Wednesday, April 30, 2008

Some Trades



Just an update from some account moves I made today. Loaded up on COF puts today. The stock itself is a good short for fundamental reasons (analysis on that coming later this week) but also for technicals. There is a ton of recent resistance at $54-55, and then right above that you've got the 200 day moving average. And then, even further at $57.5 there is a double top in terms of most recent highs. So, basically you can pick up some puts (June 40s is what I got into) and then stop out if the stock trades above any one of those stops... just use what degree of security you want in terms of loose stops or conservative ones.


Also, been long MA for a while now. This is almost a pairs trade with COF but I never intended it to be haha. Anyways, took profits on MA today and will look to get back in here on the pullback, as I'm expecting the breakout-pullback scenario with their big earnings gap up. The transition from cash to plastic is a very real story, especially in other countries who aren't as reliant on plastic (yet) as the american consumer is.



Last idea I've got (and I'll analyze this one this week as well) is to short GLD if it closes below $86. That's the support line if you check out the chart and its my line in the sand. There are some fundamentals playing into this trade as well. Stop out if it trades above $86.50-87 (this stop kicking in of course *after* the stock has closed below 86 and initiated our short).


Friday, April 25, 2008

Procter & Gamble (PG): Solid as always

PROCTER & GAMBLE CO
PG: Solid as always
Posted 0 days ago on 4/24/08
PG: Buy, Target Price: $72, Time frame: 6 months

In the midst of a recession, when the consumer is tapping out due to high energy costs and the plummeting values of their homes, stick to the basics. And, that's exactly what Procter & Gamble does. They are a boring, run of the mill blue chip stock. PG delivers solid, consistent returns just like JNJ. Procter & Gamble are involved with producing name brand consumer goods. They have health and beauty products, household care items, and acquired Gillette a few years back, incorporating their products to their lineup. Some of the names you will be familiar with include: Duracell batteries and Braun grooming products. As you can see, PG is simply a consumer staple play. Just like JNJ, Procter & Gamble doesn't provide you with a cool growth story to brag to your buddies about. It does, however, provide you with very consistent returns that can both preserve and grow your capital, as well as reduce your portfolio's risk.

If we are in a recession, these people still need batteries and shaving cream. If we are in a bull market, people will still need cleaning supplies and diapers. The economic environment doesn't matter because PG sells consumer staple goods. PG thrives in a bull or bear market, and that's the beauty of it. As we all have seen over the past few months, slowed growth and recession can hit your portfolio hard, so you need to be defensive. PG diversifies you into a consumer staples sector as well as reduces your risk due to its ability to function in any type of market. As I said in the beginning of this analysis, this pick is a boring blue chip with consistent returns. My main rationale for selecting PG along with JNJ in the consumer staples sector is that they have consistently strong numbers underlying their profitability. The fundamentals alone reveal why PG's stock returns are so consistent. PG has a trailing PE of 20 and a forward PE of 17, so it is technically cheaper on valuation than a competitor like JNJ. With a price to sales ratio of only 2.6, PG can be deemed undervalued by this metric (anything under 5 is considered undervalued). With a price to book ratio of only 3, PG is also slightly attractive in this facet. In this kind of environment, you have to pay a slight premium for protection. JNJ and PG offer that. PG is a solid company though with strong operating margins of 20.29% and a return on equity of 16.66%. These numbers illustrate that PG can perform well in any type of economic environment. Even in a period of slowed growth, PG is seeing 9.4% quarterly revenue growth (this number has accelerated too) and 14.3% quarterly earnings growth. Once again, slow and steady wins the race. And, that's all we need until the market can pick a direction and stop trading sideways in ranges.

Also, looking at institutional ownership of PG once again reveals that Mr. Warren Buffett loves the consumer staples sector, especially JNJ and PG as they both offer great valuation and consistent returns. Buffett's Berkshire Hathaway has an even larger stake in PG than in JNJ. They have pumped a $6.4 Billion investment into PG and it makes up 10.6% of their portfolio. Other notable institutions with very large stakes are investment bank JPMorgan, and investment firms such as Janus and Vanguard. Also, it must be mentioned that 4% of PG's shares are owned by insiders; a very strong number. Investors obviously don't need to recognize large institutional ownership as a reason to own PG, but it certainly helps convey the overall market confidence in PG. Next, let's turn to analyst coverage of PG. 11 analysts rate PG as a strong buy, 1 as a moderate buy, a 4 as a hold. As you can see, an overwhelming majority of analysts love PG. In terms of star rankings, UBS ranks PG 5 stars, while Merrill Lynch, Bear Stearns, and Oppenheimer all rate PG 4 stars. Once again, the investment banks are big fans of consumer staple plays (especially PG).

This is a boring stock to talk about because they make everyday items and don't provide astronomical growth-stock-like returns. However, PG does provide consistent gains, which I am a big fan of in an uncertain market like we are currently in. If negative economic data continues to be revealed, PG will be there to reduce your portfolio's risk and provide solid consistent gains over the long term. People need PG's products no matter what kind of market or economic environment we are in, that's the great thing about it. Its boring to talk about, its a blue chip behemoth, and you simply can't bet against them. PG is a long term value play because consumer staples will never go away.

PG: Buy, Target Price: $72, Time frame: 6 months


Merck (MRK): Selloff = violent over-reaction

MERCK & CO INC
MRK: Sold off due to over-reaction
Posted 0 days ago on 4/24/08
Buy: MRK, Target Price: $75, Time Frame: 1 year

Yet again, Merck (MRK) has seen its shares sold off irrationally and hastily. In recent months, MRK's value has plummeted due to investor/trader overreaction. Sure, the negative news that came out each time warranted a slashing of MRK shares. But, what we saw instead in this uncertain market environment was a complete and utter beatdown. 4 months ago, MRK was trading at $60. Now, it trades at around $38. Investors sold off this name on the panic (just like many other names) but then the shorts leaned in on this name and really drove it down. Look at it this way, nothing has materially changed at MRK's business. Their earnings are still strong and the worries surrounding their drug Vytorin are overdone. If you've followed the street for any amount of time you know that when a company misses estimates or comes out with negative news, the shares drop. Pile that in with a bear market and you've got a recipe for disaster. So, all this overreaction has simply presented an opportunity for longer term MRK investors. Remember the Vioxx scare? MRK certainly rebounded from that back up to $60. Vytorin worries now? No problem. Just pick up some shares of MRK on the drop and hold it for the year and you should see a solid recovery story just like before. Normally, when a stock announces it's going to be losing $4.85 billion, that would be seen as a very bad thing. But, in Merck's case, it is not. Merck (MRK) has settled its Vioxx lawsuits to the tune of $4.85 billion. This is actually a very good thing for the company because if they had fought each case individually, chances are, they would have had to pay a lot more. And, more importantly, it gets rid of the Vioxx noose that has been around its neck for so long. And now, with Vytorin questions looming, investors "sell now, ask questions later."

MRK has lost a third of its value this year mainly over Vytorin concerns. Yet, they have even said Vytorin is not meaningfully going to impact earnings in a negative manner. In fact, MRK just reported earnings and beat estimates by 3 cents. Even in this recession. Sure, they lowered the estimates for Vytorin and Zetia which obviously should not send the stock higher. But, it should not take off a third of the stocks value when you have not seen it affecting earnings. And, management has even said it should not change anything too much in their quarters. Roughly, this drug can represent 8% of MRK's sales and they just lowered the guidance. They didn't say this drug won't sell, they didn't say they're going to take a loss either. They're simply going to not make as much money as they once thought. MRK is trading at about 12 times earnings for this year. You be the judge.

Fundamentals: Merck has a trailing PE of 25 and a forward PE of 10.5, reflecting even more growth going forwards. Its PEG ratio of 1.27 is slightly high, but still manageable when you see that its price to sales ratio is just 3.55, indicating ndervaluation. So, Merck is actually fairly valued here. In addition to that, they have operating margins of 25.8% and a return on equity of 18%, very solid numbers in both categories. This is the main reason to buy MRK for the long term. Sure, eventually growth will slow. But, until then, you have to be in this name. Not to mention, MRK also has only $5.7 billion in debt, as compared to its $8.2 billion in cash. So, their debt to equity ratio is quite low and they can service this debt without any problems. Lastly, they are a dividend darling in the sense that they have a strong dividend of 4% and this dividend has been raised over numerous years. Since it's a long term play, treat it as your high yield savings account as this stock by itself yields more than typical online high yield savings accounts and most bonds or CD's. In addition, you get whatever share appreciation there should be over the year. And, if you want to make the deal even sweeter, write some covered calls on this name 10% or so out of the money each month. This will generate some premium that you can pocket each month in addition to the dividend.

Institutional Ownership: Some of the great hedge funds out there own this name. MRK can be found in numerous hedge funds' portfolios including: Maverick Capital, Caxton Associates, Ken Fisher, and Bridgewater Associates. Maverick is a $10 billion fund with consistent guidance from Lee Ainslie. Caxton Associates is a $20 billion fund with a global macro trading platform. Ken Fisher runs a $30 billion asset management firm and is a well respected big time investor. Bridgewater is a powerhouse in the hedge fund industry, managing over $160 billion. So, as you can see, there are some big guns in MRK and the most interesting bit is that all these funds implore different strategies, yet they are all in MRK. That says a lot about MRK as a company. No matter what strategy they are using, they all want to be in MRK for different reasons. MRK is clearly a solid play. And, you can bet that some of these firms have been adding on the severe "fire sale" of MRK shares.

MRK has been beaten down solely because of the market environment we are in. Should this have been a typical bull market, MRK shares would only be off 10% at most. Yet, since we are in a bear market with uncertain conditions, MRK has seen investors panic and short sellers lean in on this name. This 30% haircut MRK has seen is simply a casualty of the market environment. Be smart and think for the long term to add on the dips for this name if you're a long term player. If you're not a long term player, then move along this name's not for you. 1) They finally got the massive Vioxx lawsuit off their hands. Yes, they had to pay a lot to do so, but it saved them a ton of money by settling rather than fighting each individual case. 2) Their fundamentals are very very strong and that's the main reason they are so dominant in their industry. Their quarterly earnings growth is huge, and this is the main driver for any company. That is one of the main numbers you look at in terms of a company's ability to perform. 3) Numerous big investors and hedge funds have large stakes in MRK. Whether it be for valuation reasons, macro reasons, or growth reasons, all the big names mentioned earlier have large positions in MRK. They fully expect MRK to continue to grow and dominate within the pharmaceutical industry. 4) Vytorin worries are overstated. Yes, they will not see as many sales as anticipated. But, right now the street has effectively priced in as if they will practically no Vytorin. Not to mention, this drug only makes up around 8% of their total sales for the year. Violent reactions create excellent opportunities. Buy MRK for the long term (at least a year) to capitalize on a severe market overreaction.

Buy: MRK, Target Price: $75, Time Frame: 1 year


Johnson & Johnson (JNJ): Slow and steady

JOHNSON & JOHNSON
JNJ: Slow and steady
Posted 0 days ago on 4/24/08
JNJ: Buy, Target price: $72, Time Frame: 6 months

Johnson and Johnson operates in one of the few sectors of the economy that can do ok and thrive in a slowed growth or recessionary environment. As the old saying goes, slow and steady wins the race. This cliche summarizes Johnson & Johnson (JNJ) up quite nicely. This stock is nothing extravagant, not super volatile like some Chinese or tech stocks, and quite frankly, boring. This is your atypical run of the mill blue chip beast. That's right, JNJ won't add massive returns to your portfolio like some growth stocks, but it will deliver consistent returns, and that's what is so great about it. Johnson & Johnson (JNJ) researches and makes consumer staples, that's all there is to it. They have over 250 companies involved in the industries of pharmaceutical, medical devices, and consumer products. They make the goods you use on an everyday basis to stay healthy. Items in their arsenal include Tylenol, Band Aid, and Neutrogena. JNJ makes boring stuff you use everyday, and that's exactly why you should own the stock. JNJ is not a growth story, it is not a value story. JNJ is simply a survival story at this point. Look for this sector and this company in particular to help you weather the economic storm in your portfolio. Their products are all over and constantly used; they are necessities in any household. And for that exact reason you should own JNJ. And, if you haven't noticed, the stock has been performing quite nicely while numerous other stocks have struggled the past few months.

When times get tough and people start to see their income shrinking, they stick to the basics to survive, and JNJ provides just that. Johnson & Johnson performs well in any market, but performs even better in a recession. JNJ will still deliver the same consistent returns it always does. That is the main selling point of JNJ: consistency. You know what you're getting and you don't need to worry about the market environment. In an uncertain environment like we are in now, add consumer staples to the portfolio to a) diversify your portfolio and b) reduce your risk. If other sectors in your portfolio get hit hard, JNJ will stay strong and consistent. (Hence why you see it at a 52-week high while the rest of the market begins to tank). Now, the sector of consumer staples is pretty large and filled with some big names, so why JNJ? Well, the fundamentals explain the reason as to why I am selecting it as one of my main consumer staple plays to help reduce risk in your portfolio. This means that not only does JNJ protect you from short term uncertainty, it gives you a lot of upside in the stock for the long term. Take a look. JNJ has become slightly pricey at these levels, but that's completely acceptable as it's the premium you pay to protect yourself in a rough market. With a trailing PE of 16 and a forward PE of 14, JNJ is not unattractive though considering the environment we are in. And, not to mention, it has gotten cheaper on valuation when compared to last quarter because it is now trading at a lower PE. With operating margins of 25% and a return on equity of 24.6%, JNJ has a strong core business. These numbers allow them to have a 7.7% growth in quarterly revenue, despite the environment we are in. Again, JNJ is about consistency. Lastly, by a price to sales metric, JNJ is undervalued with a PS ratio of only 3.1 (anything under 5 is undervalued). Also, JNJ's price to book ratio is 4.47 which isn't bad at all either. So, you are barely paying a premium for the protection JNJ offers. Lastly, JNJ dominates in terms of quarterly earnings growth, seeing 39.8% growth year over year.

Institutional Ownership: Warren Buffett's Berkshire Hathaway has invested over $3 Billion in JNJ and owns over 53 million shares of JNJ. It makes up 5.4% of their portfolio. Buffett's track record speaks for itself, and I can definitely see why JNJ is one of his favorites. Looking at other major institutional owners reveals that all the other big dogs are there, such as Vangauard, Fidelity, and Barclays. When looking at things from a hedge fund ownership perspective, you will see that Renaissance Technologies holds 3.1% of its portfolio in JNJ (a $2 Billion investment). This hedge fund is often regarded as one of the top10 hedge funds out there. Now, there are many other big owners of JNJ, but these are the names that speak volumes. All these firms realize that JNJ has value and that it services a sector that will never go away. A look at analyst coverage reveals 7 strong buys, 2 moderate buys, and 5 holds. Not one negative recommendation. A look at the star ratings reveals that Bear Sterns and Raymond James rate JNJ 5 stars, while Bank of America, Goldman Sachs, and 4 other major investment banks all rate JNJ 4 stars. They all expect JNJ to easily outperform expectations with low risk.

Stay diversified and reduce the risk in your portfolio with JNJ.

JNJ: Buy, Target price: $72, Time Frame: 6 months


Diageo (DEO): International Flavors

DIAGEO PLC ADS
DEO: International Flavors
Posted 0 days ago on 4/24/08
Buy: DEO, Target Price: $98, Time Frame: 1 year

A while back, I wrote an analysis on DEO with an $87 price target to be achieved in 6 months. And, I was pleasantly surprised to see that it reached that target in less than 3 months time. As a matter of fact, it surged an additional 6 points to 93 before settling back down. So, looking at the rationale behind buying DEO the first time, I noticed that the fundamental story behind DEO still holds true and there's no reason for this name not to perform well throughout next year. So, let's re-examine DEO. It's been a few months and we've let it cool off and digest its big move. After consolidating and dropping off like the rest of the market, DEO has formed a nice base and has begun trending back up higher. It's a great time to load up on this international company.

If you're unfamiliar with what Diageo does (as I was when I first heard about them a few years ago), Diageo (DEO) makes alcohol, that's all there is to it. Their brands include Captain Morgan, Smirnoff Vodka, Johnnie Walker Whiskeys, Baileys, Guinness, Crown Royal, and most recently, Absolut Vodka. People have vices, and DEO is their supplier. People all around the world obviously love alcohol and so its one of those recessionary proof names. So, regardless, this is a good name to have in the portfolio. DEO truly has a global presence and caters to nearly every type of alcohol drinker with their diverse line of products. This is a recessionary name because its alcohol (think Altria/MO/PhilipMorrisInternational/PM). At the same time it's a great multinational company due to its large international exposure. And, its just simply a well-run company.

To prove that, all you have to do is look and see that DEO has actually been stealing market share from traditional beer producers such as Anheuser Busch. The trend so far is a decrease in beer consumption and an increase in wine and spirit consumption. Specifically, in regards to the domestic beer market, consumers have been shifting from the typical names such as Budweiser and Coors and have been shifting to the craft and specialty beers, which obviously benefits DEO. Now, at the same time, don't expect domestic beers to just drop off the planet all of a sudden, but there has been a noticeable shift and it seems to favor Diageo and hurt the likes of Anheuser Busch. And, unlike Anheuser, Diageo has a vary diverse product offering, ranging from wines to liquors to spirits, etc.

Fundamentals: Currently, DEO has a market cap of $53 billion and a trailing PE of 17 and a forward PE of 15. DEO's price to sales ratio is very attractive at 3.49, well below the undervalued region of 5. DEO's PEG ratio could be better though, coming in at a slightly high 1.62. But, this is a 5 year predicted growth rate and we will only be playing this name for the next year, so we could technically calculate a whole different PEG for our purposes. Turning to operating margins we see that DEO enjoys healthy margins of 28.75% (slightly increasing quarterly too). Also, DEO's return on equity comes in at a strong 36% (accelerating rate as well). These numbers are very strong and are helping fuel DEO's bottom line. The only major negative with DEO is their debt. They currently have 13 billion worth of debt, and only 1.75 billion in cash. So, keep this in mind when considering this name. Keeping track of how DEO manages this debt is essential to their continued success. If you are a true fundamentalist, then this ratio of debt/equity might completely steer you clear of this name, which is understandable. It is indeed a lot of debt. But, at this stage, given my time frame, I'm looking more at their international exposure and diversified product base.

Next, let's turn to another major reason to buy DEO. Originally, when I first analyzed DEO, the technical signals were very bullish and were a main reason behind the buy then. This time around, they tell a slightly different story. Currently, DEO is in a slight uptrending, but still below its 200 day moving average. One positive though, is that it is currently trading above its 50 day moving average and is using this line as support. So, as long as this uptrend stays in tact, DEO should be crossing above its 200 day moving average, giving it a completely bullish chart. Given the market conditions currently (overbought, due for a correction) it is a very real possibility that DEO will trade sideways or even below its 200 day moving average. I mainly just wanted to write about this name now before I forgot about it. So, right this second is not necessarily the best time to buy DEO. Sure, the uptrending pattern from its recent low in January is a great sign, but ideally I'd like to see it break above its 200 day moving average. DEO seems to trade in a distinct range on the chart, using its moving averages and bollinger bands as support lines. There are obviously a lot of technical traders/investors who play this name since it seems to always bounce right where it should based on technicals; call it a self-fulfilling prophecy.

Looking at the institutional ownership aspect of DEO, we see that there are some big names with big stakes in this company. Lazard Asset Management, Renaissance Technologies, Fidelity, Barclays, Wachovia, Bank of America, Keybank, Fidelity, and Legg Mason all have major positions in this name. Each of these companies has invested at least $172 million into DEO, with Renaissance Technologies investing as much as $328 million into DEO. And, no, Renaissance is not actually a technology company, but rather one of the most consistent and successful hedge funds in the game. They are known for dominating the market and achieving excessive returns on a yearly basis. So, when they take a large stake in a company, you want to take notice. Their confidence in DEO should instill confidence in the everyday investor regarding this name.

As I said earlier, it might be a little early to get into this name so watch it carefully; I just wanted to write about it before I forgot. Its currently in a great slow and steady uptrend over the last 3 months and is sitting on the 50 day moving average as support. If it breaks above the 200 day moving average at around $84 then you can be a strong buyer. Right now I'd only scale into it until we get confirmation of the trend and that the support line holds. Last time the technicals worked perfectly as it reached my 6 month target in just 2 months. So, let's see if DEO can continue its uptrend as investors pile into a name they know is safe when uncertainty surrounding the US markets and economy increases. Play DEO for its product line and international exposure and maybe we'll get lucky again and have it reach the price target in a fifth of the time again.

Buy: DEO, Target Price: $98, Time Frame: 1 year


Saturday, April 19, 2008

Nike (NKE): The quintessential international company

Buy: NKE, Target Price: $73, Time Frame: 6 months

Nike (NKE) is one of the first stocks that comes to mind when you think of big, bluechip names. They consistently seem to perform and offer the slow, boring, yet consistent returns on your investment. Even though that might be the case with most bluechip names, NKE is far from that. Over the past year, NKE is up 32.6%. Over the past 5 years, NKE is up 200%. So, as you can see, NKE might be a boring blue chip name, but they certainly don't come with the typical 10-15% bluechip returns. In fact, NKE is performing at a rate that is nearly double that of most boring blue chip large cap names. The point of this analysis is to point out that obviously, NKE is a buy on any dip. If you pull up a chart of Nike, no matter what time frame, you will see a nice uptrending chart. Stocks that trade like this are simply buys on the dips, and NKE is just that. They are seeing huge growth internationally and so in addition to playing a great company, you're gaining a lot of international exposure as well.

Fundamentally, it should come as no surprise that NKE is just dominant in their industry. With a PE of 18.6, they are slightly cheaper than the industry average of 20. Their price to sales ratio of 1.82 implies that they are very cheap on valuation. Any equity with a PS ratio of less than 5 can be deemed undervalued, and NKE definitely falls into that category. They also have operating margins of 13.6% and a return on equity of 25.3% (slightly accelerating too), both very solid numbers that exemplify NKE's solid fundamental drivers. So, overall, NKE is pretty fundamentally sound, but we already knew that. They are seeing quarterly revenue growth of 15.7% and quarterly earnings growth of 32%, both great numbers, even with a slowing US environment. This just goes to show how much international exposure Nike has, and how beneficial it is to them.

Analyst sentiment: There are currently 2 strong buys, 3 moderate buys, and 3 holds on Nike. So, 5 overall buys and 3 holds is pretty bullish. The 'hold' analysts are obviously telling us to hold for the long term as they see continued, consistent blue-chip like growth ahead for NKE. In addition, both UBS and Merrill Lynch rate NKE 5 stars, while Citigroup rates NKE 4 stars. This information is also bullish for NKE. Overall, analysts expect NKE to significantly outperform the market over the next six months with very little risk. Earnings growth over the past year has held steady when compared to earnings growth over the past 3 years. And, one or more analysts have modestly increased their quarterly earnings estimates for NKE. Turning to the institutional ownership aspect of NKE, we see that Fidelity, Barclays, State Street, Vanguard, Janus, Dodge & Cox, and Berkshire Hathaway are all major shareholders. Each of the above has invested at least $448 million into NKE, with Fidelity investing as much as $993 million. Not to mention, behemoth hedge fund Renaissance Technologies has a very large stake in NKE, which provides investors with that much more confidence. Anytime a consistent hedge fund performer like Renaissance is in a name you're looking at, its always comforting. They all expect NKE to continue to perform with relatively low risk.

Lastly, NKE's earnings reports just reaffirm what we already know. Nike is showing a 10% increase in profit, mainly fueled by international growth. These results all exceeded analysts expectations as well. Quarterly revenue has been up 14% and with all their international exposure, Nike certainly benefited from currency discrepancies (especially the weaker Dollar). Revenue growth in the Americas was up 19% and 18% in Europe and 17% in the Asia Pacific region. Growth in Europe and Asia was notably much stronger than what analysts were anticipating. CEO Mark Parker said that their quarter "illustrates the ability of our portfolio to deliver consistent, profitable growth." And, what more can you ask for from a company? (Especially a huge company like NKE). Lastly, Nike also saw an increase in cash, gaining $3.1 billion by quarter's end. They are making several notable changes by selling Nike Bauer Hockey up for sale and having recently acquired Umbro PLC, a soccer company. This is definitely a move in the right direction for Nike as soccer continues to grow as the "world's favorite sport." By picking up Umbro, Nike has essentially picked up a solid soccer presence to add to their already large European soccer market share. But, at the same time, Nike will see dividends paid from this investment worldwide, not just in Europe. And, they sold off their presence in the dwindling hockey market.

Nike is a solid company with solid fundamentals and solid growth. If you were to use one word to describe Nike, it would have to be: solid. They simply continue to perform in that boring, blue chip fashion. But, instead of offering the typical modest blue chip gains, Nike is tearing it up. And, the best part is, they will continue to do so. Nike is a buy on any dip.

Buy: NKE, Target Price: $73, Time Frame: 6 months


CSX Corp (CSX): Rails still red hot

CSX: Buy, Target Price: $64, Time Frame: 6 months

Typically I don't like to recommend names that are just hitting 52 week highs because they usually pull back and consolidate after their big run. However, in CSX's case, the industry is simply seeing too much strength and thus the name should have continued momentum. It took out my last price target of $51 in no time. After re-evaluating things, its still a strong play. If you thought that in a 'weak US environment' that the rails would succumb to poor performance, then think again. If you've noticed the earnings reports from all the major US rails recently, you'd notice a distinct pattern: they're all beating estimates. No matter what kind of economy we are in, CSX keeps on chugging. CSX provides rail, intermodal, and rail-to-truck services in the railroad industry. As oil prices sky higher every day, planes and 18 wheelers are looking more expensive and less attractive to transport items with. Therefore, look to the rails. As the media has hyped the last few months or so, Warren Buffett has taken a large position in the railroads recently, and rightly so. He was a little early to the railroad party, as he experienced some downside in the late summer, but nevertheless it was the right call. And, in this recent downturn, Buffett has again added to his rails position, signaling his strong belief in the core business. Rails will be a solid form of transportation whether we continue to see great global growth or whether we experience a recession. How is this possible though? Rails can sustain current profitability in a recession? Well, yes they can and its because of two things: agriculture and coal. Prices of coal and ag related commodities have skyrocketed. Thus, these products are in high demand and need to be transported constantly. These two commodities are seemingly recession proof as well, as record earnings from Potash, Mosaic and others indicate. So, even if a recession is among us or headed our way, the rails will still profit. And, as CSX's most recent earnings indicate, the rails see continued strength due to commodities demand.

Fundamentals: With a trailing PE of 19 and a forward PE of 14.5, CSX shows its increasingly rich valuation due to share price appreciation. But, this move is a fundamental move and thus allows CSX to trade at a higher multiple. Its PEG of 1.01 is decent but nothing spectacular either. Its price to sales ratio of 2.4 indicates that it is undervalued, as any PS ratio under 5 deems this. Also, its price to book of only 2.8 shows that CSX is indeed undervalued by this metric as well. Buffett likes to see PB ratios of as close to 1 as possible, and CSX is right there. The rails core business is also strong with solid operating margins of 22.2% and a return on equity of 13.9%. This ROE is slightly low when compared to Buffett's typical standard, but he makes an exception seeing as all the rails have typically lower ROE. So, as you can see, it has some decent valuation (rising multiples due to industry strength) and is even deemed undervalued by certain metrics. CSX will continue to grow and beat estimates as long as the commodity race continues. Agriculture's secular growth is a key component of CSX's ability to withstand any recessionary pressures. And, we all know this secular growth will continue as commodities demand and prices sky higher every month.

Taking a look at a 1 year chart of CSX reveals a strong uptrend with noticeable dips for buying opportunities. If you don't want to hold this one long term, you could technically flip it each time it hits the dips, as the trend is very distinct. Be warned that there might be some near term downside, but it should be limited. After all, consolidation after big moves is necessary and healthy. As mentioned earlier, the rails are being fueled by strong commodity demand and are constantly transporting agricultural products. Strong fundamental strength here is why the chart looks so bullish.

Institutional Ownership: I've been following hedge fund activity as you can really see what sectors prominent funds are heavily weighted in. I could take all the research I do on all my stocks combined and it would still be less than what some of these funds do with their research and trading teams for this one stock alone. So, why not take their lead as an indicator of where to head. After all, if you follow the prominent hedge funds (ones that return greater than 30%) you are in good hands. So, hedge funds are currently heavily weighted in rails. Like I said earlier, Buffett got into rails early, and I think even some of the hedge funds are piggybacking Buffett's idea for longterm value. So, prominent hedge funds are heavily invested in rails and in particular in UNP, and more importantly, CSX. Taking a look reveals that Atticus Capital and Tudor Investments are two majority owners of CSX. In fact, CSX makes up 4% of Atticus' portfolio. And that actually says a lot, as hedge funds hold so many different positions at any given time. They are betting big time on long term growth for CSX. Also, Carl Icahn's fund Icahn Management and Daniel Loeb's fund, Third Point are big holders of CSX. In fact, BOTH recently upped their ownership to 2.9 million shares and 2.0 million shares respectively. Both increased their positions by at least 300,000 shares each. There are many other hedge fund holders of CSX which shows an overwhelming majority, and I have only chosen to highlight the most prominent names in the space. Point is, big hedge funds are throwing big money into CSX for the long term based on its cheap valuation and their bullish outlook on the transports and particularly the rails. It should also be noted that activists Icahn and Loeb (just mentioned above) who own large stakes in CSX are calling for a split up of the company in order to extract most value. Basically, think MO (Altria) and apply it to the rails. Altria spun off Kraft foods first, and then recently just announced they plan to spin off Philip Morris International as well in order to enhance shareholder value. The same technique can be applied to CSX as Icahn's and Loeb's research points to a stronger valuation for CSX if it is broken up. So, look for that catalyst to move the stock sometime within the next year as well. Rumors are already surfacing that Icahn and Loeb have begun their activist quest. So, there you have it. CSX and the rails in general are being picked up left and right by institutional and hedge fund money.

I'm not going to cut and paste the recent earnings numbers because they're readily available on Yahoo/Google finance. If you pay any attention at all to this sector you know that it is seeing underlying strength and that's all there is to it. There are simply way too many reasons to own the railroad sector, and CSX in particular. The stock is pegged for future growth. CSX benefits from any future rise in oil prices as other forms of transportation become extremely expensive. Also, the rails will continue to drive profits from transporting the heavily desired agricultural goods. Warren Buffett staked himself in the rails earlier last summer ahead of the crowd, and numerous prominent hedge funds also have taken large positions in CSX. Buffett even added to his rails position in BNI again over this most recent sell-off. Lastly, activist investors amongst those hedge funds will also look to split up CSX to extract the most shareholder value possible. Look for CSX and the rails in general to see continued slow and steady growth. The secular growth from agriculture and other commodities is simply too great to be ignored. While we may be in a recession, you can still find solid places to put your money to work: secular bull markets. And, the rails are in one with their strong tie to commodities.

CSX: Buy, Target Price: $64, Time Frame: 6 months


Burlington Northern (BNI): Rails seeing continued strength

BNI: Buy, Target Price: $110, Time Frame: 6 months

In recent weeks, we have seen a clear shift in energy prices. Oil has primarily moved upwards due to fundamental reasons (weak US dollar). Oil is cruising higher. And, if you believe in T. Boone Pickens Peak Oil Theory, then the rails are just the play for you. Wait, but if energy prices are high, why would we look to transportation? Don't they get hit hard by these high costs? That's exactly the point. This will affect every single type of transport company (rails, trucks, planes). Rails, however, will be affected the least. We recently saw weak earnings results from trucking companies who cited slowing demand and rising fuel costs. This is all the more reason to be bullish on rails. If it becomes so expensive to ship things via trucks and planes due to high fuel costs, where will suppliers turn? To the rails, of course. Sure, the rails still have to face energy costs. However, the severity of the impact of energy prices on rails is much less than that of trucking companies or planes. It seems that transport has shifted from airplanes and trucks to good old-fashioned railroads. And, to sweeten the deal, this favors rails for the long term as well. As oil is consumed heavily all over the world on a daily basis, Peak Oil Theory will only become that much more evident. This means that airplanes and trucks will become that much more expensive to operate, and the rails will continue to see a shift in their favor. Buffett is undoubtedly playing the rails for the long-term, and he has the perfect thesis to back up his investment: Peak Oil Theory. Not to mention, the rails are the form of transport for some of the hottest commodities out there right now: soft commodities/agriculture. These crops are rising in price due to strong demand and weak supply. The rails are the principal form of transport and this secular bull market spills over right into the rails.

Since we know the fundamental story behind the industry, lets make it easy and invest in the name that Buffett keeps piling into whenever it dips down low: BNI. Fundamentally, BNI offers a compelling story and its clear why Buffett initially made his investment. Besides having strong fundamentals in the underlying sector, this specific company is strong fundamentally as well. With a trailing PE of 19 and a forward PE of 14, BNI has become slightly rich in valuation over the past few months. But, this is due to the fact that they are seeing industry strength which allows them to trade at a higher multiple. With a PEG around 1.19, there is still room for earnings growth as well. Price to sales ratio of 2.19 deems BNI undervalued as any PS of under 5 is very bullish in terms of valuation. Additionally, BNI has a price to book of 3.1 which is decent, but nothing spectacular (it was much cheaper when Buffett first got in, that's for sure). BNI cleans up compared to other rails in terms of operating margins and returns on equity. Every little edge counts and with operating margins of 22% and a return on equity of 16.8%, BNI comes in slightly ahead of its competitors in the "bread and butter" of profitability in their business. Additionally, they are seeing 9.4% quarterly revenue growth. And, that is in the rails? think about that. Such an old fashioned form of transportation is seeing slow and steady growth at this day and age is almost amazing. It all boils down to the underlying sector strength due to the commodity bull market and secular growth in agriculture. There is a negative associated with BNI and that would be their debt. They have $330 million in cash, but more than $8 billion in debt. Seeing as they are raking in the profits, look for them to spend some of that cash to pay down some debt to get their debt/equity level to more comfortable levels.


This piece merely serves to reiterate which name is the best of the pack. BNI recently reported better than expected quarterly profit. In recent quarters, the company cited increased volume from the agricultural business. This fact also benefits BNI as agriculture is seen to continue to be strong through 2008. In my recent analyses of agriculture giants Potash (POT), Mosaic (MOS), and Agrium (MOS) I cited how top management saw agricultural demand as very strong throughout 2008. With energy prices so high, suppliers and farmers will continue to send and receive products by rail. This agricultural bull market adds yet another positive catalyst for BNI and the rail stocks. So now we've got high oil prices and an agricultural bull market working in favor of the rails. The long-term outlook for these names is definitely bright.

Institutional Ownership: As an investor or a potential investor, you like to see this kind of positive outlook, but you also look for reassurance that other great minds are thinking the way you are. And, as a matter of fact, BNI's shareholders include some of the great names in terms of investors. First off, as mentioned earlier, Warren Buffett has recently acquired stakes in BNI and UNP, betting big on rails for the long term. Buffett's Berkshire Hathaway has taken a greater than 16% stake in BNI, and it is one of Berkshire's largest investments in a long time. His vote of confidence in these names alone should give other investors even more confidence. Secondly, besides receiving a seal of approval from Warren Buffett himself, BNI has also received a stamp of approval from one of the most successful and well respected hedge funds on Wall Street: Atticus Capital. 3% of Atticus' portfolio resides in shares of BNI. Now, some of you might be thinking, 3%?! That's not that impressive. Well, it immediately becomes impressive when you find out that Atticus is a $13 Billion Hedge Fund. 3% of $13 Billion? You do the math. Lastly, BNI also has seen BlackStone take a heavy stake in their company through their Kailix Advisors Hedge Fund arm of their organization. 5.1% of Blackstone's hedge fund portfolio is secured in shares of BNI. As you can see, 3 major names in the world of Wall Street have bet on BNI and the rails for the long term. Not to mention, they have bet with very large amounts of money. When you have this many smart minds investing in one name, it's definitely worth checking out. Collectively, they've done more research than all of us could do combined. If there ever was a vote of confidence in a stock, this is it. This provides just an additional reason to like BNI. With Buffett, Atticus, and BlackStone all backing this name, it's hard to bet against them.

BNI: Buy, Target Price: $110, Time Frame: 6 months


Friday, April 18, 2008

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