Companies that raise money aren't worth as much as those that actually make it
SMARTMONEY.COM: The Cash Stash
Dow Jones News Services
(Copyright ¸ 2000 Dow Jones & Company, Inc.)
By Cintra Scott
NEW YORK (Dow Jones)--When a company like Playtex Products (PYX) announces that rising interest rates will unexpectedly crimp its profits, investors get the picture: No industry is immune to Alan Greenspan's monetary fiddling.
But before you drop all your shares in consumer-products companies, remember this: Playtex didn't issue a profit warning just because it's a consumer products company. Its high debt level and steep spending plans made it especially vulnerable to the Fed's 50-point decision. Blame it on the balance sheet, not Greenspan.
With this in mind, we went screening for companies that have built up immunity to this interest rate pinch. Cooking up the recipe, we kept in mind that Wall Street almost always smiles on companies that generate cash. And when companies throw off lots of cash an environment of rising interest rates, Wall Street gets downright lovey-dovey.
Without excluding a single industry, we went searching for individual companies that have laudable cash-flow growth in their past and bright earnings growth in their future. With no other demands, 295 (out of 6,391) companies passed the test. These, we hope, are the companies that will use their own hard-earned money to fuel research and development, which is important for two reasons. First, companies that use their own money avoid profit-draining interest payments. Second, R&D spending keeps companies fit for future innovations.
Of course, any interest-rate-minded screen wouldn't be worth running without an eye to debt. It always bears repeating: Debt and high interest rates are a bad combination. (That goes for credit card-addicted consumers as well as top multinationals.) So, we screened for debt both relatively and historically. That is to say, we asked for companies with less debt than their industry peers overall (allowing for different debt levels within different industries). Then we demanded the survivors also have less debt now than they have had in the past. Once we set up all our hurdles, we found just 30 companies that passed muster.
The simple summary: yes to growing cash, no to growing debt. Be sure to check out the exact recipe to best interpret the screen's results.
What caught our eye first is that a biotech biggie like PE Biosystems (PEB) could have such a solid balance sheet. The company is known for its genetic analysis tools. Tony Blair and Bill Clinton may have hinted that new genomic discoveries should be shared (the subtext being "not sold") - but no one denies that there will be a market for gene-sequencing tools. PE Biosystems is capitalizing on that. At the same time, the company also offers tools for protein analysis and new drug screening.
PE Biosystems is still spending aggressively on research. But the limits of its aggression are also in view. Last week, the company officially called off its acquisition of Third Wave Technologies. The planned stock swap, announced back in January, came at a time when PE Biosystems' stock fetched about $170, or $85 after February's 2-for-1 stock split. But now, at Wednesday's opening price of $51, the stock trades for 40% less.
In a note Tuesday, Robert Olan of Chase H&Q explained that PE Biosystems was relatively inflexible about upping its offer terms and that Third Wave might have resented settling for less in its takeover. (What was estimated to be a $330 million offer is currently worth about $197 million.) Olan and others applauded the amicable parting for demonstrating PE Biosystems' fiscal restraint in executing its growth strategy.
Recently, Merrill Lynch's Todd Nelson initiated coverage of the stock with his firm's top rating. In his report, the analyst praised PE Biosystems' strong balance sheet, with $295 million in cash on hand. In addition, he lauded the company's "aggressive spending profile," supporting its "forward-looking nature," while noting that its long, strong history has given it "a financial profile unlike most others." That's what we're talking about.
Of course, PE Biosystems' fat cash stash does not mean it's without risk. It just means that in the high-risk world of biotech, this company actually has a rudder.
Meanwhile, the semiconductor world is more commonly known for its strong cash flow and low debt. The sector also boasts lofty valuations that defy analysis. But true believers argue that a tech leader is worth paying premium prices for. Everyone seems to know someone who knew someone who invested in Intel (INTC) years ago. The rest is history.
So for our screen survivors related to the chip world - PMC-Sierra (PMCS), MIPS Technologies (MIPS), Broadcom (BRCM) and Nvidia (NVDA) - we looked for some leadership. Word on the Street is that Nvidia, a graphic chipmaker, is beating out rival ATI (ATYT) in the lucrative high-end chip market. (ATI recently warned that it would miss its quarterly earnings estimates.) Thanks to Nvidia's rapid rollout of new chip designs, 3D alien invasions haven't been the same.
As we wrote back in March, Nvidia scored a huge coup by landing big business from Microsoft (MSFT). The Microsoft X-Box deal has already meant a $200 million payment from Redmond. That helps explain the growth of Nvidia's money tree from $61.6 million in cash in the January quarter to $269.8 million in the April quarter. Talk about a green thumb.
Like a good tech company, Nvidia isn't resting on its laurels. It is investing heavily in new products and technology - heavier than it has in the past. And with relatively little debt and good growth momentum, R&D spending looks like a good idea. Greenspan will have to look elsewhere if he wants to see his monetary policy working.
Of the smattering of retail stocks that landed in our screen results, we passed over the clothing stores - sorry, Abercrombie & Fitch (ANF) and Chico's FAS (CHCS). We headed to the consumer-electronics aisle to Best Buy (BBY), a stock recently troubled by Office Depot's (ODP) weak profit outlook. When Office Depot cited soft technology sales, Best Buy promptly swooned.
As a result, analysts rushed to check up on Best Buy as well as rivals Circuit City (CC) and RadioShack (TAN). For instance, Merrill Lynch's Peter Caruso got on the horn to check out the damage in the PC retail arena. His industry contacts didn't see any reason to fear a similar shortfall, Caruso reported Tuesday. Caruso also spoke to Best Buy management - despite their "quiet period" before earnings - who indicated they "felt very comfortable with the consensus outlook for sales and earnings for the quarter," (in Caruso's words). Consensus puts Best Buy's income at 28 cents per share, up 27%, with sales up between 8% and 10%.
But hold on: Everyone knows that interest rate hikes hurt retailers sooner or later. After all, curbing inflation and curbing spending go hand in hand, regardless of debt levels and cash stashes. So how much are the latest hikes hurting? With Best Buy, we'll know a lot more Thursday, when the company reports first-quarter sales data. (Earnings data will follow on June 13.)
Yet, despite being a traditional retailer (must we say "bricks-and-mortar" all the time?), Best Buy has some tech spending to do. While Scot Ciccarelli of Gerard Klauer Mattison believes the company is already stealing market share away from its aforementioned rivals, there's more aggressive growth plans in the works. Try not to groan when you read that the launch of BestBuy.com is a spending priority. Now that so many e-tailing mistakes have been made (ahem, boo.com ), BestBuy.com may be able to spend less and get more. Still, it's little wonder Ciccarelli and other analysts worry about the timing of its Internet launch. He's not sure that will jibe well with investors at the moment.
It was just about six weeks ago that we ran a related cash screen. This one highlighted an interesting market anomaly: companies that had more cash on hand than their total market capitalization. That is to say, certain lowly valued companies' shareholders could theoretically put claims on cash and get the businesses for free.
Without exception, all the companies that fit this odd bill were recent IPOs. But over time, both the cash and the cap for many of these companies have dwindled. The lesson here could be: Companies that raise money aren't worth as much as those that actually make it. That's the New Economy working the old-fashioned way.
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