Report From The Front Lines
Here is an e-mail I sent to some of my friends and clients a few minutes ago:
The last three days, I’ve had the chance to look at earnings from four large cap stocks. Three are members of the S&P 500 and three are economically sensitive cyclicals.
The reports have confirmed my view that the economy and stock market are in very shaky condition. That’s because the top line continues to be very weak and valuations are stretched.
The four companies are: Best Buy (BBY), Adobe Systems (ADBE), Joy Global (JOYG) and Federal Express (FDX).
I will probably be writing about this in next week’s Client Note but here is a preview.
Best Buy’s US same store sales were positive at +4.8%. My interpretation is that consumer balance sheets are being repaired by the stock market rally and stabilization in the housing market (though not the high end). This has emboldened them to go out and spend, though they are still price conscious and bargain hunting.
Valuation here is no longer cheap with Best Buy forecasting $3.00-$3.15 in EPS this fiscal year for about a 14 current multiple.
Joy Global, a maker of mining equipment a la Caterpillar but smaller, reported a 44% decrease in bookings for the quarter ended October 30, 2009. Recall that commodity prices stayed high well into the recession, only peaking out in the Summer of 2008. Bookings are off 55% from the peak quarter ended August 1, 2008. Their business is holding up well due to past orders/bookings but this suggests things are about to weaken unless the economy and commodity prices really pick up.
Joy is forecasting $2.65-$3.05 in EPS for this fiscal year for a 19 forward multiple. That is too expensive for this type of company at this point in the cycle. It’s pricing in a full recovery up more than 300% from its 52-week low.
Adobe Systems reported a 36% EPS decline on a 17% revenue decline from a really strong 4th quarter last year. Adobe is trading at 23 times the just completed years earnings and 19 times analyst estimates for this year’s – which I believe are optimistic.
Federal Express reported a +3.5% increase in average daily US package volume – but revenue per package was off 19%. That resulted in a 10% decline in revenue and 30% decline in net income from the year ago period.
They are forecasting $3.45-$3.75 for this fiscal year – a 24 multiple on the current stock price.
There is some positive news here with Best Buy’s same store sales and Fed Ex’s US daily package volume improvement. There is more economic activity. But pricing pressure at both companies shows a high level of cost consciousness among consumers and businesses. The top line is still quite weak – though admittedly stabilizing over the last few quarters. The problem is that valuation now reflects all the improvement. Three of these stocks (JOYG, ADBE, FDX) are quite expensive on a valuation basis while Best Buy is fully valued.
Just on a purely fundamental basis, all of these stocks and the market as a whole are probably a Mild Sell.
But the key is the macroeconomic context. So much (all?) of the improvement is due to the US governments reflation of financial markets and their reflexive impact on the real economy. Should this reverse with dollar strength and financial market deflation, reflexivity will work in the opposite direction. The air will come out of the global economy and that will hurt corporate fundamentals. Valuations will then begin to look quite expensive and the market will be an unequivocal Sell.
All in all, these four corporate reports from the last three days have confirmed my overall view about the economy and stock market. I missed this rally but it is too late now to jump on board. Risks are weighted to the downside. Caution and capital preservation are the order of the day.