Monitoring Microsoft (MSFT)

Microsoft is the world’s largest software company (based on revenues) and about 80% of its revenue comes from sales of its Windows, Office and Server & Tools software.  However, cloud computing, sometimes called “Software as a Service” (SaaS) is a direct and serious challenge.  As a response, Microsoft’s newest version of Office, now in early testing, will offer online versions of Word, Excel, and PowerPoint that can be used on a computer, Web browser, or mobile phone.

MSFT was the Online Stock Study at the Better Investing website for September that was led by Jim Thomas.  Jim is a director and volunteer educator with the Puget Sound chapter, a software engineer who used to work for Microsoft, and was recently appointed to the board of IClubCentral. Thanks Jim for volunteering.

Each month, the Online Stock Study completes a SSG in about one hour with the judgments made by the online participants using consensus decision-making.  The Consensus SSG, Jim’s presentation slides, and the Value Line report are all available to BI members for downloading.  The recorded session should be available sometime soon.  [AF: it took one month, but the recording finally became available for downloading on 10-6-09]

Jim used the Online SSG which is much more limited than our SSG software.  Among its many limitations, the Online SSG projects future growth only from the last Fiscal Year, ignores Relative Value & Projected Relative Value and provides only one method to decide the Forecast Low Price in the next 5 years.  

 COMPANY BACKGROUND:

- Jim gave a very thorough report on Microsoft’s operations: 95,000 FT employees, 60% in U.S.; 5,000 to be let go by FY 2010; new products include Windows 7 and Office 2010.

- 32% of FY 2009 revenue generated by MSFT’s Business division, 90% from sales of MS Office and 80% of that from sales to business; 25% of revenue from its Client division, 80% from Windows Vista pre-installed on PCs; 24% of revenue from its Service and Tools division, 50% from multi-year licensing agreements; 13% from its Entertainment & Devices division (Xbox, Zune, mice & keyboards); and 5% from its On-Line Services (BING, MSN, Windows Live).

- R&D spending 15% of FY 09 revenue, up from 14% in each of prior two years; revenue down 3% in FY 09, EPS down 13%.

- Jim also reported on: revenue by operating unit and by geographic area; long-term debt; share buy-backs; and dividends.

DISCUSSION:

- I analyzed MSFT previously (on 9-30-08 and 11-21-08) and compared my two SSGs to AnnC’s and to Take Stock;  if you’re interested, see: Monitoring Microsoft

- In the table below, I compare the Consensus SSG to two of mine and to Take Stock.  Armin-1 is my SSG as of 8-18-09, before the Online Stock Study, while Armin-2 reflects my updated SSG.  Following the table, I discuss issues highlighted by the comparison.

MICROSOFT          (MSFT)	Consensus      SSG	Armin-1	Armin-2	Take Stock
Date	9-8-09	8-18-09	9-17-09	9-17-09
Data	S&P Online	S&P	Same	Hemscott- Mstar
Price	$24.80	$23.58	$27.66	$25.30
52 week High &     Low Price	$29.74 &        $14.87	$28.01 &           Same	$27.66 & Same	Not Included
Last Q of                  Reported Data	Q ending          6-09	Same	Same	Same
Software Used	Online SSG	TK 5	Same	TS Online
Project Growth      From End of	Last FY	Last Q	Same	Last FY
Sales Growth	07.80%	09.00%	Same	-03.2
EPS Growth	10.07%	10.00%	Same	-11.0
High PE	17.4	20.5               (four year ave with 2005 out)	Same	22.0
High EPS	$2.65	$2.41	Same	$0.90
High Price	$46.11	$49.40	Same	$19.79                (55% < VL’s        low end)
Value Line Estimated High Price = $45-50 as of 8-21-09
Low PE	09.1	14.0                  (four year ave with 2005 out)	Same	15.8
Low EPS	$1.64                (last FY EPS)	$1.65                   (ttm EPS)	Same	$1.62
Low Price	$14.92                 (low PE x low EPS)	$17.70               (70% of current price)	Same	$25.60                (higher than current price)
Ave % Payout	27.00%(reduced from 78.7%)	26.9%           (four year ave with 2005 out)	Same	Not  Considered
Upside/Down	2.15	4.4	3.1	Impossible to Calculate
Total Return	14.74%	17.3%	15.6%	05.4%
SSG Buy Under	Not Included	$25.63	Same	$10.80
RV/PRV	Not Included	82.7/76.5         (2005 out)	89.0/82.2(Same)	Not Included
Quality	Not Printed	B+	Same	.50(unacceptable)
PTPM – 5 yr ave	41.30%           Trend N/A	Same              Trend down	Same	39.1%                  Trend N/A
ROE – 5 yr ave       End Equity	36.97%            Trend N/A	37.00%            Trend even	Same	Not Included
ROE – 5 yr ave      Start Equity	Not Included	35.7%              Trend up	Same	35.1%                    Trend N/A
Debt to Equity –        5 yr ave	Not Included	01.9%              Trend up	Same	Not Included

(A) THE CONSENSUS SSG:

(1) Quality

- Jim evaluated four aspects of MSFT’s quality and found that 3 were satisfactory: Sales growth at 11.9% over the past 10 years; EPS growth at 11.4%; and Pre-Tax Profit Margin stable at 34-38% [presentation slide 27, PDF page 14].

- Return on Equity merited further study, Jim concluded, but presumably was satisfactory as it was not considered a red-flag or barbed-wire fence not to cross.

- The Online SSG does not explicitly report the PTPM and ROE trends like our SSG software and Jim missed that PTPM was trending down which is typically considered a red-flag warning sign. 

** However, MSFT’s 5 year average PTPM is 40.30%, some 300% better than its industry average of 13.6% using S&P data, so I’m not worried.  To make this type of comparison, see: Investigating Industry Info.

(2) Estimating Sales Growth

- Jim gave the group three specific choices to estimate Microsoft’s future Sales growth: 11.9%, last 10 year historical growth; 10.0%, Value Line’s Sales per share estimate; and 7.8%, a composite rate that Jim devised (6 year historical + Yahoo Finance FY 2010 & 2011 estimates + VL FY 2012-2014 estimate) [slide 36, PDF page 18].

- He also offered two other choices that seem pointless: higher and lower.

- Jim did not consider MSFT’s more recent historical Sales Growth (6.9% and 11.4% last 3 and 5 years) and did not mention other analyst estimates for Sales growth (not Sales per share growth): Zacks at 10.62% estimated Sales growth for the next 5 years.

- The Consensus chose 7.8% which is no surprise since that seems to be the only realistic option out of the 5 choices offered.

(3) Estimating EPS Growth

- Because Jim used BI’s Online SSG, all projections were from the end of the last FY (2009, $1.64 EPS) unlike our SSG software which has options to project from the end of the last quarter or from the trend line.  This had no impact on MSFT because the end of its FY was also the end of its last Q.

- Jim also gave participants three choices to determine MSFT’s future EPS growth: $2.89 or 12.0% from S&P’s estimate; $2.73 or 10.7%, another composite rate Jim derived from Yahoo Finance’s FY 2010 & 2011 estimates and VL 2012-2014 estimate; and $2.65 (no rate mentioned), next 3-5 year estimate by Value Line [slide 44, PDF page 22].

-  He also offered the same two other choices: higher and lower.

- Surprisingly, Jim did not consider Yahoo Finance’s EPS estimate for the next 5 years (10.17%) which seems way more appropriate than relying on its EPS estimates for the next two years.  And, while he mentioned MSFT’s historical EPS growth (11.40%), he did not offer it as an option to the group.

- Perhaps most importantly, Jim did not consider the long-term EPS estimates from other analysts which I discuss under Armin’s SSGs.

- The Consensus chose 10.7%, Jim’s composite rate.

(4) Forecasting High & Low PEs

- Jim offered three choices to Forecast MSFT’s High and Low PEs for the next 5 years: 20x & 16x, from 10% plus or minus VL’s forecast of 18x; 17.4 & 9.1, from 2009 actual; and 15x & 10x, from Jim’s “visual” inspection of the range over the last year.

- Again, he also offered the same two other choices: higher and lower.

- The Consensus chose 17.4 & 9.1, from 2009 actual.

(5) Estimating Average % Payout

- Microsoft paid a special dividend in 2005 that distorted the five-year average. So Jim reduced the 78.70% average to 27.00% in order to estimate the average % payout for the next 5 years.  That is equivalent to treating 2005 as an outlier and averaging the last four years.  This issue was not mentioned in the Presentation Slides.

(6) Forecast High & Low Prices, Upside/Downside Ratio and Total Return

- These also were not mentioned in the Presentation Slides.

- The Consensus did not get a SSG Buy with an Upside/Downside Ratio of 2.15 (under the 3.0 minimum criteria) and a 14.74% Total Return (under the 15.00% minimum criteria).

 

(B) ARMIN’S SSGs:

(1) Estimating EPS Growth

- When I did my SSG on 8-18-09, the six analysts I always check were estimating long-term EPS at an average of 10.73% with S&P high at 12.00% and Value Line low at 10.00%.  At FactSet CallStreet via CNN Money.com, the Consensus was 11.00% (from 8 analysts who ranged from 13.0 to 5.0%); Zacks.com was 10.62%; Reuters.com was 10.61% (from 11 analysts who ranged from 13.0% to 7.00%); and FirstCall/Reuters via YahooFinance.com was 10.17%.

- When I updated my SSG on 9-17, only S&P had changed its estimate to 10.00% (down from 12.00%).

- I estimated 8.00% EPS both times, well under all the consensus estimates.

- Estimating EPS explains how I estimate EPS for all my SSGs.

(2) Forecasting High & Low PEs

- I eliminated 2005 as an atypical outlier and used the four-year historical average as my Forecast High & Low PEs.

- This was the major difference between my SSGs and the Consensus, and explains why both times I got a SSG Buy with Upside/Downside Ratio > 3.0 and a Total Return > than 15.00% while the Consensus did not.

 

(C) TAKE STOCK:

- Take Stock is a computerized, one-click program at the StockCentral website that produces an almost-SSG and is designed to generate a conservative result.

- Its EPS estimate for the next 5 years was –11.00% (that’s a minus eleven percent) which seems patently unreasonable and irrational compared to the six analysts I checked who averaged 10.72% and even to the very lowest estimate of 5.00% by one analyst at CNNMoney.

- Because of its low-ball EPS estimate, Take Stock’s Forecast High Price was $19.79, also unreasonably low and a whopping 55% below the low end of Value Line’s $45-50 High Price estimate.  If you’re interested in learning how to judge the reasonableness of SSG judgments, see: Determining What’s Reasonable and What’s Not: An Update.

- Take Stock gave Microsoft a quality rating of .50 on a ten-point scale where a minimum of 3.4 is required to pass muster and 6.7 is desired.  On the other hand, S&P gave MSFT a B+ quality rating.

 

- Armin

Flirting With Fresenius (FMS)

Fresenius Medical Care (FMS) is the world’s largest provider of dialysis services and products to patients with chronic renal disease.  It has some 2400 dialysis clinics in 30 countries, 70% of which are in the North America. In the United States, it also performs clinical laboratory testing and inpatient dialysis services and other services under contract to hospitals. 

FMS is a German company, sold as an ADR in the U.S., whose full name is Fresenius Medical Care AG & Co. KGaA.

COMPANY BACKGROUND:

According to the Reuters company report, Fresenius provided dialysis treatment to 184,000 patients in 2008, 84% were in the U.S.  During the year, FMS acquired 48 clinics, opened 127 new ones, and sold or consolidated 25.  It also launched UltraCare at Home which offers the full range of treatments and service to patients who want in-home care.

Fresenius’s most recent quarterly report shows that 62% of its revenues for the second quarter of 2009 came from North America, 22% from Europe, 6% from Asia-Pacific, and 4% from Latin America.  FMS gets about 36% of its total revenue from Medicare and Medicaid, and any reduction in reimbursement could be very detrimental.

The company’s corporate goal, adopted in 2005, is 7-9% annual revenue growth until 2010 as well as a 10% increase in net income.  This is from its Fact Sheet available at the FMS website.  Morningstar estimates a compound annual revenue growth of 7% through 2013.

Morningstar thinks FMS has several advantages over its competitors. In addition to providing dialysis services, it also sells dialysis products many of which are bought by its competitors. And, with its recent purchase of U.S. based Renal Care Group, FMS owns one of every three dialysis clinics in the U.S.  That’s key when location is important to both patients and physicians.

The one-click Annual Report spreadsheet by Bob Adams shows that FMS’s 2008 report rates a 49 out of 100 with six Bullish results (including decreasing accounts receivable, debt and shares outstanding) and twelve Bearish results (including inventories and cost of sales increasing, and inadequate ROE).  You can get this super-duper spreadsheet and a summary of its many features by going to my Favorite Link page, click here.  

DISCUSSION:

The table below compares the SSG by SaulS, which I got from BI’s First Cut page, with two SSGs of mine and with Take Stock.  The only difference between my two SSGs is that Armin-1 uses Hemscott-Morningstar data (like Saul did) while Armin-2 uses S&P data.  After the table, I discuss several SSG issues that were identified by the comparison.

Fresenius Medical Care (FMS)(ADR)	SaulS	Armin-1	Armin-2	Take Stock
Date	7-10-09	7-14-09	Same	Same
Data	Hemscott – Morningstar	Same	S&P	Hemscott -Morningstar
Price	$44.46	$43.89	Same	Same
52 week High &          Low Price	$58.38 & $34.30	Same &         Same	Same &       Same	Not                 Included
Last Q of                       Reported Data	Q4 ending 12/30/08	Same	Q1 ending 3/31/09	Q4 ending 12/30/08
Software Used	TK 6	TK 5	Same	TS Online
Project Growth          From End of	Last                  Quarter	Same	Same	Last                  Fiscal Year
Sales Growth	11.00%`	10.00%	Same	09.00%
EPS Growth	12.50%	09.50%	Same	07.64%
High PE	20.0	19.2               (Alt-M)	21.0         (Alt-M)	19.2
High EPS	$5.02	$4.39	$4.33	$4.03
High Price	$100.40	$84.30	$90,90	$77.49
Value Line Estimated High Price = NOT AVAILABLE
Low PE	14.0	12.0               (Alt-M)	12.5         (Alt-M)	12.0
Low EPS	$2.79	Same	$2.75	$2.79
Low Price	$39.00	$33.50	$34.40	$33.48
Upside/Down	10.2	3.9	5.0	3.2                (imputed)
Total Return	19.0%	15.3%	17.0%	13.5%
SSG Buy Under	N/A	$44.51	$47.98	$41.38
RV/PRV                           (no outliers)	77.7/68.8	82.2/75.2	83.2/75.9	Not                  Included
Quality	4.7 (from Take Stock)	Not                   Included	N/A	4.7
PTPM – 5 yr ave	11.4%               Trend up	Same	11.8%  Trend up	11.4%            Trend N/A
ROE – 5 yr ave          End Equity	N/A	10.8%          Trend up	10.9%  Trend up	Not               Included
ROE – 5 yr av      Start Equity	11.5%              Trend up	Same	11.6%  Trend up	11.5%              Trend N/A
Debt to Equity –          5 yr ave	???	???	73.0%  Trend up	Not              Included

 (1) Estimating EPS:

- When I did my SSGs, the 5 analysts I checked were estimating long-term EPS at an average of 12.20% with S&P high at 15.00% and both FirstCall via YahooFinance and Reuters.com were low at 10.83%.  Zacks was 11.33%, FactSet CallStreet via CNNMoney was 13.00%, and Value Line made no estimates as its report was in its Small and Mid-Cao Edition.

** FactSet’s estimate came from 6 analysts who ranged from 17.0% high to 10.0% low.  Reuters 4 analysts ranged from 14.0% high to 9.32%.

** I estimated 9.50% EPS, some 3.00% less than Saul, 2.70% less than the consensus average, and almost the very lowest of any analyst (9.32% at Reuters).

- A new feature of TK 6 allows the Preferred Procedure to show on the front page of the SSG which shows that Saul did not use the PP.  Saul’s used 12.50% EPS which he said was conservative because it was almost 3.0% less than FMS’s historical average. 

** However, 12.50% EPS was not conservative compared to the consensus average of the five analysts I checked (12.20%).  Nor was it conservative compared to Saul’s default PP of 9.60%.

(2) Forecast High & Low PEs:

 - I knew nothing about FMS before I did my SSG.  In such a case, and without any Value Line for guidance, I usually choose my initial Forecast High PE by using Alt-M.  That is often Toolkit’s most conservative option which averages the lowest 5 High PEs in the last 10 years. See: Determining What’s Reasonable and What’s Not: An Update

- Saul Forecast High & Low PEs were 20.0 & 14.0 which were close to my Alt-M’s 19.2 & 12.5.  Saul’s Low PE was from 2008.

(3) Debt to Equity:

- Using the same Hemscott data, Saul and I differed on Debt/Equity which should not happen.  Because Saul’s SSG was in PDF format I could not examine his annual data. 

- However, I spoke to Technical Support at IClub Central, the maker of our Toolkit software, and confirmed that my TK 5 was not broken.

 4) Final Results:

- With Hemscott data, Saul and I got SSG Buys (with U/Ds > 3.0 and TRs > 15%), but Take Stock did not as its TR was only 13.5%.

- Armin-1 is a SSG Buy that is well under Saul’s, but it is still a SSG Buy.  Saul got a 10.2 U/D and 19.0% TR whereas I got 3.9 U/D and 15.3%.

- Double-digit U/Ds are a red-flag warning sign for me to rethink my judgments as they might be too high.

- With S&P data, but with the same judgments, Armin-2 is a much better SSG Buy than Armin-1 with Hemscott data. That’s because Armin-2 has one later quarter of data than Armin-1.

(5) Final Thoughts:

- FMS is not recession-proof, as I would have thought, and Sales growth has declined in the last two years from 16.0% to 11.7% in 2007 to 9.2% in 2008 (Hemscott and S&P data are identical). 

- I don’t know anything about dialysis so maybe you could help me by answering some questions:

 ** Can dialysis be delayed or deferred; for exampke, can a twice-a-month schedule safely be changed to once-a-month?

 ** How much does each dialysis visit cost a Medicare patient (in dollars), a non-Medicare patient with “good” insurance coverage, a non-Medicare patient with no insurance?

Armin

[AF: please rate this post by using the new, mouse-over star system at the top and/or leave a comment below.  Let me know what you think.]