Fleck: AMAT Flunks Margin-of-Safety Inspection
By Bill Fleckenstein
01/29/2003 18:20
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First off, I'm going to spend some time talking about the early action because I think the details are important. The overnight markets were rather wild, starting with the runoff in the stock index futures yesterday afternoon, when they were smashed and driven below the cash value of the indices. They sort of idled around those prices until the president's speech began, and then started to sink further. As for the foreign markets, Asia was roughed up for a couple percent, and Europe was very weak at one point last night, led by the DAX, which was down almost 4%. At that moment in time, our S&P futures traded down to about 836, implying a cash price of probably around 833, which would have been a decline of nearly 3%.
Dead-Fish Manure Fertilizes SOX : With those as the evening lows, our stock index futures and the European markets began to grind their way back. The futures opened with their losses pared by more than half. An immediate selloff at the open took us down about 1.5% across the board. The market then began to claw its way higher. Interestingly, the semiconductor-equipment stocks were all green in the early going, on the back of what Novellus NVLS had to say last night, and also an upgrade from a dead fish (much more about that below).
The early-morning selloff was the low of the day. The market spent the rest of the time grinding higher, though it was a labored affair. I didn't see anything too shocking to report. Not surprisingly, the SOX was the best subindex. The mere fact that it held in rather well recently when the market was weak almost guaranteed that it would be the first object of OPM lust once that crowd felt the tape was turning. Turning to irrelevance, the FOMC held its scheduled seance today. It was a complete nonevent, so there's no point in commenting on it.
Away from stocks, fixed income was slightly lower, and ditto for the dollar. Gold was down 1% and silver 2%. It should be noted that those markets saw a good deal of back-and-forth motion, alternately red and green.
Of Ancestral Woe and Grounds for Heave-Ho : Now I would like to make a couple of prefatory comments before turning to the president's speech. First of all, let me make it perfectly clear, as said in Monday's Rap , that I am bearish on the stock market and the economy because of the stock market bubble, which spawned high equity valuations (from which we still suffer), and the misallocation of capital.
I am not bearish because of the potential for war with Iraq. I happen to believe that taking on Iraq is something that needs to be done. I believe the world will be a better place for us having done so. I do not take this position lightly. It is one that I came to only recently, after looking at all the evidence. I realize this may strike some who hold opposing views as a controversial statement. Everyone has his own opinion, and I certainly don't mean that everyone should hold mine.
In any case, I thought the president's speech was terrific. That said, he didn't explain (as many had hoped) why we need to attack Iraq this second. But once you understand all the points he outlined, I don't see the reason for delaying. We've let Hussein slide for a very long time. Now it should be clear to everyone that we are going forward. As for the people who are opposed to war, I think there is every possibility that once it commences, their viewpoint will change, and the war fear will lift.
Pre-Emptive Exuberance : Of course, a lot of people who don't really understand what our problems are will then say that the economy will improve and the stock market will improve, and we'll probably have an epic rally. I don't believe the second-half rebound scenario, and I plan on shorting into it rather aggressively, though I don't know what the timing of that will be. Again, this is all part of the plan I laid out this year, which so far seems to be working, though I'm sure won't be before all is said and done.
Obviously, things could go badly in the war, and we could have some terrorist incidents. But I would make the argument that we are likely to have terrorist incidents anyway, and that getting rid of a guy like Hussein, and his ability to supply terrorists, will make the world a better place, not a more dangerous place. So I think Bush's approach is good for the world. Were equity valuations not so preposterous already, it would be bullish for stock prices, but valuations are what they are, which is far too high.
Oval-Office Ovation : As for the economy, I don't believe the president's plans will be of much help. I would prefer that the government stop trying to prop things up. To reiterate my thoughts, the problems of the economy, and the stock market, cannot be fixed by government intervention. If the government would get out of the intervention business until such time as the economy and the markets are attempting to clear on their own, we'd be much better off.
Intervention only prolongs the painful process that needs to play out in the unwinding of the stock market bubble. I would just note here that having a real estate bubble in the midst of this unwinding will not make things better, and, in fact, will make them worse before all is said and done. But net-net, I like the direction in which President Bush is taking the country. I especially think that we will all benefit by his ideas on tort reform, especially vis-a-vis medical malpractice.
Security Analysis Vs. Applied Malarkey : Returning to dead-fish land, where malpractice is alive and well, I would like to take a moment to perform a little security analysis 101 on Applied Materials AMAT . This morning, the company received an upgrade by a dead fish I know, and who should have known better. I have a copy of his report, which is a good example of what passes for securities analysis these days.
Basically, he says that, "Simply, while picking SPE semiconductor- production equipment market-pricing bottoms is not possible, the risk/reward is better than 50/50. We have a 12-month target of $18 and believe the downside will be limited by October lows in the $10 range." Well, I don't know about you, but I'm not sure I want to risk $3 to make $5. But I like the idea even less when one sees how he came up with the $10 risk and that $18 target.
Taking the high target first, he says, "That is 3.8 times AMAT's book value. Since 1995 (excluding the bubble), the company has traded at an average of 4.8 times its book value." He goes on to say, "That is also 28 times calendar year 04 EPS estimates, which is the 12-month forward P/E at which AMAT has traded since 1995 (excluding the bubble)." The first problem is, I don't know how you say "since 1995, excluding the bubble," because the bubble basically started in 1995. From 1995 to now was the bubble, so I don't know what tiny period was eliminated from that analysis.
In 2000, AMAT earned $1.21. I would make the argument that we will never see semiconductor capital-equipment expenditures like this for a very long time. So I would say $1.21 is the most this company is going to earn for many, many years. A price of $18 would be about 14 times that estimate, which seems to me like a decent peak multiple for a capital-goods supplier to a cyclical industry that is swimming in excess capacity, such that many manufacturers are running at some 40% of capacity, plus or minus.
Guilty of Target Malpractice : In all probability, that $18 price target is too high, especially when one considers that in 2001, AMAT made 56 cents; in 1999, it made 47 cents; and in 1998 it made 27 cents. If you count 2000 as the bubble year, and you take 50 cents as a better approximation of what AMAT might be able to earn, and you even use the 28 multiple that he's talking about, the best you're going to come up with is a $14 price target, which is where it is today.
Now, let's talk about the downside. I don't know why he would pick the October lows, other than for pure arm-waving. Historically, these companies have bottomed out at 1 times revenues or 1 times book value, which would indicate a price target of $3 to $5. So, here is a stock that has almost no upside. But even granting $4 of upside to his analysis, AMAT could easily have $8 to $10 worth of downside. Following such analysis is exactly how people proceed to lose lots of money. In my opinion, it offers a terrible risk/reward. The idea of trying to determine risk/reward, and bringing those ratios in your favor, is what investing is all about. It's important to build in a margin of safety. This is a good example of building in no margin of safety, and doing a lot of arm-waving on the back of a false reference point, which was the bubble.
Fred 'Bone Crusher' Hickey vs. the Dead Fish : And it is a very good example of how the "investment process," as undertaken generically on Wall Street, is flawed. Fred Hickey, who shares my views, also received the same report on AMAT this morning. He found its premise so stunningly false that he took it upon himself to write back to the dead fish in question. Now, just so you understand what it takes to get Fred's blood pressure up this high, I've known Fred for about eight years, and this is the first time he's ever sent out an email. In any case, he gave permission to share the email here, perhaps to be able to influence "the process" going forward. This is not meant to pick on this particular fellow, as I think he actually means well. But it's exactly the type of shoddy nonsense that has to stop. Without further ado, here is what Fred had to say:
"I am horrified! I'm also happy because I'm currently not short any of the equipment stocks, having taken considerable profits recently. However, I can't let this pass. AMAT upped to buy on valuation ? Yet AMAT's current valuation 'remains high' and is 'not suitable for value-based buyers'? This is embarrassing. AMAT is one of the most overpriced tech stocks that I can find. It sports a current P/E ratio of 83 and 4.3 times sales. It's 68 times fiscal 03 First Call estimates.
"Intel is slashing 03 capex. Micron admits it has already spent 70% of its fiscal 03 capex budget. TSMC slashed capex yesterday. Last night Chartered forecast 35% lower capex in 03 (they have negative 50% gross margins) and virtually no cash. Today, UMC sliced its 03 capex 38% from 02, and stated 'the high era for foundry is gone forever.' DRAM prices are plunging due to an increasing glut and punk demand. Sammy's Samsung upping capex, but for how long, given plunging DRAM prices? There's an admitted Q1 glut of cell phones (NOK & MOT). There's five weeks excess of disk drives. HP has several weeks excess of PCs.
"Celestica last night missed Q4 numbers and lowered Q1 estimates, due to limited visibility in IT and communication infrastructure. Chartered blamed its poor results on a work-through of excess inventory at one or two computer customers. There's up to 10 weeks of inventory of PDAs personal digital assistants . There are so many excess Sony PS2s that they're selling them on the Internet at sharp discounts. The glutted, indebted and weary U.S. consumer is dying, and we're on the cusp of war. And you're upping AMAT?
"Your use of average forward P/Es is ridiculous. Everyone should know by now that forward P/Es are nonsense and have been 200% wrong in recent years. I'll give you a prebubble P/E ratio for AMAT. Try a 14.7 times trailing (real) average annual P/E ratio for the years 1988 to 1996. That's nine consecutive years where AMAT's average annual P/E ratio never was above 20.5, yet on an apples-to-apples basis, an 83 trailing P/E rates an upgrade to buy??? (By the way, the bubble did not begin in 1999. I'd argue it was 1997.) AMAT's average annual P/E ratio in 1995 was 13.8, and was 10.3 in 1996. AMAT's stock bottomed in 1996 at $2.70 per share at a price/sales ratio under 1.0, on the cusp of the cell-phone explosion, and in the midst of the Internet-driven PC buying binge. That's when analysts could have upgraded to buys. As you readily admit, conditions are quite different today, with a terrible macro environment and virtually no new tech drivers of demand.
"As you know, I rarely write emails, but I couldn't let this pass by. This 'relative to' stuff and rationalizations using bogus forward estimates has got to stop. People will lose real money buying AMAT here, just as they have done over the past few years by buying on similar poorly thought out buy recommendations. We've known each other for years and I respect your work and your sharp mind. I wish you could take your 'buy' recommendation back, but the damage has already been done. Bubblevision (CNBC) has been flouting it all morning, of course, without the words of warning accompanying your piece. All the masses hear is 'buy' AMAT. Some of the suckers have already bought, and they'll probably sell -- at under 14.7 times earnings and under 1 times sales. All I can do is to try to influence your approach so that I'm not horrified when I read your future upgrade recommendations."
Enough said! |
