Are AMAT comparisons good for CYMI?
This Jim Jubak article from Microsoft Investor supports CYMI's story re: SE Asian situation, because DUV lasers can be used to retool "existing" plants if serious delays hold up new plants next year. He uses PRIA as an example in the article. This contrasts with his opinion of companies who get most of their business from the construction of "new" fab plants -- for which he uses Applied Materials as an example.
With AMAT's earnings out on Friday, this perspective may come in handy to either piggy-back on any good news or distance CYMI from AMAT if the picture isn't quite rosy.
Staring Down Those Monsters
"A hard look at the Asian-market goblins hiding
under investors' beds shows when to be
frightened. And when not."
By Jim Jubak
Microsoft Investor
November 19, 1997
Sometimes you just have to look for
monsters under the bed before you can go to
sleep. My 2-year-old taught me that. Trying to
calm him by insisting that monsters don't
exist never works. We have to get down on
the floor together and peek under the bed. I
doubt that he can really see anything down
there in the dark, but the act of confronting
the monsters calms him. He's usually
resting peacefully within minutes.
Right now, investors are clearly behaving as
if they, too, are afraid of monsters under the
bed. The Dow sinks 100 points on no real
news, then climbs 100, but everyone is
looking nervously over their shoulders. I don't
think you'll get much peace in this market
from simply denying that the troubles in Asia
could take a big whack out of earnings; that
the financial unrest that has rattled Thailand
could shake South Korea; or that the
Japanese banking system could implode.
Instead, I think we need to admit these
possibilities, see how bad things could get,
and figure out how a worst-case scenario
affects our portfolios. It's the last step that
turns this from an exercise in scaring
ourselves to death into a useful bit of
investing homework. Let me build a scary
story for you and then apply it to the stocks in
Jubak's Picks to show you how you can do
this with your own portfolio.
Make no mistake about it: Things could get
very ugly in the next few months.
We all felt pretty good when the Dow Jones
Industrial Average bounced back almost all
the way from the 550-point loss it suffered on
Oct. 27. Investors looked at the financial
crisis that had spooked them and felt
chagrined. After all, this was a crisis in
Thailand, Malaysia, the Philippines, and
Indonesia, not in Japan or Mexico or
someplace really important to the U.S. The
gurus reminded us that these four countries
accounted for just 4% of total U.S. exports in
1996. Abby Joseph Cohen of Goldman
Sachs, the most respected bullish analyst of
this bull market, attempted to put the official
nail in that coffin of worry when she said that
trouble in Southeast Asia might actually be
good for U.S. earnings. Cohen put her
clients' money where her mouth was, too,
increasing Goldman's recommended
allocation to stocks by 5%.
But instead of coming to heel, foreign
markets showed new weakness. Hong Kong
continued to teeter. That Hang Seng is now
down about 28% for the year. Latin American
markets shuddered in sympathy as investors
worried that the over-valued Brazilian real
would be the next currency to fall. The Bank
of Korea had to intervene to support that
country's currency. Overnight interbank
interest rates in Seoul rose to almost 15%.
And worst of all, Japan's Nikkei stock index
tumbled to 15,082 on Nov. 14, its lowest level
since July 1995.
All the toppling dominos of Asia lead to
Japan. Japanese banks have lent at least
$87 billion in Hong Kong. Thanks to falling
stock and real-estate prices, some of those
loans aren't likely to be repaid. Not exactly
what the country's banks -- who have an
estimated $500 billion in bad loans on their
books -- need.
By rigorous accounting standards, South
Korea is close to broke. According to SBC
Warburg Dillon Read, South Korean
companies should earn only about $1.2
billion in profits this year -- about
one-seventh the 1995 level -- thanks to an
economy that seems headed for just 3%
growth in 1998. On the debit side, those
companies owe about $110 billion to foreign
banks, and about $70 billion of that is
short-term debt due within a year
South Korean companies will try to export
every last widget that they can in order to
make payments on whatever part of that debt
they can't renegotiate. With the Korean won
already cheap and likely to get cheaper,
Japanese companies will be forced to
viciously cut prices in order not to lose
market share to the Koreans -- their major
economic competitor in many Asia markets.
That's going to dent corporate profits in
Japan -- and result in lower share prices --
just as the country's banks face a March
deadline to adopt stricter international
reserve requirements. Japanese banks
trying to raise capital to cover write-offs for
bad loans and to meet the higher reserve
requirements have led the selling in Tokyo.
The preferred solution to the current
economic mess is likely to slow economies
from Brazil to Jakarta. Following International
Monetary Fund-approved austerity programs,
countries are putting the brake on domestic
demand to reduce imports and export every
available widget and sprocket to push the
balance of trade into the black. (Japan
doesn't need IMF prodding to adopt this plan.
The Bank of Japan seems determined to let
the yen fall so that Japanese companies can
export their way out of their current financial
difficulties.) With economic growth falling --
or already negative, as it is in Japan -- and
destined to go lower throughout Asia and
Brazil, where will everybody send those
exports? Hope you want to buy a lot of
Brazilian shoes, and Thai cement, and
Japanese TVs.
This scenario is the monster under the bed.
Take a good look.
Exactly how scary is this story? For the U.S.
economy as a whole, and for U.S. stocks as
a whole, not very.
Yes, it will definitely knock a few tenths of a
percentage point off economic growth in the
U.S. What about earnings? Well, Jeff
Applegate, Lehman Brothers' chief U.S.
investment strategist, calculates that 28% of
U.S. profits were earned abroad in 1996 and
just 20% of that came from the Asia/Pacific
region. That could hurt if, as some analysts
fear, slower worldwide growth persists. If
investors become convinced that the fourth
quarter of 1997 marks a peak in earnings,
price-to-earnings ratios will fall across the
market. That could leave the market stuck in
a trading range near current levels as
earnings per share continue to grow (albeit
at a slower rate) and multiples that investors
are willing to pay for those earnings slide.
On the plus side, the Asian crisis has
probably killed the possibility that inflation
will return any time soon. That -- plus slower
growth -- adds up to declining U.S. interest
rates, and that makes stocks more attractive.
Even a very modest decline in interest rates
from this point makes a rapid sell-off in
stocks less likely.
This scenario is likely to do big damage to
some individual stocks, however. Investors
will be uncertain about the effect of the Asia
crisis on earnings until they see several
quarters of profits, and when it comes to
stocks with "Asia problems," that's likely to
make them shoot first and ask questions
later. The market will show a bias to the
downside -- a tendency to read the glass as
half-empty -- that will make buying a stock
that's been hammered on bad news a risky
and painful proposition. The hardest-hit
technology stocks -- makers of memory
chips and equipment for the semiconductor
industry, for example -- aren't likely to bounce
back too quickly, since a steady stream of
bad news from Asian markets will constantly
remind investors of the risk in these stocks.
So how do you apply this to your portfolio?
First, forget about your losses and gains on
a stock -- those are all history -- and instead
recalculate each stock's potential upside
under this new scenario. This doesn't apply
just to technology stocks, either.
For example, I recommended Black &
Decker (BDK) for Jubak's Picks based on the
potential for a new line of products to put
some pizzazz into the company's bottom line.
(See "Tools For Investing.") Do I want to
continue to hold Black & Decker when the
economic scenario seems so different? The
global company sells its products into some
of the economies likely to show slower
growth next year. For example, Brazil was
Black & Decker's strongest growth market in
1996. The company certainly faces stiff
pricing pressures from Japanese and other
Asian producers in key product lines -- in its
1996 Form 10K, the company noted that
competitors' prices were already responsible
for pressure on operating margins.
Manufacturing in Malaysia and Brazil will help
costs at Black & Decker, but since the bulk of
the company's plants are in countries such
as the U.S., England, Germany, and Italy, it
seems a net loser on the currency/lower cost
front. Even though I'm down 12% on this
stock since I bought it, I think it's time to
move on to better opportunities.
With a technology stock, if the story that led
you to buy, or that currently entices you,
remains intact, consider the effect that time
will have on your potential reward. Applied
Materials (AMAT), for example, was
supposed to rebound from earnings per
share of $1.34 in the fiscal year that ended in
October 1997 to $2.11 a share next year. (In
fiscal 1996, the company earned $1.68 a
share.) A slowdown in Asia is likely to lead
some semiconductor makers to delay
ordering new equipment. How many will put
off orders is impossible to know at this point.
The fear is that the company will see
massive cancellations. So far, however, the
damage seems minimal. But say the worst
comes to pass and the rebound to $2.11
doesn't take place until fiscal 1999. What's
the effect of a year's delay? Instead of buying
a $36 stock today that would be worth $42.20
in a year (a price-to-earnings ratio of 20
times $2.11 in earnings), an investor
considering Applied Materials is looking at a
$36 stock that will be worth $42.20 in
November 1999. If the current troubles in
Asia do cost the company a year, instead of
getting a return of 17% in one year, you'd
reap 17% spread over two years.
If the story turns out to be less scary, the
stock should do better. And I know AMAT
looks cheap -- it is down $20 a share from its
52-week high. But I think there are better
bargains in the market -- stocks that come
with less "what-if" risk or where the
worst-case scenario is actually likely to put
money in the companies' pockets rather than
take it out.
You can find two such stocks among those
I've already recommended. PRI Automation
(PRIA), which I first wrote about in my June
20 column ("Selling Without Stress"), has
been killed along with the other
semiconductor-equipment stocks. But this
company makes equipment that improves
the productivity of new and existing
semiconductor factories. It simply isn't as
exposed as the rest of its industry to a
downturn in sales due to the cancellation of
new plants in Asia. Two recent acquisitions
have filled holes in the PRI Automation
product line, for the first time making the
company into a one-stop supplier of chip
automation equipment and software. I think
the stock is a definite buy at its current price.
Oil drillers and service firms such as the
Rowan Companies (RDC) are cheaper than
they were at the start of this market decline,
but only because panicky investors have sold
shares to lock in their big gains. A company
like Rowan -- which supplies international oil
companies with offshore rigs and provides
contract drilling of oil and gas wells on land
as well -- has more business than it can
handle at rapidly escalating prices. (See my
Oct. 21 column, "Which Direction After the
Dip?") The drilling and service sector is still
at the beginning of long upward trend, and
the recent sell-off is a good chance to get in.
Finally, I'm going to add one new idea to
Jubak's Picks. With the U.S. economy set to
grow -- although a little more slowly -- and
with U.S. companies facing increased
competition from cheaper imports, I'd
suggest investing in companies selling
efficiency and productivity. Paychex's (PAYX)
payroll service now makes up about half the
company's business, but I think its
rent-an-employee business and its
explosively expanding 401(K) retirement
record-keeping division are both likely to
prosper in an economy where corporations
use outsourcing to squeeze the last buck
from the corporate bottom line. (See my Oct.
24 column, "Top Dogs With Real Bite," for
more on Paychex).
See, sometimes even scary stories have
happy endings.
New Developments on Past Columns:
Stocking up on Biotechs
Ligand Pharmaceuticals (LGND) reported a
third-quarter loss of 35 cents a share --
above the 30-cents-a-share loss expected by
Wall Street analysts. But more importantly,
the company announced that its European
Phase III trials of Panretin topical gel showed
positive results for treating Kaposi's
Sarcoma. The company is expected to
announce the results from a U.S. Phase III
trial next month and to file a new drug
application with the Food and Drug
Administration early in 1998.
More Updates . . .
Changes in Jubak's Picks:
Dropped Black & Decker (BDK). I
recommended Black & Decker based on the
potential of a new line of power tools to put
some pizzazz into the company's bottom line.
But the global company sells its products
into many of the economies likely to show
slower growth next year. It also faces stiff
pricing pressures from Japanese and other
Asian producers who will be able to use their
weaker national currencies to cut prices.
Even though I'm down 12% on this stock
since I recommended it, I think it's time to
move on to better opportunities.
Addded Paychex (PAYX). Starting with a
single payroll-accounting business in
Rochester, N.Y., in 1971, Paychex CEO
Thomas Golisano, 53, has built up the
second-largest payroll-accounting firm in the
U.S. -- after Automated Data Processing
(ADP) -- by concentrating on the
small-business market. Although the
payroll-client base grew to 262,700
companies in the fiscal year that ended in
May, the company still has plenty of room to
grow, since about 85% of all small
businesses still do their own payroll. |
