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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