January 30, 2003
Questionable Fed Guidance
In yesterday’s FOMC statement the Fed said that, ‘against the background of its long-run goals of price stability and sustainable economic growth’ the risks are ‘balanced’. The Fed noted, however, that rising oil prices and geopolitical risks ‘have reportedly fostered continued restraint on spending and hiring by businesses.’ The Fed did not elaborate on the meaning of the word ‘reportedly’, but rumor has it that members were watching CNBC when they wrote up their statement.
It is worth remembering that even as the U.S. economy showed signs of retrenchment in December that Greenspan and company did not mention ‘oil/geopolitical’ risks. Rather, in the December statement the Fed believed the economy was working through a ‘soft spot’. Accordingly, that the Fed elected to play the Iraq card during its latest statement is not unlike O’Neill trying to blame the U.S. recession entirely on 9/11; O’Neill’s 2002 ‘no recession’ call (O’Neill said that without 9/11 the U.S. economy would not have contacted at all), was proven inaccurate when revised government statistics showed the recession actually started in 1Q01, and yesterdays oil/geopolitical cop out from the Fed may also be considered inaccurate following this mornings 4Q02 GDP gain of only +0.7%.
That said, the second sentence in the FOMC statement was the most amusing:
‘The Committee believes that as those (oil/geopolitical) risks lift, as most analysts expect, the accommodative stance of monetary policy, coupled with ongoing growth in productivity, will provide support to an improving economic climate over time.’
Who are the ‘analysts’ the Fed is referring to? Are these the analysts that have been bullish on stocks since the bear market began? Are these the economists who, using the consensus, completely missed calling the recession and the late 2001/2002 recovery, and are now completely ignoring the possibility of another recession? Or perhaps the Fed is referring to government ‘analysts’, oil strategists, or military analysts?
Whatever the case may be, for the Fed to conclude that risks are ‘balanced’ based on what ‘most analysts expect’ is -- lets be honest -- pathetic. Think about it: since the bear market began CNBC has interviewed about 1,000 professionals who believed that ‘sidelined’ money was going to soon rush back into the markets. These pundits and analysts have been proven wrong time and time again. Is the Fed acting any differently than CNBC when they revert to using sources that claim oil will retreat and/or that consumers and businesses will feel better and start spending/investing when Iraq is conquered?
It is difficult for the Fed to justify its belief that the economy is suffering some horrible an unexpected demise when all that is really happening is that the U.S. consumer is beginning to save a few more bucks. Granted, if the U.S. quickly defeats Iraq and oil drops to $20 a barrel the U.S. economy will be better off than if Iraq tension linger and/or oil goes to $50 a barrel. Nevertheless, when bankers turn into military/foreign policy strategists a degree of objectivity and honesty is taken away from the profession. The Fed statement, and the speeches and rhetoric that will inevitably follow, are tantamount to a CNBC interview; describing what is possible using biased ‘sources’ while ignoring what is happening right now.
To Smoke or Chew?
Altria Group, formerly Philip Morris, posted an 18% decline in year-over-year earnings and (weighed down by a 22% drop in domestic Tobacco sales), a 5.6% drop in revenues. Due to earnings concerns both MO and KFT got stung with losses yesterday. However, neither stock retreated below their previous 52-week lows.
UST lost its appeal and will have to pay $1.05 billion to competitor Conwood Co. LP for antitrust violations (a $1.3 billion pretax charge). This news could have severely hurt UST shares if it were not for renewed investor enthusiasm in dividends following Bush’s proposal, and UST’s (slightly) improving outlook. UST is hovering around $30 a share, which is well above its former double bottom area ($25).
We continue to look at MO and UST as possible investments. However, neither UST nor MO looks attractive at current levels. Quite frankly, unless MO breaks to new 52-week lows we have a difficult time believing that it represents a beaten down buy. For certain, the semi-diversified MO not only faces Tobacco sales woes, but a reduced outlook from Kraft as well (not to mention ongoing court battles). As for UST, it is possible that shares will be struck lower when, and if, the copy cat Conwood cases progress.
Incidentally, it is well worth remembering that announcement(s) of upcoming product launches (MO), expected growth from acquisitions (MO), and new promotional campaigns (MO, and UST) is not what make these companies attractive. Rather, MO is attractive because it sells Marlboro’s, and UST is attractive because the company still dominates the snuff arena with Cop and Skoal. The dividend rewards both companies offer, while attractive, could become more attractive. The major near term risk for MO is high end pricing concerns, and for UST (which is maintaining its pricing power) it is court developments.
Never Short a Good Balance Sheet
Nautilus Group declared its first dividend yesterday and announced approval of a $50 million repurchase program. The company’s shares jumped by more than 13% on the news as shorts scrambled to cover. NLS shares had previously been beaten lower – from a 52-week high of $45 to $11.71 – following a couple of earnings misses and growth concerns.
Given the sheer size of the short position on NLS – an astounding 32.3% of outstanding shares (10.5 million) were reported short as Jan 8 – the stock could continue to see further gains in the coming sessions. That said, the Nautilus story is a confusing one: with patents on the company’s flagship product, Bowflex, set to expire this year there is the question of whether or not already slowing rates of growth will be impacted further. Using the Tobacco example, NLR was once an attractive business because it produced a high margin product with longevity, but the ‘longevity’ of this product is coming into question.
As for the short sellers: those that tried to tag NLS as a losing company, not just a company with evolving growth attributes, could be in for a rough ride. By using its strong balance sheet NLS has taken steps which may not only squeeze shorts (buy backs), but ensure that they do not return (if the company can maintain its current dividend (3% yield) shorting the stock appears to be risky). Yesterday the company traded 1.3 million shares versus 2.3 million on Jan 14 (or after the company warned it would miss 4Q02 expectations). There still looks to be many millions of shares short NLS.
WMS Misses Its Mark
WMS should not provide any guidance until the company is producing machines and incurring the somewhat predictable costs associated with the production of these machines (not scrambling to get a new operating system completed and approved). Instead, WMS felt it necessary to state that they would earn a few pennies in the latest quarter and yesterday, when the company missed its mark, they reverted back to offering no specific guidance for the upcoming quarter (‘near break even’).
Guidance issues and stock price volatility aside, the WMS story is much the same as it has been for the last 8 months: “We remain on track to receive our first CPU-NXT approval late in the September quarter.” With this in mind, the decline in the company’s installed base of participation games and slackening domestic acceptance of older titles is not the real concern. Rather, the real concern is whether or not WMS can regain lost marketshare when, and if, software and regulatory issues abate.
Guidance Games
There is nothing wrong with EPS guidance per se. For certain, if a company’s EPS numbers have been historically predictable and management believes the bottom line will remain predictable, the company should inform shareholders of their EPS opinions. However, what is happening today is that managers who have no clue of future performance guess what EPS might be because they feel obligated to do so. What is more, some companies use accounting tricks to meet their EPS estimates, some companies raise/lower estimates in coordination with insider dealings, and some companies underestimate future results to consistently ‘beat the Street’. Suffice it to say, when EPS is highlighted the actual performance of the business can become the sideshow -- company ABC beats or misses EPS estimates by a penny so its stock price collapses or rallies by 10%.
Determining the Current and Future Value of a Company
Free cash flows and shareholder equity, neither of which most companies offer regular guidance for, are two of the best numbers investors can use to accurately depict a company’s value.
-- A reliable indicator of a company’s current value is its balance sheet (book value), or break-up value.
-- A reliable indicator of a company’s future value is the free cash generated by the company’s underlying assets. The simplest calculation to determine this is Cash flow from operations minus (capital expenditures + change in working capital), but there are many other calculations that work better/worse depending upon which company (industry) the stats are being calculated for.
The Guidance Game Ends and Begins
Nautilus’s strong balance sheet enabled the company to hurt those that bet against them. Having already cut interest rates down to 1.25% the Fed can no longer punish those who bet against the U.S. economy. WMS has a turnaround timetable that, if met, could help the company. The Fed has no such timetable and is betting on a quick Iraqi victory to turn the U.S. economy around. Lastly, MO and UST have key brands that, despite challenges, should stand the test of time. With the Federal Funds rate at 41-year low and the U.S. dollar weakening the argument could be made that the Fed is out of time.
As companies like Coke, McDonald’s, and AT&T stop providing guidance, arguably to avoid participating in guidance games not because their businesses are falling apart, the Fed has decided to offer even more guidance within their FOMC statement. However, instead of providing an objective monetary policy outlook the Fed feels that it is necessarily to offer guidance using the most optimistic set of ‘analyst expectations’ and unsourced ‘reports’.
If the Fed was a company they would currently be under siege from class action suits claiming they mislead investors, CEO Greenspan would be stepping down because he failed to successfully merge ‘anti-deflation’ and ‘pro growth’ policies, and the SEC would be forcing the Fed to more thoroughly disclose FOMC voting procedures. As it stands now, it will take 5-years (the January 2003 FOMC transcripts will be released in 2008), until we find out what the Fed was really thinking about yesterday.
Disclosure: With the exception of WMS, no one at FallStreet.com owns any of the companies mentioned above. Brady Willett & Todd Alway own shares in all Wish List companies.
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