Here is the relevant excerpt,
Scott Black
Barron's: It's been a tough six months for your kind
of stocks, Scott.
Black: We're up between 11% and 12% -- which, for
small- and medium-caps, isn't too terrible. But it's been
hard. We're getting hit on small tech stocks. Even good
values, with clean balance sheets, are cratering.
Q: Is the market going to stay tough?
A: I never try to forecast it. But on pure valuation, the
S&P's close today [June 17] was 1107. The operating
earnings are $47.50, so that's a 23 multiple; 4.5 times
book. You have roughly a 1.3% dividend yield. I think
the market is vastly overpriced. I would actually say
more overpriced than in '87. What it reminds me of is
the Nifty Fifty era -- 1973.
Q: The narrowing breadth is certainly reminiscent of
that era.
A: Also some of the blue chips, companies like Coke,
selling at over 40 multiples. It used to be the rule of
thumb that you shouldn't have a higher P/E on a growth
stock than its growth rate. Many of these are only
12%-13% growers. So this reminds me of Avon,
Xerox, Litton and Polaroid -- before they got bombed in
'73. Ultimately, 12%-15% growth doesn't hold up 50
multiples. For the stock market as a whole, corporate
profits were up only 2.9% in the first quarter, are
probably slowing again. I don't understand how you get
a 23 market P/E with no growth in profits.
Q: There are a lot of bang-up fourth quarters
expected.
A: Those analysts are looking a long way across the
valley. I'm a realist. If corporate earnings are growing
very slowly, they aren't suddenly all going to turn in the
fourth quarter. True, it's just one sector, but I've been
talking to companies we own out in Silicon Valley. Other
than the few that aren't hooked to PCs -- for example,
LSI Logic -- they tell me business just disappeared in
April and May. Whether it wasKLA-Tencor, Cohu,
Applied Materials, the story was the same. It's a lot
worse than many of the sell-side analysts want to
believe. The turn may come a lot later than people think.
Q: What's ailing them?
A: Korea and Japan are in desperate straits, and they
are a lot of the swing factor at the margin in those
companies' backlogs -- and there are no orders out
there. It's very hard for a Korean company to tool up
when it can't get a bank line -- and half those companies
are under water. That's the real issue. I asked, for
example, the No. 2 guy at KLA what it'll take to turn the
industry. He said it was getting the supply/demand
balance in DRAMs into equilibrium -- and we are a long
way from there.
Q: Are you giving up
on the techs?
A: One of the
companies I
recommended in
January is Integrated
Silicon Solution.
Jimmy Lee, the
founder, had worked
at Hewlett.
Self-made. Asian-American success story. Jimmy had a
terrific first quarter. Got revenues up on a sequential
basis to over $40 million versus $39 million. Got the
company back to break-even. Still has all cash on the
balance sheet. No debt. I just called Jimmy. Asked
about the second quarter. He said, "I am sorry to tell
you, but revenues are going to be back down in the mid-
to high 30s and we are going to be slightly below
break-even. Nothing I can do about it. We are beating
the competition on leading-edge SRAM. But demand's
down."
Cohu I recommended and the stock shot to 48. It's
back at 25. The second quarter was not bad. Gross
margins will be hurt by a new equipment launch. But
when I talked to the finance VP out there, he said, "My
backlog has died. I don't know what's coming on in the
third quarter. We don't have an order book now."
It is going to be painful. A lot of these stocks are killing
people. We don't own Novellus, but it's down 30 points
from its peak this year. Think about it. Interestingly, a lot
of these companies are selling below book. But it is too
early to buy them; there's no earning power. Brooks
Automation, on Route 128, we went out to seem them.
No earnings. It is selling below book. Electroglas, which
Rhonda Brammer has written about, was 12 this
morning. Has $7 a share in cash with no debt; it's selling
right around book. But again, no earnings.
In the technology sector, if you have a two- or
three-year horizon, you will do extremely well in those
sorts of names. But in the short term, there'll be pain.
Q: LSI, you said, is different?
A: Yes, because they have no content on the personal
computer. Theirs is a system on a chip, and their
business is doing extremely well, holding up sequentially.
This quarter will be up. They have a new fab coming on
in the fourth quarter, which they say should handle their
growth as sales go from $1.25 billion to $3 billion over
the next three years. So we could see $3- $3.50 in
earning power, two or three years out. This stock, which
I recommended in January, is a giveaway at 23. It is one
of the few tech stocks that's up in a down market this
month. Word has gotten out that their earning power is
holding up.
Q: Have you found another like that?
A: One. It has zero content on the PC. Still profitable.
It's here on Route 128. Altron. ALRN is the ticker; 10
5/8 today, 16 million shares, a $165 million market cap.
It did $172 million in revenues last year; earned 91 cents
a share, down from $1.11. But over the last five years
the company has grown its top line at 20%
compounded, despite last year's downdraft. Grown its
after-tax net 30% compounded, earnings per share, at
21%. They earned about 14% on book last year. The
prior four years, between 20% and 24% -- with zero
debt on the balance sheet, something I always like.
Q: What happened last year?
A: There was some margin pressure from competition.
Secondly, they expanded their plant substantially.
Capital spending went to $26 million to build a couple of
facilities. In the first quarter revenues were up, margins
were down slightly, so they had a 22-cent quarter versus
27. Not terrible. The founder says he thinks that's the
bottom of their cycle.
Q: What does Altron make?
A: Backplanes, basically connecting assemblies. They do
surface mount assemblies and multilayer circuit boards.
Stuff that goes into telecom, datacom and medical
devices. Their customers are 3Com, Cisco, EMC,
General Electric, Hewlett-Packard, KLA, Johnson &
Johnson, Lucent Tech, Motorola. The biggies. The hard
book is $7.50 a share. Net cash is about $15 million. A
bulletproof balance sheet. For '98, it'll earn between 90
and 95 cents. I have $1.25 next year. The P/E is 8; very
cheap. Obviously, underfollowed.
Q: How long has it been public?
A: Over 20 years. The stock has been decimated. It's
down from 21, sitting on its low. They turn inventories 4
1/2-5 times a year, so you don't have to worry about a
buildup of obsolete inventory. This year the cap ex will
drop to $10 million. Big positive free cash flow.
Q: What else has caught your eye?
A: Claire's Stores. It's controversial because Rowland
Schaefer is 80 years old, and the guy who was his No. 2
took a hike. But his successor has lived in the company
for several years. And the fact is, the company is
unbelievable. The gross margins are like 54%; it grows
15%-20% a year like clockwork. An enormous return.
The stock is 19; 48 million shares, a $920 million market
cap. Rowland Schaefer owns 6.2 million shares. Claire's
had $500 million last year in revenues, net of $58.2
million, or $1.21, with a 26% ROE. Generated $36
million in free cash. About $124 million in cash on the
balance sheet, with zero debt.
Their target is to grow square footage in the U.S. by
15% a year and to grow comparable sales 3%-4%.
They have done it historically.
Q: What do they sell?
A: Essentially, junk jewelry to little girls. Knockoffs of
bracelets and pierced earrings. Their average ticket is
$8.68. The stuff is made in China, but they have other
sources, too. Have 1,750 stores in the U.S. that do
$325 a foot. In England, they've opened a few and are
doing $700 a square foot. Unbelievable.
Q: Sounds like they've pretty well carpeted the U.S.
with stores, though.
A: They say they have enough places to grow for the
next four or five years. This year they are going to add
225 stores here. They are taking their jewelry concept
into a catalogue, called Just Nikki. And they just bought,
for very little, something called Mr. Rags -- 63 stores
that will go to 85. It's aimed at teenage boys who
rollerblade; sells jeans, outerwear. Claire's earnings
should be $1.42 for this calendar year, $1.65 next. It's
trading at 11 1/2 times next year's earnings. Generates
nothing but cash.
Q: Tell us about another idea.
A: This one is pretty controversial because we are near
the end of an economic cycle. But with interest rates
going down, it's awfully cheap and well run: Toll
Brothers. TOL on the Big Board. Stock is around 26
1/2, 36.9 million shares, $978 million market cap.
Q: Almost too big a cap for you.
A: It's okay. We are not finding great values in the really
big stocks now. We are not buying the Alcoas and
Phelps Dodges because demand, at the margin, for
metals is not too good, given what is going on in the Far
East. I think it's better to find small companies that have
good dynamics than to try to outguess people on the
large-caps at this point. Toll has an October 31 fiscal.
Builds houses, aims at an upscale, affluent buyer. Their
average home was $385,000 last year. It will go to
$400,000. They closed on 2,517 last year. Up 19%.
The backlog after the first quarter is $665 million, up
33%, year over year. They have expanded heavily into
Southern California, where there is such demand that
they're raising prices by $40,000 on homes and
instantaneously selling them out. In the first quarter,
revenues were up 21%, to $243 million. Net was $17
million, earnings per share up 18%. We've penciled
earnings in at $2.25 for this October, $2.65 next. So it's
trading at 10 times next year's earnings. It earns 19% on
book. Very high margins, some of the highest in the
industry.
I once asked Bruce Toll, who's a friend of mine, what it
would take in terms of mortgage rates to kill his
business. He said, "If it gets up near 9%, we are dead."
So you don't have to worry with jumbos at 7 1/2 %-7
5/8 %.
Q: Anything else?
A: Two thoughts: For about 10 picoseconds last fall
everybody got dismayed by what was going on in Asia.
Then the market took off in euphoria at the beginning of
this year as if somebody waved a magic wand and
Asia's problems disappeared. They haven't. I am still
very concerned that if, God forbid, something happens
to Japan, you'd have a real global pullback that would
affect the U.S. I don't know the Japanese psyche. For
some reason, they don't want to own up to their
problems. They have to reflate the consumer and get the
economy moving. The key is probably some
personal-income-tax cuts to spur consumption. But if
there's a run on the yen, this thing could cascade. My
other thought has to do with the fact that, despite all the
money we've spent on technology in the 'Nineties, the
growth in productivity in the U.S. economy in the
decade has been 0.9% compounded-the lowest in the
postwar era. Which says we have spent all this money
without producing any real effect on our economy.
Q: Have you given up on any of the stocks you
picked in January?
A: The non-tech that has been experiencing some
difficulties is Giant Industries. A turnaround at one of
their refineries took a little longer than expected. Even
though their crack spreads are back over $6, they didn't
get as much output as they would have liked. They won't
do the $2.20-$2.25 we forecast, probably about $1.85
this year. They've made an acquisition that will be
accretive to earnings next year. Issued stock to do it,
getting their debt/equity ratio back to 1-to-1. But I have
to be upfront with you. Since the Roundtable, I've gone
out to visit the founder. Every year he says they'll do
well, and then they have one quarter when they don't. I
told him they're like a pitcher who's perfect through
seven innings and then gives up home runs and doubles
in the late innings. Every year there's another excuse. I'm
sort of getting worn out with it. Sold some stock at
about 21 recently. It's not like Integrated Silicon or
Cohu, where the problems are beyond their control.
Q: Thanks, Scott.Scott Black |
