From Briefing.com: Close Dow +25.01 at 10547.57, S&P +3.09 at 1203.91, Nasdaq +0.07 at 2069.03: Despite some notable economic data in the form of the Retail Sales and Producer Price Index reports for May, and better than expected earnings news from the likes of Best Buy (BBY 67.80, +8.68) and Lehman Bros. (LEH 96.05, +3.00), the major indices moved in laborious fashion Tuesday, holding close to the unchanged mark for the majority of the session... Altogether the trading action was uneventful and provided a firsthand glimpse at what the phrase "summer doldrums" means...
The vapid showing was striking when taking into account that the combination of a worse than expected Retail Sales report and a better than expected PPI report provided a good economic mix of moderating growth and contained inflation that reinforced the notion that the Fed's tightening action should be nearing its end... Enthusiasm was held in check, however, by the realization that the Consumer Price Index - a more telling inflation report for Fed officials - was going to be released before Wednesday's open... Additionally, the market was buffeted by a lack of participation from the technology sector (-0.50%) and a lack of concerted buying interest in other economic sectors...
Some exceptions in the latter regard included the Consumer Discretionary (+1.0%) and Health Care (+0.80%) sectors, which rode the coattails of Best Buy and Mylan Labs (MYL 19.58, +1.88), both of which increased their EPS outlook for the current fiscal year... Best Buy, in particular, generated a bid in a host of other retailers that spearheaded the Consumer Discretionary's sector's outperformance...
Other standouts in that space included General Motors (GM 35.87, +1.42), which reportedly informed the UAW that an agreement to cut health care costs is needed by the end of this month, and Ford (F 10.82, +0.30), which jumped in response to Monday's late-breaking news its Hertz unit is planning an IPO... By and large, big moves in Tuesday's session were reserved for individual stocks like these and Lehman Bros.... The investment bank topped the Q2 (May) consensus EPS estimate of $2.23 by three cents and rallied as investors cheered the news, deeming it better than feared after Morgan Stanley's (MWD 50.60, -0.28) Q2 warning on Monday...
Separately, the Treasury market spent most of its day on the defensive in a move that pundits attributed to a curve trade taking precedence over what would typically be considered to be supportive economic data... To that end, Retail Sales in May slipped 0.5% (consensus -0.2%) and sales, ex-auto, declined 0.2% (consensus +0.2%); meanwhile, PPI fell -0.6% (consensus -0.2%) while core-PPI, which excludes food and energy, increased just 0.1% (consensus +0.2%)... The 10-yr note shed 4 ticks, sending its yield up to 4.11%... As a reminder, the CPI report will be a focal point before Wednesday's open, but attention will eventually shift to OPEC's meeting in Vienna where it is expected the cartel will agree to a 500K barrel per day increase in production quotas...NYSE Adv/Dec 2058/1185, Nasdaq Adv/Dec 1739/1248
4:04PM Transocean (RIG) 54.49 +0.88: The offshore drillers first started showing signs of life back in late 2003 as the drilling season begun as favorable market conditions, coupled with creeping oil prices pointed to a stronger environment playing out into 2005. We suggested investors initiate positions in the group at the end of February 2004, since then the group has returned almost 60%. Our favored picks including the largest drillers by market cap Transocean (RIG) and GlobalSanteFe (00C) returning 87% and 34.7%, respectively. The group in descending order also includes Noble Corp (NE), ENSCO (ESV), Diamond Offshore (DO -See Archive Story Stocks on 2/9/05), Pride Intl (PDE), Rowan Companies (RDC - See Archives 1/19/05).
Our bullish position endured throughout last year as oil prices reached record highs. The pricing environment resulted in exploration and production companies finally start to gradually raise capital expenditure budgets to meet growing demand. Companies like Exxon (XOM) and British Petroleum (BP) were seeing their coffers start to fill with cash as prices continued to move higher almost breeching the sixty dollar per barrel mark. So, from today's vantage point does the horizon still look as bright? Considering the supply constraints with OPEC stating it would like to increase production but they just don't have any more oil and global demand trends, the drilling cycle should remain strong for the longer-term.
High oil and natural gas prices have increased demand for offshore drilling demonstrated by the rising trend in utilization rates. Our favored market is the deepwater segment, which continues to perform exceptionally well. Transocean has the greatest leverage to this market (53% of revenues) as the world's largest deepwater driller. RIG operates 93 offshore mobile rigs around the world. Management stated in May it continues to see demand increases across all asset classes. Also highlighting current capacity shortages within the fifth generation deepwater floaters market for 2005 and 2006. These tight market conditions are clearly evident with RIG operating at 99% utilization. This level of activity has resulted in day rates soaring to $300,000 per day depending on the contract duration. The market for its other floaters (mid-water segment) have also improved with the jackup market remaining quite strong.
What also speaks to the sustainability and strength of the market is the emergence of longer-term contracts. RIG recently signed a type of hybrid 5-year contract with BP that could set a trend in normalizing earnings over the longer-term if its other customers follow suit. This shows E&Ps are becoming increasingly concerned about the availability of rigs, which will only lead to higher dayrates. For now however contracts remain in the 1-2 yrs time frame, as E&P companies wait to see if the current bull cycle in dayrates last.
RIG's financial condition has dramatically improved due to robust cash flows generation. By the end of the year, the Houston-based company may be debt free. As such, there is an increasing possibility it may choose to return value back to shareholders through share buybacks or through a special dividend. The caveat to the story exists on the cost side. With increased activity levels comes higher costs from the drilling suppliers (Grant Prideco GRP is a suggested holding in our Active Portfolio) to worker's compensation. Other risks for the drillers include drilling success, commodity moves, weather conditions, labor disruptions, international political risk, and economic slowdown.
Tuesday, Wachovia initiated coverage of RIG with an Outperform rating citing its exposure to the deepwater segment and the Latin American market, which it feels will drive earnings over the next few years. Despite the considerable performance the offshore drillers have enjoyed over the last year, we feel there the bias remains to the upside. ----Kimberly DuBord, Briefing.com
3:37PM Lehman Brothers Holdings (LEH) 94.41 +1.36: We certainly can't look to Wall Street for any insight into what the Brokers will report in terms of second quarter earnings this week. According to Bloomberg, the Brokers on average trumped analysts' expectations by 23% last quarter. Today, as expected, Lehman kicked things off surpassing consensus estimates by three cents due to stronger top line and operational performance. Its results also provides insight into what we can expect from its rivals out later in the week.
The bigger picture here, before we get into the numbers, is that the second and third quarters are seasonally weak periods for the brokers. As such, investors with a longer-term perspective should take advantage of any exaggerated selling due to potential misses as the outlook for these companies remains quite good. Expectations heading into this quarter were mixed as several firms telegraphed weak environment impacting profits including JPMorgan (JPM) and Morgan Stanley (MWD). With the Amex Securities Broker/Dealer index (XBD) nearing a multi-year high, there could be some near-term profit taking. However, this cyclically slow period will likely transition into a stronger environment over the longer-term driven by increased trading and M&A activity, and an improved capital management environment.
Lehman's results were as generally as expected earning $683 mln, or $2.26 per share up 12% from last year. Net revenues, backing out net interest expense, in the second quarter rose 12% y/y to $3.28 bln - only down 14% sequentially despite challenging market. Contrary to popular belief, Lehman's earnings are much more diversified than being just a fixed income house. The New York-based company took advantage of the bear cycle following the Tech Bubble to build up its equity, capital markets, and trading businesses particularly overseas in Europe and Asia. By the close of 2004, fixed income accounted for 58% of total revenues down from 62% in 2003. This diversification helped Lehman report its second best quarter ever according to its CEO despite tough market climate. It also enjoyed record consecutive results in its Asian operations.
The upside was driven on the top line despite falling from last quarter, as expenses were held in-line. Fixed income revenues rose 23% y/y to $1.8 bln down just 15% from last quarter which was better than expected due to strength in mortgage backed securities. Considering low trading volumes and weaker new issue activity during the quarter, equity capital market revenues fell 24%. Capital markets revenues fell 17% and investment banking fees dropped 15%. The bright spots came from its investment management business with revenues up 8% as assets under management gained 17% y/y to $151.2 bln, along with its international operations. Strong fixed income and investment banking results drove its Asian operations, while European revenues jumped 58% driven by interest rate products, mortgage securitization, and equity derivatives. Pretax margins came in at 30.9% compared to 30.2% last year. ROE was 18.2% much higher than the industry average of 13.3%.
Overall, a solid quarter considering the market headwinds Lehman faced. So what does this tell us about what to expect this week from its peers? The strong mortgage business could bode well for Bear Sterns out on Wednesday, but weak trading revenues are sure to show up in Goldman's results hitting the wires prior to the bell on Thursday. ----Kimberly DuBord, Briefing.com
12:35PM Best Buy (BBY) 66.55 +7.43: Best Buy, the nation's largest consumer electronics retailer, reported fiscal first-quarter earnings ahead of analyst expectations on Tuesday. The company recorded Q1 EPS of $0.51 on $6.12 billion in revenue versus the consensus estimate of $0.30 on $5.97 billion in revenue. EPS expanded from $0.34 year/year, while revenues increased 11.7% for the same period, from $5.47 billion. In addition, the company raised its fiscal year EPS guidance from $2.95-3.10 to $3.10-3.25, and affirmed strong revenue and same store sales growth. The robust quarterly results were largely attributed to strong demand for digital music players, televisions, and videogames, as well as to the company's expanding customer service operations and investment initiatives.
Best Buy continues to exude strong market performance in an extremely challenging business environment. Despite increased competitive pressures and product commoditization, the company has embraced strategic growth initiatives to help differentiate its business model and increase customer focus. In particular, Best Buy has heavily invested in converting its stores to a "customer centric model", whereby individual stores will focus on specific customer segments. The company has also shifted focus on evolving to a more service-oriented structure. Led by the emergence of Geek Sqaud, service is expected to become an integral component for revenue growth, and should have positive implications for future cash flow and margins.
As is the case with any retailer, Best Buy faces concerns about rising inflation, a slowdown in consumer spending, and increased competition. It is Briefing.com's contention, though, that inflation will remain well-contained and that increased hiring activity and moderating gas prices will effectively guard against a material slowdown in spending. That should bode well for Best Buy; accordingly, we find the company's increased FY06 EPS guidance to be achievable.
With new game consoles and digital televisions poised to entice demand, product trends appear strong for the consumer electronics retailing industry that includes competitors such as Circuit City (CC), Dell (DELL), RadioShack (RSH), and Wal-Mart (WMT). While the influence of the aforementioned companies is always a threat to Best Buy's returns and market share, Best Buy has proven resilient in maintaining leadership in market share, profitability, and productivity through in-store investments and differentiating products and services. To that end, the roll-out of consumer centricity is based around the concept of customer focus and comprehensive service.
While the outlook for Best Buy remains challenging, the company is well positioned to capitalize on its investments and increased focus on customer service. At the current multiple of 22x trailing earnings, Best Buy trades at a discount to its avg. PE level of 28.5x over the past five years. In addition, the company's strong balance sheet and near-term earnings momentum remain attractive. ---Richard Jahnke, Briefing.com
9:05AM Page One - PPI News Is Bullish : The core rate on PPI for May was up just 0.1%. Stock futures indicate an up open.
Total May PPI fell 0.6%. That was caused by a 2.6% drop in energy prices. Total PPI has been fluctuating with swings in energy prices, and a one-month drop is not all that significant. Far more important was the fact that the core PPI came in at only a 0.1% increase. A gain of 0.2% had been expected.
The core PPI was up 0.1% in February, 0.1% in March, 0.3% in April, and now 0.1% in May. That comes to about a 1.8% annual rate of increase over a statistically significant four-month period. This very modest trend suggests that underlying inflation at the producer level is well contained - far more so than most market participants had assumed earlier this year, when the silly stagflation talk emerged. The trend in core PPI the past four months is actually below the year-over-year increase in core PPI of 2.6%.
May retail sales dropped 0.5%. This was weaker than an expected 0.2% drop. It follows a strong 1.5% April increase, however, and represents an offset to April strength rather than the start of a trend. Excluding autos, sales were down 0.2% following a big 1.4% April jump. The overall trend in consumer spending is of slightly slower growth than in 2004, but still enough to produce 3% or higher real GDP growth this year.
Oil prices are down slightly this morning after a big jump yesterday. The OPEC meeting is tomorrow. The resilience of the stock market to high oil prices suggests that if the bubble bursts at all, stock prices could benefit significantly.
Lehman Brothers reported earnings 3 cents ahead of expectations. Brokers have volatile earnings and this will not be seen as great news, particularly after Morgan Stanley's lowered earnings guidance yesterday. Bear Stearns reports tomorrow. Best Buy, however, had a clearly strong earnings report and guided 2005 profit estimates higher.
The PPI news this morning is clearly good. If the May core CPI tomorrow comes in at 0.1% or 0.2%, it will underscore the positive inflation outlook that seemed so at risk a couple of months ago. Dick Green, Briefing.com
9:37AM Western Digital (WDC) Piper Jaffray downgrades Outperform to MARKET PERFORM. Target $16. Piper Jaffray downgrades citing the following: 1) the stock is just 2% away from their $16 price target; 2) Seagate (STX) has raised the ante on perpendicular magnetic recording technology, a transition which might happen sooner than expected; and 3) glass media shortages heading into 2H05 could cap notebook and 1-inch drive performance.
9:36AM Amerada Hess (AHC) Friedman Billings upgrades Underperform to MKT PERFORM. Target $103 to $109. Friedman Billings upgrades AHC based on the crude oil price forecast increases and due to the co's high earnings leverage to crude oil prices with most of the co's low-priced hedges roll off in 2006. Firm says although global inventory levels have risen, crude oil prices continue to surge due to above-average economic growth and uncertainty as to whether or not global supply will be able to meet demand in 4Q.
9:36AM Lincoln National (LNC) Lehman Brothers upgrades Equal-weight to OVERWEIGHT. Target $50 to $55. Lehman upgrades LNC saying the key take-away from their interviews with wholesalers is that LNC's sales of annuities and funds in Q2 should again beat expectations.
9:35AM Diodes (DIOD) Raymond James upgrades Outperform to STRONG BUY. Target $36. Raymond James upgrades DIOD given the recent share-price weakness, positive order patterns, and what they view as an improving semiconductor environment. Also, they believe the new CEO of the co, Dr. Keh-Shew Lu, will be positive, not negative as recent share-price weakness has indicated. They think that business trends continue to support their $36 price tgt.
9:35AM Fairchild Semi (FCS) Harris Nesbitt upgrades Underperform to NEUTRAL. Target $14 to $17. Firm believes fundamentals are very close to bottoming. They think the co's recent initiatives in the form of incentives to distributors to move the co's elevated inventory is already showing progress with distributors in Asia beginning to place new orders. Additionally, firm believes that pricing for over half of the co's business, power discrete, has stabilized, based on their checks with distributors as well as the latest SIA data.
9:34AM Delphi Auto (DPH) Deutsche Securities upgrades Sell to HOLD. Target $4.8. Deutsche Bank upgrades DPH following their meeting with mgmt, saying while the co's future remains far from clear, mgmt remains hopeful that they'll be able to arrive at a restructuring solution. From a liquidity perspective, although there are significant risks related to the outlook for GM production and US pension reform, firm believes that the co's recent debt financing plus asset sales should be sufficient to carry it through 2005 and 2006.
9:33AM Talbots (TLB) Harris Nesbitt upgrades Neutral to OUTPERFORM. Target $40. Firm believes the co is in the early stages of a merchandise-led turnaround that could bring comps and earnings acceleration. Firm sees a pick-up ahead in the casual sportswear business, driven by on-trend styling and better in-stock positions that support a favorable margin mix-shift. Also, they see a favorable competitive environment.
9:33AM California Pizza (CPKI) KeyBanc Capital Mkts / McDonald upgrades Hold to AGGRESSIVE BUY. Target $35. KeyBanc upgrades CPKI citing: 1) comps continue to impress, SSS was up 9% in the 1Q after 8% in 2004; 2) mgmt has been quite forthright with its expansion strategy; 3) they believe the co can beat its guidance for 2Q and FY05 guidance; and 4) the co has no debt and $40 mln of cash.
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