October 30, 2002
No Revenue Rebound This Year -
No Common Sense from the SEC

Yesterday’s consumer confidence report was entirely terrible. And while it is true that the conference board’s take on consumer confidence is not always accurate – after all, the board surveys only 5,000 people of which 3,000 usually reply -- when combined with recent consumer ‘confidence’ and ‘sentiment’ readings (Mich. ABC, CNNfn, Gallup’s) the report does foretell of weak consumer spending ahead. 

That the consumer is less confident today than at any time following 9/11 is not only surprising but also worrisome.  To be sure, in the 12 months following 9/11 the Fed cut interest rates, businesses became resolute in their quest to dump inventories, and home refinancings rapidly grew. By contrast, the same scenario is unlikely to unfold today: even though the Fed is likely to reduce rates again the consumer is more leveraged today than they were in 2001, businesses want to increase profitability (trying to avoid another round of cost cuts), and the pace of home refinancings, while still strong, is unlikely to match the pace of the last 12 months given that rate of foreclosures is rising, interest rates have less room to drop, and housing prices have less room to climb (focusing on the inevitiabilities of interest rates and prices). In sum, it is clear that the last year’s stimulatory agents are not going to reappear today – this is why consumers are less confident, and are unlikely to lack confidence until another stimulatory agent (perhaps government/business spending) arrives.

Fed Cut Coming
Greenspan and company will likely decide after Friday’s unemployment report, and the subsequent reaction in the financial markets, whether or not to cut interest rates next week. Quite frankly, if the employment news is extremely negative the Fed will cut. 

As suggested on Monday, the markets could applaud an expected Fed rate cut even if it is the result of poor economic news.  Given that the markets rebounded following yesterday’s awful confidence numbers and that prices ended higher today, this theory seems to be panning out.  However, and to state the obvious, there remains the possibility that bad economic news will send prices lower.

Uncovering The Earnings Recovery
Of the 25 Dow components that have reported 3Q02 earnings 10 reported lower year over year revenue gains. These are not exactly encouraging results considering that 3Q02 was largely considered a write-off due to 9/11 and an exceptionally weak economy (companies loaded up their statements with every scrap of bad news they could find because investors excepted the fact that earning would be poor).

Dow 30

02 - Revs

01 - Revs

02 - Earn

01 - Earn

AA

5,222*

5,511

193

339

AXP

5,910

5,720

687

595

BA

12,700

13,700

375

713

C

18,774

17,007

3,920

3,177

CAT

5,080

5,060

213

205

DD

5,737

5,776

469

142

DIS

7-Nov

 

 

 

EK

3,354

3,308

334

96

GE

32,585

29,468

4,087

3,281

GM

43,580

42,480

615

385

HD

19-Nov

 

 

 

HON

5,570

5,790

412

360

HPQ

18-Nov

 

 

 

IBM

19,821

19,783

1,313

1,595

INTC

6,500

6,550

686

106

IP

6,400

6,500

145

-275

JNJ

9,080

8,060

1,820

1,530

JPM

7,300

7,690

40

449

KO

5,320

4,700

1,160

1,070

MCD

4,050

3,880

486

545

MMM

4,143

3,961

545

394

MO

20,000

20,250

2,700

2,570

MRK

12,890

11,920

1,880

1,950

MSFT

7,746

6,126

2,726

1,283

PG

10,800

9,770

1,460

1,110

SBC

10,556

11,338

1,770

2,072

T

12,000

13,000

207

11,300

UTX

7,300

6,920

612

565

WMT

13-Nov

 

 

 

XOM

31-Oct

 

 

 

                                      * All figures in million $.

During their earnings releases 5 companies (GM, HON, JPM, MCD, T) warned that further (job) cuts loom, 5 companies either raised or warned (others have kept quiet) about increased pension liabilities (AA, GM, IBM, IP, MMM), and 1 company (SBC) warned of further reductions in capital spending next year: SBC initially wanted to spend $9.2 billion in 2003 but now the company says it will spend $7.5 billion (down from $11.2 billion in 2002).

As for those Dow companies bucking the weak trend: MSFT is a monopoly, GE appears destined to never miss an earnings estimate until their accounting policies blow-up, a handful of companies (CAT, DD) squeaked by because of lower taxes, Coke warned of future problems, Kodak couldn’t have performed worse in 3Q02 than in 3Q01 if they tried, and a collection drug, Tobacco, and financial stocks (AXP, C, MO, JNJ) generally performed well.

Of the 25 Dow companies that have already reported, revenues were up by less than 3% and net income was down by 18.8%.  The net income data was dragged lower because of AT&T’s 3Q01 spin-off of AT&T wireless. Backing out AT&T’s numbers net earnings on the Dow are actually up roughly 18% in 3Q02.

Conclusions
Whereas year-over-year revenue comparisons are telling of a weak economic rebound the net income comparisons are more encouraging. For certain, many of the best run companies in America, supposedly what the Dow 30 contains, were able to better manage their costs and produce better earnings results. Needless to say, the methodology used to attain such results varies from company to company  – the above chart attempts to highlight first call data (backing out charges in some cases while including them in others).

The market watcher should remember that 4Q02 results will be compared to 4Q01 results. Not only were 4Q01 earnings results 4.2% higher than 3Q01 results (S&P 500), but 4Q02 operational results are expected to be lower than 3Q02 operational results.  Point being, and based upon current economic speculations, it is probable that annualized revenue comparisons on the Dow will be weaker in the final quarter of 2002 than in 3Q02. Yes, weaker than a mere +3%...


Buy and Buy
The stock markets are coming off of a respectable rally that has been fueled, in large part, by ‘corporate earnings’.  A couple of accounting rule changes, as last weeks core earnings data demonstrated, would dramatically reduce these earnings.

Baring seasonal factors and/or Fed rate cuts, there is not many fundamentals which will lead the investor to believe that current stock market conditions warrant further exposure. As such, and unless low(er) interest rates can be considered the gospel when investing, it is time to preach prudence. Quite frankly, the investor should only hold an equity position (and this is my opinion) if they are prepared to purchase more shares if prices drop. We are not yet at the point when it is easy to make solid investments in cheap stocks, and seasonal/interest rate gambles are simply that.

DIMON
Wish List company DIMON held its annual meeting today and raised its dividend. Continuing the ‘turnaround’ theme for the company, the dividend increase is encouraging.  The company’s earnings call is scheduled for November 6.

As an example of how we try to allocate our capital when investing – we are prepared (and would welcome) the opportunity to purchase more shares of DIMON at a significantly lower price.  This is not say we believe that DIMON’s shares will drop – we don’t.  Only that when equity market liquidity dries up few companies are spared. Put simply, unless a company is undervalued based upon its break-up price (the gutted assets) no share price is safe if, and likely when, investor’s start chanting ‘new low!’

10-Months Wasted
Not unlike a well rehearsed comedy skit, during today’s Open Meeting SEC Commissioners quibbled about the different interpretations of the words ‘may’, ‘remote’ and ‘reasonably likely’. To put these words into context – SEC members were theorizing about the impact these words would have with regards to the commissions’ current off balance sheet proposal.

Quite frankly, the new SEC off balance sheet proposal fails miserably. After listening to the meeting the investor can be left with only one question: WHY IS THE SEC GIVING COMPANIES ANY LEEWAY AT ALL?

Investors do not want to read Corporate America’s opinion of their off balance sheet financings. This deplorable undertaking by the SEC, to have companies report confusing summaries of off balance sheet debts, is nothing more than a gigantic waste of time.  In fact, the SEC went so far as to debate how ‘burdensome’ it would be for companies to report off balance sheet financings, and members repeatedly questioned that if the standards are too strict this would make the amount of information being disseminated ‘extraordinarily unhelpful’ – providing the investor with ‘information overload’.

What the SEC fails to understand is common sense.  I suppose this comes from living in an information vacuum – a place where companies and lobbyists are the primary parties feeding you advice. Investors do not need a CEO and CFO to figure out if their off balance sheet interests could impact their business based upon the ‘realm of what is reasonably possibility’.  Rather, the investor would benefit most if companies report the data – ALL OF IT!  Then the SEC could waste decades trying to figure out a way to structure the data afterwards.

I am quite sure that investors would have benefited from knowing that Enron had hundreds of off balance sheet entities, most of which were offshore, with billions of dollars in assets (‘what are these assets’? the investor could have asked years ago). Furthermore, I am also sure that if companies can take the time to set these financing schemes up they can record the activity and report it to shareholders with literally no ‘burden’ whatsoever.   Is it a burden for GE to sponsor a SPE and then boast its earnings from a gain on sale to the SPE?  No, they do it all the time…

The SEC’s off balance sheet proposal is expected to pass in January 2003, or after a few more months of pointless debate (no one at the SEC is even suggesting companies should consolidate OFBS interests). If all goes according to plan, a couple people within each company will decide what information gets disseminated to investors.


BWillett@fallstreet.com

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