week of November 8th 1999: An all new stock ideas section featuring
long and short ideas.
MORE GO SHORT
OPINION ARCHIVES: 4
(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.
(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
(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.
(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.
(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.
|(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.
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.
(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
|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
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.
(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.
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.
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.