week of November 8th 1999: An all new stock ideas section featuring
long and short ideas.
OPINION ARCHIVES: 3
CLICK ON A NAME TO VIEW CURRENT
In the current bull market stocks with strong brand
name recognition have been richly rewarded as new investors bought what they were familiar
with. Gillette has been one of the prime beneficiaries of the buy what you know mentality.
Strong promotional hype for its new razor blade system has recently put the stock's
valuation into orbit. We'll grant Gillette the technological wonder of their new blade,
but we don't believe people will be rushing out to spend 30% more for a new razor.
Competitors have also introduced new blades--at lower prices. We don't see any further
upside for G which is trading at 41X 1998 earnings and 35X 1999 estimates, with a PEG of 2
(based on '99estimates). The stock recently failed to surpass its previous high and the
money flow into the stock has turned negative. We will Go Short.
(General Electric) Perhaps the best managed and run
American company--but everyone knows it and has bought it during the current bull
run. This has resulted in GE trading at unsustainable valuation levels of 30.7
times 1998 earnings and 26.9X next year's, with a PEG of 2. We expect this stock to return
to more normal valuation levels during any market downturn as investors sell the
overvalued blue chips they have gorged themselves on. We see no further upside since we're
not great believers in the "this time it's different" justification for current
market levels. Distribution has been taking place in GE, with money flow failing to
confirm recent highs. Remembering that great companies don't always make great investments
over an intermediate timeframe, we would be sellers of GE at these levels.
(Ballard Power) This Canadian fuel cell developer's
stock jumped from 29 in August to 133 in March after being highly touted by a certain well
followed newsletter writer. We see this stock following the same pattern as many of this
newsletter writer's other picks--a sharp runup followed by an equally sharp decline as
fundamentals take over from promise. Although this company does have very promising
technology and strategic corporate alliances, we see problems developing for the stock. It
has many patents on fuel cell technology, but so do its larger competitors. We feel that
the financial muscle of its larger competitors will make it hard for this company to
dominate the emerging fuel cell field. We also believe that the mass introduction of fuel
cells won't happen until at least 2010.The Daimler-Chrysler merger will also have a
negative effect on this company. This stock has runup too fast and is presently
discounting earnings expectations for the next 5+ years. Technically the stock has begun
to break down. The stock has broken down through the 38% fibonacci resistance level. MACD,
Stochastics, RSI, and on balance volume have all turned down from overbought levels. The
stock has fallen below its 50 day moving average and entered a downturn. We look for it to
(American Int'l Group) This giant international
insurer operates in 130 countries. We believe this company's global reach will become a
negative for the stock price in the coming months. The company has extensive business in
Asia. While investors have been quick to beat down the price of Asian equities, they have
tended to overlook the implications of the Asian crisis on the business of non technology
related U.S. blue chips. We believe that Asia will have an earnings impact on companies
with significant Asian operations. We believe that AIG's Asian operations will be a drag
on earnings. We see no justification for the stock's current valuations--24X '98 estimates
and 21.3X 1999's. This stock has come down from 140 and we see further downside risk.
O.B.V. has been heading lower since 4/22, and the stock has fallen below its 55 day moving
average. We look for AIG to retest its January low of 100.
(Walt Disney) We believe that Mickey
Mouse will have a great fall. Walt Disney's stock valuation is based on brand
recognition rather than fundamentals. We see severe problems ahead. Weak ratings at
ABC and a high priced NFL contract will cut into profits. The current valuation ( a PE of
35 and 30 times next year's earnings) is not justified by the deteriorating fundamentals.
After hitting a peak of 128, the stock has recently corrected 12%. We look for it to
fall below 90 this summer. The stock has completed a failed double top. Money flow is
negative and the stock has fallen below its 55 day moving average. Deteriorating
technicals and fundamentals have caused the Magic Kingdom to jump onto the Go Short
We feel that the Spanish Market is extremely
overextended. The Madrid Stock Exchange Index has jumped 65% since late October in the
euphoria surrounding EMU. Lower interest rates, increased investor participation, a strong
economy and high hopes for Spain's entry into EMU all contributed to the market's meteoric
rise. The market is overvalued at a PE of 28.1 and a yield of just 1.7%.With the easing of
EMU related over zealousness, we expect a sharp correction to return the market to
more normal valuation levels. The following stocks are the best way to play a market
SPANISH BANKING SECTOR: The greatest beneficiary of EMU euphoria has been the Spanish banking
sector. The Madrid banking index has almost doubled since November as investors
piled in on lower interest rates and hopes for consolidation in the industry.The sector is
now extremely overvalued. We believe that positive sentiment towards the group is at an
extreme and that a top is in place. The group peaked in early April and recently completed
a double top. Distribution is taking place as the smart money sells, and money flow is
decidedly negative. We would short the big 3 banks: STD: (Banco Santander) STD: (Banco Santander) (Banco Santander) STD: (Banco Santander) (Banco Santander) STD: (Banco Santander) has risen from
an October low of 23.5 to 53. This bank is trading at a PE of 27.6 and at 21.5
times 1999 estimates with a PEG of1.8. has risen from
an October low of 23.5 to 53. This bank is trading at a PE of 27.6 and at 21.5
times 1999 estimates with a PEG of1.8. BBV: (Banco Bilboa Vizcaya)BBV: (Banco Bilboa Vizcaya)BBV: (Banco Bilboa Vizcaya)BBV: (Banco Bilboa Vizcaya) The most
overvalued of the big 3 Spanish banks, BBV has shot up from an October low of 23 to 52.5.
BBV is trading at an unsustainable PE of 31.4. The PE on next year's estimates is 25.3,
with a PEG of 2.1. Short BBV first. (5/27/98)
While the recent merger of Banco
Santander and Banco Central Hispano improves the bank's competitive position in the
Spanish and Latin American banking markets, the valuations accorded this stock continue to
be a concern. The stock's current P/E ratio is twice its long term growth rate of
12.6% per annum. The bank still has an uphill battle to fight against larger
European banks. (4/24/99)
(Telefonica de Espana) This international phone
company with strong Latin American operations has doubled off its October lows. It is up
40% since mid February. Restructuring, moves to enhance shareholder value, and favorable
sentiment towards the telco industry have been the prime drivers of its surging stock
price. TEF is trading at 28.2X '98 estimates and at 24.1 times next year's. The stock is
extremely overbought, trading 36% above its 40 week moving average. We believe that all of
the good news (and then some) is already factored into the stock price. Look for a
pullback to the 40 week moving average.
(Vodafone plc) U.K. based international cell phone
company VOD has been on a tear this year as merger speculation has seen the stock jump
from its January lows of 69 to a recent 125. A better than expected yearly earnings report
saw further gains for the shares. We believe all of the good news has been priced
into the shares. VOD is overvalued, trading at a PE of 41.6 and 30.8 times next year's
estimates. The shares are trading at a PEG ratio of 1.8, and at a price\sales ratio of
12.5. We believe that any bid for the company would not offer a significant premium to
today's price. We look for increased competition, and lower profit margins in the cell
phone provider field as the hunt for new users heats up. We believe that new customers
will increasingly come from the lower usage, lower margin consumer segment as the
business user market becomes saturated. We look for cell phone rate levels to decline
towards line based telephone rates over the coming years. Technically, VOD is extremely
overbought. The weekly ADX has turned down from 65, and MACD, stochastics, and RSI
are all showing divergences. We look for these shares to decline to their 200 day moving
average at 81. Hang up the phone on this one.
U.S. Electrical Utilities: The
slow growing electricity industry has reached historically overbought valuation extremes.
We have turned negative on electrical utilities for two reasons. First, we view the
current analyst bullishness on deregulation as misguided. For every electric co. that
gains from deregulation we expect there to be another that loses business. Competition
will lead to a lowering of rates, and profit margins. The only real winners we see
from deregulation are Wall Street investment bankers. Our second reason for
pessimism on the group stems from our belief that long term interest rates have
bottomed. The recent plunge in interest rates was mainly due to investor's
panic over the situations in Asia and Russia. As the situation calms in Asia we expect
this flight to quality that led to record low rates to reverse. We expect Asia's
economies to begin a recovery later this year. This will take away the one factor
that has been keeping a lid on inflationary pressures in the U.S. The interest rate
sensitive utilities will fall as long term bond yields rise. The group's recent
runup to new highs was entirely due to foreign investors parking their money in
U.S.treasuries for safety. We believe the worst has passed in Asia and the flight to
quality , and subsequent runup in the utility averages, is over.
(Consolidated Edison): New
York electric company Con Ed leads our list of electric co shorts. The company has
recently purchased Orange and Rockland utilities. We see limited earnings benefits from
this deal. ED's current price discounts any improvement in earnings far into the future.
Con Ed , with a PE ratio of 15.9, is trading at historically high valuation levels. We
expect a rise in long term yields to hit the share price hard. Technically ED's
shares are looking decidedly negative. ED's chart is showing a failed double top.
The recent runup was accompanied by a negative divergence in OBV. Stochastics and %R
are giving sell confirmations. The negative volume index peaked in March and
has been falling during the recent price rally--a bearish signal. We expect Con Ed's
PE ratio to contract to 11 times earnings, for a target of 33 over the next year.
It's time to turn off the lights on this stock.
(Niagara Mohawk Power): NMK has survived a near death
experience. The electrical utility, which sells electricity to 1.5 million customers in
upstate New York, was teetering on the edge of bankruptcy in 1996 as unfavorable payment
terms in government mandated long term contracts with independent power producers rendered
the company unprofitable. The company has since renegotiated these contracts and
restructured its operations. Payments to independent power producers have been reduced by
$500 million annually. A return to profitability is expected this year. The company is
planning to adopt a holding company structure with 2 principal subsidiaries: Niagara
Mohawk (a regulated company) and Opinac NA (unregulated). The company plans to further
reduce its debt load by selling its hydroelectric plants. NMK's stock price has recovered
in tandem with company's rising prospects, rising from $6 in 1996 to the present $15 1/2.
Unfortunately for NMK shareholders, the shares' present valuation fully reflects a
complete recovery. We see no further upside in the shares. The company still must deal
with the uncertainty of looming deregulation (large industrial customers are free to
choose their electric provider starting November 1st, with other users to follow in steps
in 1999). The company's debt burden remains high by industry standards: NMK's LT
Debt/Equity ratio is 1.8 versus the industry average 1.11, and interest coverage is 0.56
versus 2.91 for the industry. The company still has a long way to go to bring
profitability measures up to industry norms: operating margins were 3.9% for the latest 12
months versus 18.3% for the industry, revenue per employee was $460,000 for NMK versus an
industry wide average of $610,000. There is still a long road to travel before a
full recovery is in place.
The technical outlook for the shares
has also been weakening since their September 18th peak of 16 3/8. The September rally
stopped at the 50% retracement of the 1993-1996 decline. RSI and MACD both exhibited
strong negative divergences during last month's peak. Weekly Money Flow and OBV are
in downtrends. Weekly ADX has fallen below 40, giving a sell confirmation. The underlying
technicals for the Electric Utilities as a whole have deteriorated over the past
month. We feel that NMK shares are particularly vulnerable during a sell off in the
utility sector. Our 6 to 9 month price target for the shares is $10 to $11 a share.
FPL (FPL Group Inc): FPL
is a holding company whose principal subsidiaries are Florida Power and Light and FPL
Capital. FPL Capital's principal operations are FPL Energy (a developer of
independent energy products) and Turner Foods (a developer and operator of citrus groves).
FPL Group has enjoyed strong earnings growth over the past few years, and has become a
darling of Utility analysts. Strong fundamentals, heavy analyst praise, and a
favorable interest rate environment have combined to lift share prices to historically
high valuation measures over the past year. We believe the shares are now overvalued, and
are recommending the shares as a short based strictly on valuation levels,
deteriorating underlying technicals for the Utility group as a whole, and our belief that
closely correlated long term interest rates have bottomed.
FPL's forward 17.4 P/E is at the high
end of its historic range (as we've said many times in the past, historically the best
investing performance has been obtained by buying at the low end of the P/E range and
selling at the high end). The company is trading on a forward PEG of 2.8, with an
expected 5 year growth rate of 5.5% a year. The company's valuations are high compared to
the industry average: FPL's P/B ratio is 2.42 versus 1.86 for the industry, and the
Price/Sales ratio is 1.84 versus 1.23. The high valuation levels accorded FPL
make the shares particularly risky given our belief that the Utility averages, and the
bond market have peaked. In the event of a second wave of panic induced buying of
Treasuries, we do not believe that the Utilities will benefit. Investors are more likely
to seek the safety of cash, rather than Utility stocks, if another stock market selloff
leads to panic.
Several technical indicators showed
strong negative divergences with price action during the early October peak in the
Utilities. This is a normal occurrence during panic driven market events. Prices are
driven to abnormal heights, while the underlying indicators show divergences.
Distribution has been taking place over the past few weeks, with both Money Flow and OBV
turning down. We are sellers of FPL Group shares at these levels, with a 1 year target of
$50 a share.