Archive for the ‘General’ category

Is BP a Sell?

July 13th, 2010

Take a look again at fair value table for BP. Given a 9% cost of equity (which is quite generous given remaining risk) BP is fairly valued in the upper $30s. So unless you feel another energy shock is on the way, or another event that is going to propel energy prices higher near-term, allowing for a major boost to free cash flow on similar output, I would advise investors sell their shares in BP for other investments offering greater value with lower risk (cost of capital).

Even if a halt to the spill forces share higher, its not worth the risk and would be unjustified given the estimated free cash flows. So, unless free cash flow improves dramatically, not a likely event near-term, investors will be better rewarded elsewhere.

See related articles:

Disclosure: No positions

Kenneth S. Hackel, C.F.A.
President
CT Capital LLC

www.credittrends.com

BP has risk and should not wish to be considered by certain investors-consult your investment professional.

Investors and potential investors should not rely on any information contained herein or communicated by any means to replace consultations with qualified investment professionals to meet their individual investment needs.  The materials contained herein are for general purposes only.  They do not have regard to the specific investment objectives, financial situation or risk tolerance of individual or corporate investors.  Investors should consult with a financial professional prior to making any investment decision or investing in any of the firm’s products.  CT Capital LLC, its employees, or any associated individual, is not responsible for any investment decisions the recipient of these materials may make with respect to any investment.  Data contained herein is gathered from sources believed to be correct and reliable but assume no liability for the accuracy or validity of any material whether written or verbally communicated.  Nothing in this presentation should be construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any security or investment by CT Capital LLC, its directors, officers, principals, employees, agent, affiliates, or any third party.

No employees or clients of CT Capital LLC  or credittrends own a position in BP, nor was CT Capital or credittrends paid for preparing this report.

Intel-Reporting After the U.S. Close

July 12th, 2010

(updated July 13 6:21 a.m. est)

Intel Corporation (INTC) will release its financial results after the US financial markets close.

We spotlight INTC due to its consistent ability to produce free cash flows and strong credit, both of which manifest in a below-market cost of equity capital. INTC is, by Credit Trends, rated “A” for both cash flow and debt, as seen below.

While the model has picked up some deterioration of its credit quality over the past year (operating cash flow adjusted for working capital changes, leases, total debt, ratio of working capital to total debt, pensions, inventory/sales, reinvestment, taxes, others), INTC remains a very strong credit, and is thus accorded our highest rated class.

The table below shows INTC could free up additional free cash flows by reducing its selling, general and administrative expense more in line with its rate of growth. Interestingly, INTC has done this with its R&D even though R&D as a percentage of both sales and cost of sales has declined. This was due to the absolute expense reduction in nominal dollars during its past fiscal year of approximately $100MM. This was quite close to the $91 MM we calculated as corporate “fat” we called for a year ago.

INTC is a low tax rate payer by any measure, but in a higher rate (on a cash basis) and more importantly, a more consistent rate than AMD or TXN.  In “Security Valuation and Risk Analysis” we show how taxes should be analyzed for areas of weakness and strength, including its role as a leading indicator. In its last fiscal year, INTC was in a 16.5% cash rate versus the 23.4% rate reported to shareholders. By contrast, AMD was in a 3.4% cash rate and TXN a 16.4% rate. Over the past 6 years INTC’s cash tax rate has averaged 6 percentage points higher than TXN.

As for fair value, given its estimated 7% rise in long-term free cash flows and low cost of capital, INTC is currently about 13% undervalued.

Date Source: Research Insights, CT Capital LLC

Kenneth S. Hackel
President
CT Capital LLC

www.credittrends.com

INTC has risk and should not wish to be considered by certain investors-consult your investment professional.

Investors and potential investors should not rely on any information contained herein or communicated by any means to replace consultations with qualified investment professionals to meet their individual investment needs.  The materials contained herein are for general purposes only.  They do not have regard to the specific investment objectives, financial situation or risk tolerance of individual or corporate investors.  Investors should consult with a financial professional prior to making any investment decision or investing in any of the firm’s products.  CT Capital LLC, its employees, or any associated individual, is not responsible for any investment decisions the recipient of these materials may make with respect to any investment.  Data contained herein is gathered from sources believed to be correct and reliable but assume no liability for the accuracy or validity of any material whether written or verbally communicated.  Nothing in this presentation should be construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any security or investment by CT Capital LLC, its directors, officers, principals, employees, agent, affiliates, or any third party.

No employees or clients of CT Capital LLC  or credittrends own a position in INTC, nor was CT Capital or credittrends paid for preparing this report.

Alcoa (AA) -Initial Impression

July 12th, 2010

Alcoa (AA) worked its assets to eke out some free cash flow during the quarter, as it has the past three years.

However, management’s statement that free cash flow would have been even higher had it not been for the ending of several accounts receivable programs doesn’t hold a lot of water.

Over the past three years, after adjusting for “working the balance sheet”, AA produced on average $1.2 billion in cash flow from operations, or 38% below that reported to stockholders under cash flow from operations. Thus, while AA still has some additional “capture” here, the bulk of the work is done. We are, however, impressed with AA’s fixation on free cash flow, although I point out this is not unusual for debt heavy firms which have been reporting tax losses, like Alcoa. For example, during FY ’09,  AA’s cash tax rate was negative, while its effective rate was 38.7%

AA still has an underfunded pension, which surprisingly did not come up during analyst questioning, despite the $600MM stock contribution the company made in its first fiscal quarter. AA still has steep debt payments over the coming few years.

AA appears to be a risky stock I would avoid, although a better than a dreadful scenario, and general equity market rally will likely result in some advance in its shares.

Disclosure: No positions.

Kenneth S. Hackel, C.F.A.
President
CT Cpital LLC

www.credittrends.com

Role Of Recording Goodwill on Stock Price

July 12th, 2010

How should balance sheet goodwill be viewed by the equity analyst?

Goodwill is measured as the excess of the purchase price of a purchased business over the fair value of the tangible and intangible assets acquired, minus liabilities assumed. If there is a bargain purchase where the acquirer pays less for the assets than the stated amount, “negative goodwill’ occurs and the buyer is required to recognize such excess in earnings as a gain. This would be recognized as a non-cash event in operating activities.

Goodwill has measurable value to the extent the assets it represents can produce free cash flow in excess of the firm’s cost of capital.  Since goodwill represents an economic benefit, to the extent this benefit is impaired, so too must its value, including a possible increase in instability metrics related to the firm’s cash flows. But because the value of goodwill is included in the calculation of return on invested capital, its write-down could distort the analysis of management’s ability to spend and earn a rate of return in excess of its cost of capital. In theory, an entity should in fact write down all assets that do not produce a cash return at least equal to its cost of capital, so those assets reflect economic reality.  Impairments, by itself, do not affect free cash flow, and why we look to growth rates in that measure when selecting an investment portfolio.

For the cash flow analyst, the governing rule, FAS 109, Accounting for Income Taxes, does not permit the recognition of deferred taxes related to goodwill that is not deductible for tax purposes. If the assets creating the goodwill are expected to be of indefinite value, the goodwill is not amortized and the related deferred tax liabilities will not reverse until those assets become impaired. The tax treatment of the goodwill depends on the expenditures that created the goodwill. If an acquisition is structured as a stock purchase, no amortization of goodwill is permitted. If the purchase is structured as an asset purchase, goodwill is amortized over 15 years using straight line depreciation. For shareholder reporting, goodwill is not normally amortized unless the assets are deemed impaired.

When goodwill is not tax deductible, any book/tax difference is considered a permanent difference and no deferred taxes are recognized.  When goodwill is tax deductible and is being amortized on the corporate return, it creates a deferred tax liability once the amortization period is up. When a company makes an acquisition, it may be required to reclassify its acquired intangible assets as goodwill if the intangibles are not tax deductible, and any deferred tax liability associated with those intangibles will be reversed as a reduction to goodwill.

To see if investors penalize entities which have large amounts of goodwill relative to shareholders equity, all companies (including companies which became inactive through merger or bankruptcy) which had greater goodwill than equity were studied, with no other financial considerations taken into account; if goodwill had been valued at zero for these entities, shareholders equity would have turned negative. For the five years ending November, 2009, this group had a median stock return of 1.4%, virtually in line with the average return of each sector these companies are a member of. The companies had a median market value of $ 1.5 bn., $918 mil in goodwill and $ 436 mil in shareholders’ equity.  Based on this one study, it appears investors do not penalize firms having excessive goodwill when making buy/sell decisions.

Because FAS 109 requires for periodic testing for impairment of goodwill, the analyst should consider it in their calculation of shareholders equity. If these assets fail to produce cash flows in excess of the firms cost of capital, it will quickly show in the reporting periods and effect the free cash flow multiple, growth rate in free cash flow, stability of cash flows and associated metrics including cash flow/debt  and return on invested capital. Given the above study, any write-down is most likely already reflected in the market price.

BP – What’s Fair Value Now?

July 12th, 2010

With BP (BP) apparantly agreeing to at least $10billion in asset sales (in addition) to the dividend omission, both acts we called for a month ago, it is again time to revisit the stock.

It is quite clear that unless the price of energy rises on the order of at least 10%, or if the market perceived the ultimate cleanup/litigation liability will be below $ 50billion, forcing us to raise the free cash flow estimates in the table (they are in per share), fair value is currently in the mid $30s for BP.

However, if investors perceive risk to be further reduced, its US stock could rise to the upper $30s, as currently indictated by our present value/cost of capital model. This is clearly a fluid situation with no obvious answer-unless you are a buyer of BP’s underlying assets-they are the obvious  winners thus far.

Keep in mind we are also penalizing BP for our perceived underfunding of its pension plans, an issue they will need to address within the coming 12 months, a large general financial market rally aside. For now, BP is paying out a large multiple of what it is paying into its plans; we estimate such plans are at least $3billion underfunded at the end of June. This is a sensitive issue for BP having undergone costly strikes and threats of walkouts in the past resulting from pension issues.

Credit Trends Interviewed by Pensions & Investments

July 12th, 2010

Credit Trends was interviewed about BP’s pension plan by Pensions & Investments Magazine.

What Return Can Stock Investors Reasonably Expect?

July 11th, 2010

The table at the bottom affirms the relationship between stock price valuations and cost of capital. While the free cash flow multiple is also clearly important and carries significant value, and is a far superior indicator than the P/E multiple, it is change in risk that leads the equity market’s direction. Most pundits would agree, as last validated March, 2009. Keep in mind the free cash flow of the firm is the income to the investor. The same cannot be said with earnings!

During bull markets expansion in multiple valuations is commensurate with like growth in free cash flows, pushing those multiples even higher.

During bear markets, even though firms