries and individual companies. Rather than summarize them, and there are worthwhile comments on the rising bankruptcy risks, the implosion risks as big banks and the finance industry being re-structuring (!), oil & energy, the wild world (literally) of the auto industry and more on tech, let's set the stage.
If it's not clear at this point we think the economy is slowing and seriously exposed to sudden & sharp disruptions as Housing and the Credit crisis worsen and it becomes more fragile. We also think that the Markets still haven't grasped this nor, definitely, is it reflected in pricing, earnings outlooks or valuations. Even on current course and speed with no major disruptions there's some serious re-thinking that needs to happen, at least IMHO. But if you start looking now and understand what's going on then there are going to be industries and enterprises that weather this storm, if not with style and grace. Finding them will be the trick and the trick to the trick starts with understanding the deeper structural fragilities that have been created by non-organic earnings and liquidity-driven buybacks. Well as is becoming a practice Paul Kasriel has already done the heavy lifting so we'll let his comments and charts speak for us. Here's the key point - on a macro level buybacks, real declines in profits and increased leverage indicate that business enterprises are very exposed to shocks if/when they come. In other words a hurricane will breach the dike and it'll take a well-founded company to manage the floods :). So pay careful attention to Paul's words and charts - think about 'em, 'cause they could be incredibly important.
Now it’s your turn, Corporate America. For
starters, the growth in your “operating” profits has slowed to a crawl – just 1.9% year-over-year in the third quarter (Chart 13). Moreover, if it were not for your earnings from overseas operations, which are inflated when translated into depreciating greenbacks, your profits would be contracting (Chart 14.) As Merrill Lynch’s chief North American economist, David Rosenberg, has reminded us, corporate hiring of U.S. domestic residents and capital spending in the U.S. depend on corporate profits generated in the U.S., not corporate profits generated in Germany or China. And while we still are on the subject of domestically-generated profits, note that profits from the nonfinancial sector have contracted four quarters in a row and the growth of profits from the financial sector have slowed significantly (Chart 15).
And the 2nd excerpt:
Despite this relatively poor corporate profit performance, the prices of corporate equities are up on the year. We wonder if it has something to do with the record amount of corporate equities that have been “retired” via share buyback programs and leveraged buyouts of late. Nonfinancial corporations have stepped up their credit market borrowing of late, both in absolute terms and relative to their cash flows from operations (Chart 17). Have nonfinancial corporations increased their borrowing to fund capital outlays? Apparently not, inasmuch as the ratio of their borrowing to their capital outlays is rising and now is just a shade below where it was in the first quarter of 1999 (Chart 18). So, as corporate profit growth is slowing, it appears that corporate treasurers are tapping the credit markets more to fund their share repurchases. With corporate borrowing costs rising absolutely and relative to the U.S. Treasury’s borrowing costs, how much longer will corporations be able to levitate the value of their shares via levering the corporation itself ?
Business
2008: Year of the bankruptcy Market analysts warn that more U.S. businesses are likely to hang "going bankrupt" signs on their doors next year as the twinned blows of slower economic growth and pricey commodities force the weakest companies to seek refuge from creditors. In a twist from this year's trends, the pain is likely to spread from mortgage lenders, homebuilders and consumer-oriented firms - all areas that contributed to a 40% jump in bankruptcy filings in 2007 and are expected to play a role in 2008's misery. Next year, industries at risk for the biggest increases in Chapter 11 filings include electronics makers, energy miners like coal companies and agriculture firms, according to Global Insight. Makers of durable goods like machinery are also more at risk and will likely contribute to a 13% rise in bankruptcies in 2008, says the private research firm, which bases its estimates on issuers' credit quality and operating conditions.
Outlook Darkens for Big Banks For major banks, the next few years will be a return to a simpler and possibly less-profitable time. The subprime crisis and ensuing credit crunch have thrown a wrench into the highly profitable bank business model: Make loans that are then sold off to investors while arranging corporate financing through off-balance-sheet vehicles that keep banks' capital costs down. Now, banks are holding on to more of the loans they make, as they did years ago. And the off-balance-sheet lending business is crippled. It isn't clear how long this will last, or how the banking model might evolve in response to the current market crisis. What is clear is that some of the banks' more profitable lines of business have been shut, either temporarily or permanently. The upshot: Bank investors expecting a big rebound in earnings growth after the debacle of 2007 will likely be disappointed. Wachovia CEO ready for dour 2008, Citi, HSBC reportedly eye asset sales
- Happy New Year? Don't Bank On It In the credit crisis, banks have been taking extraordinary steps to shore up their finances, selling stakes to foreign investors and snapping up loans from central banks. Now comes the yard sale. In a sign that they see tough times ahead, U.S. and European banks are considering sales of everything from branches to entire units. Buyers could be hard to find in an environment where many financial companies are in trouble. Still, say analysts, the motivation to sell is strong. For one, asset sales generate immediate cash at a time when banks are likely to face persistent difficulties borrowing money. Despite extraordinary efforts by central banks that appear to have fended off a year-end funding crunch, the interest rates at which banks lend to one another are still elevated amid worries about further losses on subprime mortgage investments.
Citigroup May Cut Dividend by 40% to Preserve Capital, Goldman Sachs Says Citigroup Inc., the biggest U.S. bank, may cut its dividend by 40 percent to preserve capital and write down more fixed-income securities than it has told investors to expect, according to Goldman Sachs Group Inc. The New York-based bank may write off $18.7 billion in collateralized debt obligations such as subprime mortgages, up from its Nov. 4 estimate of as much as $11 billion, Goldman's William F. Tanona wrote in a note dated Dec. 26. Citigroup, which paid out 54 cents each quarter this year, will have to raise $6.2 billion in extra capital to reach its target.
Bottomless Buffett Warren Buffett didn't call the bottom.That is the main takeaway of investors from Berkshire Hathaway's takeover of the Pritzker family's Marmon Holdings industrial complex. Markets have been abuzz with expectations the billionaire would use some of Berkshire's $50 billion war chest to scoop up financial firms floundering on the sandbars of the credit crunch, such as Countrywide Financial or Bear Stearns. Instead, Mr. Buffett, 77 years old, is making his first major acquisition in years in the dowdiest of sectors. Marmon operates more than 100 businesses making such heart-racing products as specialty tubing and intermodal tank containers. It couldn't be farther from the alchemy practiced by Mr. Buffett's rumored financial targets. It is, however, classic Buffett. It isn't just that the kinds of companies the Pritzkers built up over three generations are a type that Mr. Buffett, whose investments range from Coca-Cola and Benjamin Moore paints to an Omaha furniture emporium, understands well. The circumstance under which he is acquiring them is textbook Berkshire.Oil gusher: Tough act to follow It's been a phenomenal time to invest in oil, but analysts say the huge gains of the last year are most likely a thing of the past. 2007 was truly a banner year for the industry. The big integrated oil companies - ones that produce and refine crude - saw stock gains in the 30 percent range. Oil company stocks tend to rise and fall with the price of crude, so any prediction on stock prices needs to start with a look at the underlying commodity. Although U.S. crude is trading near $100 a barrel, 2007 was a very volatile year. Prices began the year by dipping below $50 in January, spiking above $75 in July, then pulling back to the high $60s by the end of August before embarking on its recent record run. For the year, the average price for crude was around $72. Most analysts have bumped up their estimate for 2008to around $80 to $85. But others think the sector is played out. "Fundamentally, it's expensive," said Jack Ablin, chief investment officer at Harris Private Bank in Chicago. "A lot of investors are eager to get into energy, and it's pushed the values to unattractive levels." Ablin said stocks of energy companies are expensive by a number of metrics. Their price-to-book value - the value of all their outstanding stock compared to book value of their underlying assets - is about 5 percent higher than the S&P average. Normally, energy companies have a price-to-book value about 15 percent lower, said Ablin. He said he sees a similar pattern with other measures like price to cash flow and price to sales.
Autos' year of living dangerously If you followed the money in the auto industry in 2007 you got some clues about where the industry is headed. And the future doesn't look anything like the past. Start with Chrysler going private. The money guys at Cerberus Capital who now own Detroit's Number Three automaker are turning it upside down. They brought in industry outsider, Bob Nardelli, as CEO and Nardelli is taking a fresh look at everything. Going forward, Chrysler will be eliminating models and possibly some brands, closing dealers, and laying off workers. One area where Nardelli has been particularly aggressive is in pursuing foreign partnerships. But if Chrysler succeeds, it could create a new model of cross-national alliances. Meanwhile, speculation is building about Cerberus' exit strategy from Chrysler, as well as its timing. For another cataclysmic change, how about minnow Porsche moving ahead with its plan to swallow whale-like Volkswagen? Finally, there is the evolving adventure of India's Tata Motors pursuit of two iconic British brands, Jaguar and Land Rover. At $2 billion, the price could be a secondary concern. The larger question: is the manufacturer of a $2,500 car is capable of designing, building, and marketing luxury vehicles? If the Tata deal goes through, it turns the entire auto industry into a global bazaar. What's next -- a Chinese company buying Alfa-Romeo? With rivers of capital free-flowing across national boundaries, the possibilities are endless. The failed marriage of Daimler and Chrysler may have been only the beginning of a global shuffling of brands and owners. The other day, a GM executive was speculating that the auto industry was sorting itself into two categories: two super-companies, GM and Toyota, with annual production of nine million vehicles each, and all the rest.
Toyota Raises 2008 Sales Target to 9.85 Million Vehicles on Global Demand Toyota Motor Corp. raised its sales forecast for 2008 to 9.85 million vehicles, cementing the company's lead as the world's most profitable carmaker. Sales will rise 5 percent from an estimated 9.36 million this year, the Toyota City, Japan-based automaker said in a release today. Toyota plans to make 9.95 million vehicles, also a 5 percent increase. The company previously forecast sales of 9.8 million next year. Toyota, close to ending General Motors Corp.'s 76-year reign as the world's largest automaker by sales, needs to sell more vehicles in emerging markets to achieve its targets, as demand for automobiles is forecast to decline in the U.S. and Japan, the company's two biggest markets. Toyota opened a factory in St. Petersburg, Russia, last week and will add production in China next year. Automakers are boosting sales and production in emerging economies such as China, Russia, and India, where rising incomes are making automobiles affordable to more people. The growth is offsetting slumping sales in Japan and the U.S., the world's biggest auto market.
Faces of Enterprise: Ratan Tata The ‘one-lakh car’ continues the chairman’s transformation of the group to global conglomerate, challenging preconceptions. Mr Tata will be one of the most visible faces of the new India in 2008. He was on Friday waiting to hear whether Tata Motors, a truckmaker that has diversified into passenger cars, had been successful in its offer for Jaguar and Land Rover, luxury brands put up for sale by Ford. In the wake of this year’s audacious $13bn (€8.4bn, £6.5bn) purchase of Corus by Tata Steel, the Indian company’s bid for these two prestige marques has again highlighted the risk-taking verve of one of India’s most ambitious corporate empire builders. The news will come as Mr Tata prepares to unveil the most keenly awaited car ever to roll off an Indian assembly line. Tata’s small car, which the Cornell-trained architect helped design, is slated to appear at the Delhi Auto Show on January 10. It will sell for Rs100,000 ($2,550, €1,730, £1,275) – a rupee figure known in India as one lakh – and bring motoring to a mass market. With a new plant in West Bengal able to make 250,000 a year, the “one-lakh car” will more than double Tata’s car capacity. “Mr Tata encourages us to take big, calculated risks,” says Ravi Kant, Tata Motors’ managing director.
Tech can fly high and crash hard, too The real appeal of tech is the potential for hypergrowth by any company, at anytime. And it can happen with new companies and old ones. Any company in the sector can have a burst of phenomenal growth because there is a fashionable aspect to technology, whether at the base semiconductor level or the consumer-electronics level. Much of this has to do with infrastructure in which the better part of a tech company is virtualized through the use of chip foundries, outsourced manufacturing, contractors and other ancillary operations. This allows for quick growth . So investors are generally enamored with tech, and if you discuss the topic with many of them you discover that they are often so enamored that they can't imagine technology being subject to the whims of the business cycle. In fact, many will deny the business cycle exits.
New Dell PC Design Rivals the iMac Something interesting is going on at Dell. The Texas personal-computer behemoth, long associated with boxy, boring machines, has started emphasizing industrial design. And the company, which in recent years seemed to care only about corporate customers, techies and hard-core gamers, appears once again interested in average, mainstream consumers who value simplicity. The most tangible example of this new approach is Dell's XPS One desktop -- an elegant, handsome, cleverly designed one-piece computer. If it didn't have the Dell logo on it, the XPS One might be mistaken for a product of the PC industry's design leaders, Apple or Sony. Like Apple's iconic iMac, the XPS One looks like it's simply a sleek, flat-panel monitor. The guts of the computer have been stuffed into the back of the screen. But this new Dell is no mere iMac clone. It makes its own style statement, even though it shares the same 20-inch widescreen display and a similar Intel dual-core processor with the base-model iMac.
Motorola's pain is Samsung's gain An emphasis on the fast-growing global market for cell phones costing around $40 has catapulted the South Korean company into the No. 2 spot in handset sales. Samsung Electronics confronts bad news on many fronts. The South Korean company is facing probes into an alleged bribery scheme, and its money-spinning memory-chip business is in the worst slump in five years. That's why Samsung executives must be thrilled to have their mobile-phone business, where the future appears upbeat. The numbers tell the story. Samsung surpassed struggling Motorola in 2007 to become the world's second-biggest handset maker after Nokia . Samsung's global market share is up about 3 percentage points from last year, at 14.5% in the third quarter, compared with Motorola's 13.1%. Samsung has set sales records in every quarter this year, with the 115 million phones sold in the January-September period exceeding the 114 million sold during all of last year. And Samsung believes its record-breaking run is just beginning. The company expects to sell 160 million handsets this year, a 40% improvement from 2006. Executives expect sales of 200 million mobile phones next year and a growth pace that's about double that of the rest of the industry.
Bewkes May Dismantle Time Warner, End Its Reign as Largest Media Company Jeffrey Bewkes, who takes over as chief executive officer of Time Warner Inc. next week, may be measured by how quickly he can dismantle the world's largest media company. Bewkes may spin off the cable-television division and sell the AOL Web and Time Inc. magazine units, said Gamco Investors Inc. fund manager Chris Marangi and National City Bank analyst Daniel Poole. The remaining company, anchored by the film studio and cable-TV networks, would resemble Viacom Inc. -- and accordingly command higher multiples, Marangi said.
