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Coming the week of November 8th 1999:  An all new stock ideas section featuring long and short ideas.

MORE GO SHORT OPINION ARCHIVES: 4

BestFoods British Telecom American Express
Cisco Systems Wal-Mart Stores The Gap Inc
Pfizer Charles sch Schering Plough
eBAY Inc    

 

BFO (BESTFOODS): BestFoods, the former CPC Int'l, is the maker of such well known food brands as Skippy, Hellman's, Mazola, Arnold breads, and Thomas muffins. A second quarter earnings gain of 16% sent the shares to a new high. BFO is another of the name brand stocks that investors have driven to new highs in their effort to avoid the Asian debacle.   It is also another high PE ratio stock with flat sales. We view the shares current levels of 23X next year's earnings, with a PEG of 1.93 as excessive for a company with flat sales growth. Technically the stock has begun to break down. It has fallen below both its 21 and 55 day moving averages. OBV has shown very strong divergences with price movement during the recent runup. Weekly MACD and RSI have both entered downtrends from overbought levels.  Our first down side target is the 50% retracement level near the 100 week moving average at 48.  We expect the stock to ultimately correct to the 43-44 level.  
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BTY (BRITISH TELECOM PLC):  BTY provides local and long distance services in the U.K. and international services to and from the U.K. The shares rose to a record high of 149 last week after the company announced a global alliance with ATT that will combine the 2 companies international operations into a $10 billion a year joint venture.  The new venture's size will give it an advantage over smaller startups, but we don't think this alone justifies the shares excessive runup on the news. The BT-ATT venture will be competing against other large global consortiums that also possess the size to effectively compete for new business. We see the choice of ATT as a partner as a negative. Both BT and ATT have spent much of this decade struggling to defend market share in their home markets as they shed the bloated corporate structures left over from their monopoly days.  We believe that the leaner, less bureaucratic structure of rival global consortiums will prove to be a serious challenge for the BT-ATT alliance to overcome. BTY continues to face harsh operating conditions in its home UK market. Nimble rivals like Colt Telecom and Energis are proving to be serious threats to BT's share of the key business market. Domestic revenues continue to be hurt by rate cuts. BTY's second quarter profits declined 17.9% as higher interest costs and the startup of new cellular joint ventures bit into profits. British Telecom shares, trading on a forward PE of 23.2, are currently extremely overvalued based on underlying fundamentals and growth prospects. The rampant investor enthusiasm for the telecom sector has taken a hit in the past few days, as evidenced by sharp falls in the shares of Vodafone, Engergis, and Colt Telecom. We expect sentiment to return to levels that more closely reflect industry fundamentals. This fall in sentiment will exert a strong downward pressure on British telecom industry shares over the coming months. Technically, the outlook for BTY shares has turned negative. Distribution has begun to take place in the shares, and money flow has turned negative. Stochastics and MACD exhibited strong divergences with price during the recent 2 month runup from 102 to 149, and both have turned down. ADX has given a sell confirmation, turning down from an overbought 51. We look for BTY shares to find their first downside support around the 50% retracement level at the 115-120 level. Our 6 month downside target for the shares is near May's lows at the 200 day moving average level of 100-102.  

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AXP (AMERICAN EXPRESS): Take over rumors, better than expected earnings, and a favorable climate for financial stocks have turned AXP shares into star performers this year, rising from a January low of 78 to a mid July high of 118. We believe that a slowing U.S. economy and a stock market correction will dim investor's ardor for the financial sector. AXP shares are especially at risk. A slowing economy will hit consumers hard, leading to increases in credit card loss rates. A falling stock market will slow the growth of financial services and inflows into mutual funds, leading to lower growth rates for AXP's financial services business. Consumers, who have a record percentage of their assets in the stock market, will be hard hit during a serious market correction. We expect this to have a negative affect on AXP's travel related services as investors cut back on spending and concentrate on trying to rescue their dwindling nest eggs. The takeover premium built into AXP shares will dissipate as a falling stock market  lessens the ability of company's to use their stock as takeover currency.The valuation of AXP shares, at 20 times next year's earnings estimates, leaves no room for a change in the bull market/growing economy scenario that has prevailed during the 1990's. We look for the financials to be harder hit then the rest of the market during either a market correction or a period of slow economic growth. The technical outlook for AXP shares has already turned  negative. Insiders have been net sellers all year. Distribution is taking place as the smart money sells to people eager to get a piece of last year's trend. OBV and Money Flow both showed strong negative divergences during the recent highs. Both indicators have turned strongly to the downside. The shares have fallen below both their 21 and 55 day moving averages. We look for AXP to find first downside support at the 88-90 level. A bottom for the shares should occur around the 75-78 level last seen in January. Trading at 2.8 times sales, and 5.8 times book value, we rate American Express a strong short. 

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CSCO (CISCO SYSTEMS):  Valuation levels and the stock's ominous technical picture have caused us to turn negative on analyst darling CSCO. We view Cisco's current share price as 20-25% above fair value. A sharp slowdown in European economies later this year will negatively impact the tech sector which has relied on European growth to counteract negative Asian growth. We also look for increased competition from Lucent Technologies and Northern Telecom to lead to price drops for network equipment and a slowing of margin growth among the networking stocks. We believe that the current fundamentals for CSCO do not warrant the stock's current valuation level of 12 times sales and a  P/E of 39 times next years earnings. It is the stock's current technical picture, however, which has caused us to institute short positions in CSCO. Money flow and the R.S.I. have shown a strong negative divergence with price since the stock hit   104 on July 21st. A double top  pattern is forming  on the stock's chart. This forming double top signal is particularly ominous because the latest leg up has occurred on decreased volume. We look for the stock to break lower and find its first downside support in the 88-92 level. Fibonacci support at 84-85 should hold. After a decline to this level, we expect the shares to trade in a range of 75 to 85 until the end of the year. 

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WMT (WAL-MART STORES): The shares of Wal-Mart, the world's largest retailer, rose more than 200% after breaking out of a 5 year trading range in early 1997.  The rise is over. An overvalued stock price and strongly negative technicals will lead the shares lower over the coming months. WMT is trading at the high end of its 5 year P/E ratio range. The shares currently fetch 32 times this year's estimates and 28.3 times next year's. The PEG ratio based on next year's earnings is 2.08. Historically, the best time to buy shares in a company has not been when it is trading at twice its growth rate and at the high end of its P/E range.  Current earnings estimates will need to be lowered if a slowing domestic economy, or fears of a slowing economy, lead to a cutback in consumer spending. We view the current rate of consumer spending as unsustainable, and look for earnings estimates for retailers to be slashed across the board as a slowing economy makes its mark felt.  Wal-Mart could also be hurt if the Asian contagion finally spreads to Latin America.  The company operates stores in Mexico, Brazil, and Argentina.

It is the technical outlook for the company's shares that has us the most concerned however.  A double top has formed on the company's chart. This is a very negative sign (witness the downward price action that occurred after double tops formed in the Dow Industrials this year or the oil service stocks last year). Strong divergences in RSI and MACD occurred on the second peak. Weekly ADX has turned down from an overbought 42 to confirm the downward move. We look for a decline to the 46-48 range in the shares of Wal-Mart over the coming months.

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(GPS) The Gap Inc:   Apparel retailer the Gap has benefited from a boom in consumer spending this year. The company's Gap, Banana Republic, and Old Navy Clothing Co. stores have registered impressive sales gains as consumers have spent at record rates.  Investors bid up the price of GPS and other retailers to  the high end of their historic P/E ratio ranges in the first half of the year as retail sales registered impressive gains.   Unfortunately, the retail spending surge is now showing signs of waning. August retail sales were anemic, and the slump has continued into September. We expect retail sales growth to continue to moderate this fall as a slowing economy, and a heavy   consumer debt load take their toll on spending.  The stock market's recent fall will also put a damper on consumer spending in the months ahead. We believe that the slowdown will continue into the important Holiday season .  Current analyst earnings estimates have yet to be adjusted downward to reflect the slowdown in consumer spending.   We believe that the fully valued shares of retailers will be hit hard this fall as investor sentiment turns more negative towards the sector.  We expect the shares of the Gap to be especially hard hit. The company's shares are now overvalued and are trading at the high end of their historic valuation range.  The Gap shares now fetch over 33 times this year's expected earnings and 28 times next year's estimates.  The shares are down 12% from their high but will fall further as the P/E premium accorded to retailers disappears in the face of slow growth.

The shares technical patterns already reflect a coming downturn. A double top has formed on the share's chart. Distribution has been taking place as the smart money sells to investors late to the game.  OBV showed a negative divergence with price on the second top.  Money flow is in a steep downtrend. Weekly RSI and MACD are both in downtrends.  %R has given a sell confirmation. Weekly ADX has turned down and fallen below 40.  The shares recent attempt at a rally was stopped by strong Gann resistance at 60-61. We expect the shares to find their first downside support around 50. We look for the shares to bottom in the 40-45 range in the late fall.

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PFE (PFIZER): Shares of Pfizer soared to 121 3/4 in April on the back of rising hopes for wonder drug Viagra.  At the height of Viagra mania the shares fetched a record 63 times earnings.  Sales of Viagra, which is expected to achieve sales of $1 billion in its first year, have begun to slow. Slowing sales, and a rash of bad publicity have also begun to cool investors desire for shares of PFE.  We expect shares of the still overvalued PFE to closely follow downwards the ebbing of investor enthusiasm.  As is often the case in financial manias, the downward movement in share prices closely correlates with the rapid decline in investor sentiment.  A cooling of investors' Viagra mania isn't the only thing that will negatively impact PFE shares in the coming months.  The impact of foreign economic crises on the drug industry has also been downplayed as investors sought out safe havens.  We believe that earnings estimates for the drug industry do not fully take into account the impact of foreign economic turmoil.  Drug sales in Japan are expected to fall 10% in dollar terms this year.   Emerging market economies will contribute no drug sale growth this year.   Overall worldwide drug sales are expected to rise just 1.7% this year. Share prices for drug stocks will fall as growth expectations are scaled back for the next two quarters.  We expect overvalued PFE shares to be hit harder than the average drug stock.  PFE is still trading on a 1999 prospective P/E ratio of 38, at 9.9 times sales, with a forward PEG ratio of 1.93.

The technical outlook for PFE shares has been deteriorating since its late April peak.  Weekly money flow has been in a downtrend since late Spring. Insider selling has been heavy over the last few months.  A double top occurred in April-July, with strong negative divergences occurring in OBV and RSI on the second peak.   The stock closed Friday at its 200 week moving average.  We expect the shares to find their first downside support at 86.  Our year end target is in the 70-75 a share range.

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SCH (CHARLES sch): Discount brokerage pioneer and leader SCH has managed to avoid the 50% plus declines experienced by many of its full service competitors. The shares surged in mid September after the company announced that third quarter earnings would beat analysts estimates.  The company cited high trading volumes, lower costs,  and a lack of exposure to troubled international areas as primary causes for the higher earnings.  The shares now trade at 33 times this year's prospective earnings and 27.7 times next year's tentative estimates.

We stress the words tentative estimates. Profits in the brokerage industry have been historically volatile.  The retail brokerage business, sch's primary business, is not immune to these profit swings.  During economic slowdowns consumers' ardor for the stock market ebbs as they seek safer parking spaces for their cash.  The outflows in domestic equity funds in August are the norm during a prolonged market slump.  We believe that a second leg down in the market will finally erase investor's belief that they should buy on the dip (as they did in September when an estimated $18.5 billion poured into equity funds).  Fear, and wealth preservation will take over as the prevailing investor concerns.  We expect the retail brokerage industry to experience a similar slowdown to that now being felt in the retail store industry: as economic concerns mount, the consumer's desire turns to capital preservation and he becomes less likely to engage in wealth consuming activities (i.e. buying shares in a declining market). The initial surge in trading volumes seen at the outset of bear markets soon dwindles as fewer investors are likely, or able to risk their assets in uncertain economic times. 

We expect trading volumes accross the brokerage industry to decline for a period after the market completes its fall, as they historically have in bear markets. Witness the sharp declines in trading volume seen in southeast Asia and Japan after these markets declined.  It is the retail sector of the industry that historically has experienced the sharpest contraction in trading volume at  the bottom.  It is for this reason that we believe current estimates will prove to be too high for SCH. We expect the P/E ratio on these shares to contract to a slightly below market multiple when the market bottoms.

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SGP (Schering Plough): Drug maker Schering-Plough is a leader in biotech, genomics, and gene therapy.  The company's allergy, respiratory, anti-cancer, and dermatological products have contributed to the strong growth in earnings and share appreciation seen over the past year.  Unfortunately everyone knows SGP's earnings story, and the time to buy a stock is before the news is widely known--not after.   Investors, in their bid to find a safe haven from global turmoil, have bid the shares of drug makers up to unsustainable levels.  Schering shares have been one of the primary beneficiaries of this flight to quality. SGP now trades at 42.3 times this year's earnings and 36.4 times 1999 estimates. The shares are trading at the top end of their historical P/E range. The PEG on 1999 earnings is in nosebleed territory at 2.33.   The stratospheric valuation levels of Schering stock, and a corresponding weakening of the technicals for the drug industry are the primary reasons we now rate this stock a short sale candidate.

The underlying technicals of the drug group have been weakening since August, and this week investors finally applied selling pressure to the stocks.  The underlying technicals for SGP are among the weaker of the drug stocks. A double top is forming on SGP's chart and the stock has completed an Elliott Wave 5 up pattern.  Weekly MACD and RSI both showed strong negative divergences with price action on the second top.  Distribution has been taking place since late July. OBV and Money Flow  exhibited negative divergences on the second top, and both are in strong downtrends.  We look for the first downside support to be in the 80-85 range. Our 3 to 6 month downside target is 70.   We would consider the stock as an attractive long term purchase candidate in the 65 to 70 range, but at current levels the stock is unattractive.

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EBAY (eBAY Inc): Recent hot IPO eBAY went public at $18 on September 24th and saw its stock open at $53 1/2, giving it a market cap of $2 billion. The stock has cooled off over the past week, and now trades at $40 a share (a figure that some brokerage firm analysts consider a bargain).  EBAY runs person to person online auctions and receives a small placement fee and commissions from sellers and buyers. To the uninitiated, this is similar to the fees newspapers  receive for running   classified ads.  As in the classified ad business, eBAY doesn't have to buy or store the items being sold. Thus it has none of the costs associated with carrying an inventory and is able to achieve very high gross margins. However, there are risks involved.  Just as the potential exists for fraud in the print classified business, it exists in the online person to person auction business. It is estimated that fraud occurs in 1% to 2% of all transactions.  This presents potential legal liabilities for a company like EBAY. The company itself stated that "there can be no assurance ... that  it will successfully avoid civil or criminal liability for unlawful activities carried out by users through the company's service."  EBAY has put some safeguards in place to try to protect against fraud, but some legal experts believe that by attempting to protect users, a company like EBAY is actually implying that it has a responsibility to protect users, thus opening it up to lawsuits when these safeguards fail.  EBAY itself has had a problem collecting from its users. The company's accounts receivables were over 28% of sales in the first half of this year. It believes that $1 million of this amount is uncollectable (approximately 6% of first half sales). Besides the risks from potential  fraud, the company also faces competition from Yahoo and Excite which have both started person to person auctions.  EBAY's IPO success was largely attributable to it being one of the few profitable internet companies, but the company has warned that it may need to incur losses  as it mounts a large advertising and promotion campaign in a bid to maintain a high level of revenue growth.   Current estimates are that EBAY will have revenues of $37 million this year and $76 million next year . Operating profits are estimated to be $4.8 million this year and $6.2 million next year.  Based on these figures the company's current market cap is 21 times next year's estimated sales. To justify these valuation levels, the company would have to be on the verge of becoming the next Home Depot (which we do not see happening). In our view, the person to person auction business, like its print cousin the classified ad, is a niche business that is never going to become a dominant form of exchange of goods. When these shares are available to short, we would be shorters.  Six months from now we look for these shares to be trading below their IPO price of $18.
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Last modified: April 16, 2001

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