THE MOTLEY FOOL'S EVENING NEWS
Friday, August 14, 1998
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MARKET CLOSE
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DJIA 8425.00 -34.50 (-0.41%)
S&P 500 1062.75 -12.16 (-1.13%)
Nasdaq 1790.19 -12.35 (-0.69%)
Value Line Index 855.94 -4.25 (-0.49%)
30-Year Bond 99 12/32 +27/32 5.54 Yield
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CONTENTS
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I. Heroes: Shaw Industries; J.P. Morgan
II. Goats: Ciena; Stryker Corp.
III. Fool on the Hill: Big Banking Bargains
HEROES
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Shaw Industries (NYSE: SHX), the largest U.S. carpet maker and the leading consolidator in the business for the better part of the '80s and the early '90s, is putting its brief foray into retail and the international realm behind it and is getting back on the acquisition trail. The company's shares rose $1 9/16 to $19 9/16 after announcing that it will buy the fourth largest carpet maker, closely held Queen Carpet Corp., for $690 million. Shaw will pay $470 million in cash and stock and assume $220 million in debt. The divestitures of its retail operations and its U.K. business, and the purchase of 10.8 million shares pursuant to a Dutch auction tender all probably stemmed from attempts to improve return on invested capital (ROIC). With ROIC at around 6% at year-end 1997 and the company's cost of capital at a conservative 11.5%, Shaw is looking to boost its capital turnover and inventory turns while lowering SG&A spending in order to grow net operating profits after tax. It looks like this acquisition will definitely help the company to increase its returns above its cost of capital.
J.P. Morgan (NYSE: JPM) surged $9 5/8 to $126 7/8 after Business Week's "Inside Wall Street" column reported that the bank holding company has been in informal talks with a "much larger European bank" regarding a possible merger or acquisition. The magazine said that $30 billion, or $175 a share, is the price being discussed but that J.P. Morgan wants a bid of $200 a share. Adding further fuel to the fire of speculation, German news agency VWD reported that Deutsche Bank is prepared to offer $175 -- a 49% premium over J.P. Morgan's closing price yesterday. According to Business Week, Chase Manhattan Bank (NYSE: CMB) was also eyeing J.P. Morgan earlier this summer. When the elder of the two U.S. halves of the House of Morgan announced plans to cut 700 jobs, or 5% of its workforce, in late February, there were reports that the company was considering a merger or acquisition to boost its shareholder return and financial performance. Business Week quoted a strategist as saying that J.P. Morgan is "at the head of the list of banks ripe for a buyout."
QUICK TAKES: United Airlines parent UAL Corp. (NYSE: UAL) took off today, regaining $3 9/16 to $69 3/16 after reiterating that it expects Q2 and full-year earnings to meet analysts' mean estimates of $3.97 and $10.65 per share, respectively... Oil giant Amoco (NYSE: AN) gained $1 to $50 after winning European Union approval for a venture with Repsol SA, Spain's largest oil company, and Iberdrola SA, the country's No. 2 power company, to build a power station in northern Spain. In addition, BT Alex. Brown upgraded its rating on Amoco to "buy" from "market perform." British Petroleum (NYSE: BP), which this week announced it will merge with Amoco, also moved up $2 3/4 to $82. Other oil companies climbed as well: Mobil (NYSE: MOB) added $3 to $72, and Texaco (NYSE: TX) advanced $1 5/16 to $60 5/16.
Shares of disk drive makers advanced as the industy gathered at the Hambrecht & Quist storage conference this week. Quantum Corp. (Nasdaq: QNTM) gained $1 9/16 to $19 1/4, Seagate Technology (NYSE: SEG) moved up $1 7/8 to $27 1/4, and Maxtor Corp. (Nasdaq: MXTR) jumped $1 13/16 to $11 5/8. Disk drive component maker Read-Rite Corp. (Nasdaq: RDRT) also gained $1 1/8 to $8 9/16.
Fiber optic cables network builder Global Crossing (Nasdaq: GBLX) soared $6 1/2 to $25 1/2 after selling 21 million shares in a $399 million initial offering priced at $19 a share... Internet advertising firm 24/7 Media Inc. (Nasdaq: TFSM) surged $6 1/4 to $20 1/4 in its trading debut from an IPO price of $14 a share.
PaineWebber Group (NYSE: PWJ) picked up $13/16 to $40 13/16 on rumors that General Electric (NYSE: GE) may be interested in selling its 22.5% stake in the investment bank and brokerage firm... Bar code scanning products maker Symbol Technologies (NYSE: SBL) jumped $3 1/8 to $48 1/16 after Guy Wyser-Pratte, minority shareholder (4.9% stake) of Telxon Corp. (Nasdaq: TLXN), announced he has commenced his proxy solicitation in opposition to Telxon's board of directors for rejecting Symbol's acquisition proposals of $40 and $42 per share in early June... Computer reseller MicroAge Inc. (Nasdaq: MICA) tacked on $3/4 to $15 1/4 after Business Week's "Inside Wall Street" column reported that the company will sell its Pinacor computer wholesale unit to CHS Electronics (NYSE: HS) for $650 million in cash and stock.
Casket maker York Group (Nasdaq: YRKG) gained $7/8 to $14 7/8 after yesterday issuing a statement clarifying that the pending loss of business from Service Corp. International (NYSE: SRV) mentioned in its June 30 10-Q had been announced previously on Feb. 5... Premier Bancshares (AMEX: PMB) rose $1 13/16 to $26 1/16 on news the banking company will take the place of Collagen Corp. (Nasdaq: CGEN) in the Standard & Poor's SmallCap 600 Index after the close of trading on Monday. Collagen is spinning off its Cohesion Technologies unit... Digital signal processing equipment maker Applied Signal Technology (Nasdaq: APSG) climbed $9/16 to $12 1/4 after reporting fiscal Q3 EPS of $0.32, up from $0.25 in the year-earlier period and ahead of analysts' expectations of a quarter in EPS.
Oral transmucosal drug delivery company Anesta Corp. (Nasdaq: NSTA) delivered a $1 3/8 gain to $15 after reporting a Q2 loss of $0.31 a share versus a loss of $0.25 in the year-ago period. Analysts had expected a loss of $0.39... Electronic equipment maker Cubic Corp. (AMEX: CUB) rose $2 1/16 to $25 1/2 after it was named along with Electronic Data Systems (NYSE: EDS) to install a "smart card" ticketing system and replace a 93-year-old power station for the London Underground.
GOATS
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Ciena Corp. (Nasdaq: CIEN), which provides bandwidth enhancement technology for fiber-optic communications networks, was cut $17 1/16 to $54 1/8 after pre-announcing fiscal Q3 EPS (before charges) between $0.13 and $0.15, lower than the $0.34 earned last year and short of the First Call mean estimate of $0.32. The company blamed the shortfall on the delay of a $25 million order receipt and price concessions to "a large customer" in return for volume commitments. Given that Ciena derived 95% of its fiscal 1997 revenues from two clients -- WorldCom (Nasdaq: WCOM) and Sprint (NYSE: FON) -- it's a pretty safe bet that one of the two firms is the mysterious "large customer." Today's developments cast some doubt over Tellabs' (Nasdaq: TLAB) proposed acquisition of Ciena, which is scheduled to go to a shareholder vote next week. Tellabs slumped $13 11/16 to $58 1/8.
Orthopedic implants and surgical products maker Stryker Corp. (NYSE: SYK) lost $5 3/4 to $36 after agreeing to acquire the Howmedica orthopedic products unit of Pfizer (NYSE: PFE) for $1.9 billion in cash. Stryker expects the deal will add to earnings starting in 2000 and figures to amortize about $1 billion in goodwill over the next 30 years. The deal gives Stryker (not to be confused with the character in the movie Airplane! by the same name) a 15% stake in the worldwide orthopedic products market, but will slow earnings growth to 5% in fiscal 1999. Growth should return to the firm's historical rate of 20% in 2000, though. For Pfizer, the sale marks the final divestiture of its Medical Technologies Group. Analysts expect the drugmaker will use the cash from the sale to expand its marketing efforts and bolster its $2.3 billion R&D budget for fiscal 1998.
Oilfield equipment supplier and contract driller EVI Weatherford (NYSE: EVI) was knocked down $4 to $19 after saying that falling oil prices and lower demand will result in Q3 and fiscal 1998 earnings below analysts' estimates. The First Call mean estimate had called for EPS of $0.65 in Q3 and $2.63 for 1998. Further, CEO Bernard Duroc-Danner suggested that analysts covering oil equipment firms would be wise to cut their earnings estimates for the sector. "The whole industry is going to have trouble meeting earnings estimates over the next year," he said in an interview with Bloomberg News. The comments were enough to help send other oil equipment companies downward as well. Cooper Cameron (NYSE: RON) dropped $1 9/16 to $27 1/8, Smith International (NYSE: SII) slid $1 7/8 to $21 1/2, BJ Services Co. (NYSE: BJS) lost $1 5/16 to $17, and National Oilwell (NYSE: NOI) slipped $3/4 to $14 1/8.
QUICK CUTS: Cable TV company Tele-Communications Inc. (Nasdaq: TCOMA) slipped $1 13/16 to $36 7/16 after reporting a fiscal Q2 loss of $0.28 per share. The First Call mean estimate called for a $0.12 per share loss, although the individual analysts' estimates were all over the place and ranged from a $0.39 per share loss to a $0.07 per share gain. Merger partner AT&T (NYSE: T) fell $1 15/16 to $55 3/8... Chemicals and life sciences company DuPont (NYSE: DD) slid $1 3/4 to $53 1/4 following a Goldman Sachs downgrade to "outperform" from "recommended list." Dow Chemical (NYSE: DOW), which received the same treatment from Goldman, fell $4 5/8 to $85 1/2... Number 2 U.S. automaker Ford Motor Co. (NYSE: F) slipped $2 3/16 to $48 7/8 after the firm decided to idle a small-car production plant next week to guard against excessive inventories.
Telecommunications equipment maker Lucent Technology (NYSE: LU) slid $2 3/16 to $85 7/8 after saying in a federal filing that it will record more than $145 million in charges in fiscal Q4 related to several recent acquisitions... Motion picture film camera systems maker Panavision (NYSE: PVI) reel-ized a $1 5/8 loss to $19 1/8 after reporting a fiscal Q2 loss (including charges and one-time expenses) of $3.57 per share. The company also warned that its Q3 results will be hampered by fewer scheduled film and TV productions... Bakery operator Au Bon Pain Co. (Nasdaq: ABPCA) was burned $7/8 to $7 1/2 after agreeing yesterday to sell its namesake restaurant unit to a private investment firm for $78 million in cash.
Food products maker International Home Foods (NYSE: IHF) fell $1 1/4 to $21 1/4 after the company registered 4.4 million secondary shares for selling shareholders in a federal filing... Telecommunications systems constructor Able Telecom Holdings Corp. (Nasdaq: ABTE) sank $1 5/16 to $6 11/16 after investment firm Asensio & Co. issued a press release discussing a recent Able federal filing. The release said Able must come up with $10 million in funding to prepay certain notes assumed in its acquisition of MFS Network Technologies by Aug. 31 or risk "severe" consequences. Able's CEO told Dow Jones the press release was "ridiculous"... MGIC Investment Corp. (Nasdaq: MTG), which provides mortgage insurance to mortgage lenders, dropped $5 11/16 to $45 1/8 after Goldman Sachs took the stock off of its "global list" and placed it on its "recommended list," which is apparently a bad thing.
Vineyard operator Scheid Vineyards (Nasdaq: SVIN) was stomped $1 7/16 to $5 after reporting a fiscal Q2 loss of $0.04 per share, missing the Street's expectations of earnings of $0.01 per share. The company added that it will miss analysts' fiscal 1998 revenues and earnings estimates as well... Plastic films and shaped aluminum and vinyl products maker Tredegar Industries (NYSE: TG) fell $1 5/16 to $21 1/2 following a Goldman Sachs downgrade to "market perform" from "trading buy"... Property and casualty insurer Orion Capital Corp. (NYSE: OC) dropped $2 7/16 to $39 1/2 after saying it will take a fiscal Q3 charge of $12.5 million, or $0.35 per share, to its operating earnings to refocus its specialty commercial programs unit.
Healthcare computer networks designer DAOU Systems (Nasdaq: DAOU) was DOA today, tumbling $5 3/4 to $12 3/4 after saying in a 10-Q federal filing that its Q2 selling, general, and administrative (SG&A) expenses were $3.5 million, or $1.1 million more than what it told analysts in an earnings conference call two weeks ago. The company said the increase was due to the way it reports merger costs for the SEC. SG Cowen lowered its rating to "neutral" from "buy"... Database and systems management software firm Platinum Technology (Nasdaq: PLAT) sank another $1 5/16 to $26 1/16 after announcing a $500 million stock bid for security software developer MEMCO Software (Nasdaq: MEMCF). MEMCO fell another $1 5/16 to $20 3/8... PMI Group (NYSE: PMA) slid $2 1/2 to $59 5/16 as Goldman Sachs downgraded the mortgage and title insurance underwriter to "market performer" from "trading buy."
An Investment Opinion by Dale Wettlaufer
FOOL ON THE HILL: Big Banking Bargains
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One of the industry groups that has been beaten up the worst in the market downturn over the last five weeks or so has been the large banking companies. Among the best-performing groups over pretty much any period in the 1990s you would want to select for examination, the third quarter hasn't been particularly kind to the big banks.
In early July, acting Comptroller of the Currency Julie L. Williams excoriated the industry for a decline in lending standards. "Across the board, banks are granting broader and more generous concessions to business borrowers," she said, citing preliminary results from the Office of the Comptroller of the Currency's fourth annual survey of bank underwriting practices. "Provisions governing covenants, guarantors and tenors have become less rigorous for borrowers. Collateral requirements have been relaxed," Williams said, likening the situation to the lending practices of the late 1980s. "The deterioration in credit underwriting standards we are seeing in the banking system today is serious. It could presage the same kinds of problems that afflicted the industry nearly a decade ago."
Great. Essentially Williams is saying that the fat increase in net income we've seen over the last year has come in part due to credit loss provision expenses being too light. According to an Office of the Comptroller of the Currency (OCC) press release: "And even as banks have increased their exposure to risk, they have also reduced their ability to cover potential losses out of existing resources. 'Call report data shows a steady drop in the percentage of loan loss reserves to gross loans and leases over the past 22 quarters,' Williams said."
Not that the OCC will crack down and hurt the industry, but a more conservative investor would want to give the OCC's observations their due. Not only has asset growth per share been excellent, but credit loss expense growth has remained subdued. This has been a best-of-all-worlds environment for commercial banks as regulations on the amount of business they generate in formerly proscribed lines of business have fallen, consolidation has increased the industry's leverage over fixed costs, employee productivity has increased, and the general economy has progressed at such a robust level of employment that credit costs have remained wonderfully low.
Right now, charge-offs and net charge-offs (gross charge-offs minus recoveries) have been kept low through a combination of good recoveries of loans that had formerly been written off and by a continuing mild level of loan delinquency, especially in the credit card sector. Months of charge-offs in reserves and months of net charge-offs in reserves remain very strong, though. Judged on these data, acting Comptroller Williams is on the bleeding edge of analysis, as actual losses experienced by banks are well under control.
There is an average of 30 months charge-offs in reserves among larger banks including NationsBank (NYSE: NB), Citicorp (NYSE: CCI), Chase Manhattan (NYSE: CMB), BankBoston (NYSE: BKB), Norwest (NYSE: NOB), Wells Fargo (NYSE: WFC), SunTrust (NYSE: STI), and Mellon Bank (NYSE: MEL). Measured as months of net charge-offs in reserves, the average is 39.3 months, including US Bancorp (NYSE: USB) in the second figure. Similarly, loan loss reserves to nonperforming loans are large, averaging 319.9% over twelve banks.
However, with the wrong lending standards and a deterioration in macroeconomic conditions, both parts of net charge-offs -- recoveries and charge-offs -- could go the wrong way and bring down these very good-looking numbers rather quickly. That's a worry that any investor has to deal with, though. All things being equal on the macroeconomic side, some interesting-looking bargains have once again emerged in the banking sector.
Measured by return on assets (ROA) before goodwill amortization, the average large bank is returning 1.47% on assets. To get to return on equity of 15%, a banking company can scale back leverage to 10 times assets to owners' equity, leaving the company in an overcapitalized state. To run in a leaner yet still well-capitalized state of 13.6 times equity to assets, a company generating a 1.47% ROA would return 20% on equity. At an average price of 3.3 times shareholders' equity right now, a 20% return on equity implies an earnings yield (earnings/price) of 6.1%, a premium to bonds and still a very good premium to equities in general.
Measured against the larger market, banks still offer a pretty good bargain, though not as good as when those who foresaw the current state of the banking industry could pick up franchise properties near book value and at single-digit P/E ratios. However, the current numbers aren't that bad. In ascending order, here's how banks stack up based on multiple to 1999 EPS estimates (adding back goodwill amortization to earnings estimates):
KeyBank...11.33
NationsBank...11.57
First Union...11.58
Chase Manhattan...11.82
BankBoston...12.32
Citicorp...13.15
BankAmerica...13.49
Wells Fargo...13.96
Norwest...14.22
Mellon Bank...15.15
US Bancorp...15.21
SunTrust...16.34
Another bank in the bargain-basement category that we don't regularly track is BANC ONE (NYSE: ONE), at 11.16 times the 1999 estimate, including goodwill amortization. Though BANC ONE didn't issue a very informative press release last quarter, word was that it didn't do so hot -- so poor performers are, of course, going to get hit. In addition, the company is in the process of merging with (or acquiring) First Chicago NBD (NYSE: FCN), which introduces uncertainty into the estimates. That same fate has befallen NationsBank/BankAmerica and Norwest/Wells Fargo. Wells Fargo in particular is performing quite well in its fundamental business and has seen estimates climb as management has guided numbers higher.
While the large banks are far from being historically cheap, their performance as a group is excellent. ROA and return on shareholders' capital are both at historical highs, while the group trades at a meaningful discount to the forward P/E multiple of the rest of the market. For companies with worldwide franchises, such as Citicorp, or megaregionals with great diversified lines of business, such as Norwest/Wells Fargo, the current market swoon offers an interesting entry point.
While the OCC's observations on credit quality should be taken into account by investors, the decision on bank performance should be made on a case-by-case basis. Lower prices are great for consolidators, too. Even smaller regionals that are acquired at premium valuations have more than enough room to be shaped up and provide a return on invested capital far in excess of the cost of capital, however you want to adjust the return to account for risk. Investors looking for prices below intrinsic value might want look at this industry while the market idles.
CONFERENCE CALLS
~~~~~~~~~~
Please see the Motley Fool's Conference calls page for call information and links to synopses.
Yi-Hsin Chang (TMF Puck), a Fool
Brian Graney (TMF Panic), another Fool
Alex Schay (TMF Nexus6), Fool, too
Dale Wettlaufer (TMF Ralegh), Final Fool
Contributing Writers
Brian Bauer (TMF Hoops), another Fool
Bob Bobala (TMF Bobala), a Fool's Fool
Jennifer Silber (TMF Amused), Fool at last
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