Reporting on RIMM (Research in Motion)
May 23, 2010
Research in Motion (RIMM) makes the high-end BlackBerry smartphone which is extremely popular with business customers, and with President Obama.
RIMM is an outstanding growth company that’s heads-and-shoulders better than its Industry Averages on FIVE fundamental metrics. Perhaps best of all, RIMM also satisfies my demanding SSG Buy criteria.
RIMM Compared to Industry Averages:
With Morningstar-Hemscott data:
- EPS growth, 5 year average: RIMM is much, much better than its industry average (52.8% vs 2.6%, Diverse Communications Industry) and ranks 1st out of 49 companies;
- Sales growth, 5 year average: RIMM is much, much better than its industry average (69.1% vs 13.3%) and ranks 4th
- Debt to Equity, 2009 average: RIMM is much, much better than its industry average (-0- vs 134.2%) and is tied for 1st
- Pre-Tax Profit Margin, 5 year average: RIMM is much better than its industry average (27.8% vs 12.7%) and ranks 2nd, although this is the only metric of the five where the company’s trend is down
- Return on Equity, 5 year average: RIMM is also much better than its industry average (29.3% vs 16.4%) and ranks 3rd
With S&P data:
- EPS growth, 10 year average: RIMM is much, much better than its industry average (150.8% vs 1.9%, Communications Equipment Industry); there is no company-by-company listing for S&P data and therefore no rankings are possible;
- Sales growth, 10 year average: RIMM is much, much better than its industry average (65.9% vs 13.4%);
- Debt to Capital, 5 year average: RIMM is much, much better than its industry average (0.2% vs 26.0%);
- Pre-Tax Profit Margin, 5 year average: RIMM is better than its industry average (28.1% vs 20.5% and, again, this is the only metric where the company’s trend is down;
- Return on Equity, 5 year average: RIMM is much better than its industry average (29.3% vs 16.4%).
### To learn more about Investigating Industry Info, click here.
Company Background:
– In 2009, Fortune magazine ranked Research in Motion the fastest growing company (#1 out of 100) as it had a three-year average annualized growth of 84% EPS, 77% Sales, and 45% Total Return.
– RIMM is a Canadian company and, according to its latest Annual Report, explained that the Blackberry phone was designed to deliver a “push” based user experience that also offers advanced security, manageability, spectral efficiency, and power management [PDF page 9].
** Sales grew 35% last FY (ended 2-28-10) to $15 Billion and EPS grew 31% to $3.30. The number of Blackberry’s sold increased by 41% or 10.7 Million.
– The S&P Stock Report observed that RIMM had over 41 Million subscribers by the end of FY 2010 and over 16 million additions since the end of FY 2009.
** While initially focused on the business or so-called enterprise market, RIMM in recent years has introduced new consumer-oriented products and, according to S&P, has increased its subscribers to over 50% consumers.
– Morningstar, however, was skeptical of the Blackberry’s sustainable appeal to consumers despite RIMM’s clear success:
** The company’s most durable advantage, according to Mstar, is the business or enterprise market which, unlike consumers, is most attracted to the Blackberry’s always on e-mail and its end-to-end security.
– In RIMM’s latest quarter (Q4, ending 2-28-10), Sales grew 18% and EPS grew 40% based on S&P data.
** The company’s press release reported that a record 4.9 Million net new subscribers were added in the quarter and that the BlackBerry was the #1 selling smartphone in the U.S. at the end of CY 2009.
SSG Discussion:
– The following table compares the SSG by JaniceC, which I got from BI’s First Cut page, with two of mine and with Take Stock. Both my SSGs use the same judgments, but Armin-1 uses S&P data (like Janice) and Armin-2 uses Morningstar-Hemscott data.
– Take Stock is a computerised, one-click program at the StockCentral website designed to produce a conservative result.
– After the table, I discuss several SSG issues and then examine RIMM’s declining Pre-TaxProfit Margin and its Financial Condition.
| Research In Motion (RIMM) | JaniceC | Armin-1 | Armin-2 | Take Stock |
| Date | 4-7-10 | 4-22-10 | Same | Same |
| Data | S&P | S&P | Hemscott-Morningstar | Same |
| Price | $69.83 | $71.40 | Same | Same |
| 52 week High & Low Price | $88.08 & $54.30 | Same & Same | Same & Same | Not Used |
| Last Quarter of Reported Data | Q4 ending 2-28-10 | Same | Same | Same |
| Software Used | TK 5 | TK 6 | Same | TS Online |
| Project Growth From End of | Last Q | Same | Same | Last FY |
| Sales Growth | 12.00% | 10.00% | Same | 20.00% |
| EPS Growth | 11.00% | 10.00% | Same | 20.00% |
| High PE (outliers) | 30.0 (no outliers) | 26.1 (06-07-08 out) | 25.1 (Same) | 30.0 |
| High EPS | $7.36 | $7.04 | $6.95 | $10.73 |
| High Price | $220.80 (23% > VL) | $183.70 (2% > VL) | $174.40 | $321.90 (79% > VL) |
| Value Line Estimated High Price =$120-180 as of 3-12-10 | ||||
| Low PE | 13.0 | 10.6 (from 2008) | 11.2 | 11.1 |
| Low EPS | $4.38 (ttm) | Same | $4.30 (ttm) | Same |
| Low Price | $30.10 (ave low last 5 years) | $35.10 (recent severe low price) | $35.30 (Same) | $47.73 (low PE x low EPS) |
| Upside/Down | 3.8 | 3.1 | 2.8 | 10.5 (imputed) |
| Total Return | 25.9% | 20.8% | 19.6% | 35.1% |
| SSG Buy Under | N/A | $72.21 | $70.04 | $116.27 |
| RV/PRV | 51.2/51.7 (no outliers) | 88.6/80.5 (06-07-08 out) | 91.2/82.9 (Same) | Not Used |
| RV/PRV (no outliers) | 57.2/51.7 | 58.6/53.3 | 61.5/55.9 | Not Used |
| Quality | N/A | S&P = B 5th of 8 grades | TS = 3.2 (fails) | TS = 3.2 (fails) |
| PTPM – 5 yr ave | 28.1% Trend down | Same Same | 27.8% Trend down | Same Same |
| ROE – 5 yr ave Ending Year Equity | 29.0% Trend up | Same Same | 29.3% Trend up | Not Used |
| ROE – 5 yr ave Begin Year Equity | N/A | 39.1% Trend up | 39.4% Trend up | Same Trend N/A |
| Debt to Equity – 5 yr ave | N/A | 0.20% Trend even | Same Same | Not Used |
Janice C’s SSG:
– Janice estimated future growth at 12.00% Sales and 11.00% EPS based on implying those rates from Value Line’s dollar data.
** While VL usually estimates a future EPS growth rate, it did not do so for RIMM.
** Implying a VL rate is tricky as there are at least two methods (VL’s and the traditional approach to CAGR) that result in different outcomes. Janice used a third, unexplained method.
– She also used 30.0 as her Forecast High PE that was mid-way between 40.53 (RIMM’s average High PE for the last 5 years) and 24.0 (VL’s estimated average PE for the next 3-5 years).
** Seeing a downtrend and wanting to be conservative, she used 13.0 as her Forecast Low PE but did not explain why she decided on that value.
Armin’s SSG:
– When I did my SSG, the six analysts I checked were estimating long-term EPS at an average of 19.38% with Morningstar high at 21.70% and Reuters low at 16.99%. VL, as I mentoned, made no estimate.
** Reuters 12 analysts ranged from 30.00% high to 9.70% low.
** I decided to use 10.00% EPS for the next 5 years based on the very lowest of all the estimates (9.70% from the one Reuters analyst, rounded).
### To learn more about Estimating EPS, click here.
– And, after eliminating 2006-2008 High PEs as outliers, I used the resulting average as my Forecast High PE.
– I thought 2009 was atypically low, so I used 2008 as my Forecast Low PE, the lowest Low PE in the last four years.
Take Stock:
– Take Stock estimated 20.00% future Sales and EPS growth, the maximum it is programmed to allow.
– It also estimated a Forecast High PE of 30.0, another maximum limit, and 11.1 as its Forecast Low PE.
Final Results:
– The SSG Buy criteria that I use require a 3.0 Upside/Downside Ratio AND a 15.0% Compound Annual Total Return for the next 5 years. In additiom, I also don’t want to substantially exceed Value Line’s High Price estimate:
- Janice got a 3.8 U/D, a 25.9% TR, and a Forecast High Price that was 23% greater than VL’s High Price estimate;
- Armin-1 (with S&P data) got a 3.1 U/D, a 20.8% TR and a Forecast High Price that was only 2% greater than VL;
- Armin-2 (with Hemscott data) got a 2.8 UD, a 19.6% TR and a Forecast High Price that was less than VL;
- Take Stock doesn’t use U/D, got a 35.1% TR and a Forecast High Price that was an unbelievable and irrational 79% greater than VL.
– Armin-2 came close, but only Armin-1 satisfied all three of my SSG Buy criteria.
Pre-Tax Profit Margin (PTPM):
– VL and S&P reported declining profit margins because RIMM’s prices for consumer phones are less expensive.
– Janice saw that RIMM’s average PTPM for the last 5 years was trending down with the last two years sharply down. She also found a PTPM downtrend for RIMM’s competitors, but provided no details except to identify three competitors.
– I’ve already shown that RIMM 5 year average PTPM with Morningstar-Hemscott data is much better than its industry average (27.8% vs 12.7% and ranks 2nd and. with S&P data, is also better than its industry average (28.1% vs 20.5%).
– The table below compares RIMM and the three competitors identified by Janice: Cisco, Qualcomm and Juniper (note that RIMM is the only phone-maker). The table also includes the three close competitors identified by YahooFinance: Apple, Microsoft, and Nokia (two are phone-makers) and two more direct competitors and phone-makers identified by Morningstar: Motorola and Palm.
** Using S&P data, the PTPM of all of them is trending down except for AAPL
| Pre-Tax Profit Margin | 2005 | 2006 | 2007 | 2008 | 2009 | 5 Year Trend |
| RIMM | 2% up | 5% down | 2% up | 5% down | 2% down | DOWN |
| CSCO | 1% up | 1% down | .2% up | 1% down | 4% down | DOWN |
| QCOM | 3% down | 7% down | 2% down | 6% down | 5% down | DOWN |
| JNPR | 6% up | 6% dn | even | 2% up | 5% down | DOWN |
| AAPL | 8% up | 2% up | 6% up | .4% up | 7% up | UP |
| MSFT | 7% up | 3% down | 4% down | 3% up | 7% down | DOWN |
| NOK | 8% up | .5% down | 1% up | 1% down | 8% down | DOWN |
| MOT | 2% up | 3% down | 9% down | 4% down | 3% up | DOWN |
| PALM | 3% up | 3% down | 16% down | 33% down | N/A | DOWN |
Financial Condition:
– Both Morningstar and Value Line reported that RIMM has no debt and $1.6 -2.0 Billion in cash. Morningstar added that the company sits on another $1 billion in long-term investments. VL also gave the company an A+, its second highest rating, for Financial Strength.
– The one-click Annual report spreadsheet by Bob Adams gave RIMM a 62 out of 100 with 10 Bullish and 9 Bearish findings:
** The Bullish-good things include: no debt, good Free Cash Flow, and a green flag (very good) ROE;
** The Bearish-not-so-goods include: the Cost of Sales is growing faster than Sales and Sales are growing slower than Cash Flow.
### You can get this super-duper, easy-to-use free spreadsheet along with an explanation of its many features by going to my Favorite Links page: click here.
Questions:
– Do you agree with Morningstar that consumers are not a sustainable market for the BlackBerry and that its always-on e-mail appeals primarily to business customers?
– Do you have a BlackBerry and what features do you like (or dislike) most? Let us know if you are a business or consumer customer.
Armin
[please leave a coment and/or rate this post on the mouse-over scale below as your feedback is important and useful to me]
Savoring Sysco (SYY)
April 21, 2010
Sysco Corp (SYY) is the leading food service distributor in the U.S. and Canada with over 400,000 customers and 186 distribution facilities. It delivers some 300,000 food and related products to restaurants (62% of FY 2009 sales), hospitals and nursing homes (11%), hotels and motels (6%), and schools (5%).
SYY was the Online Stock Study for April at the Better Investing website that was led by Shanna Rendon, a BI Board Member. Erin Swanson, the Morningstar analyst who covers SYY, also participated.
I compared Shanna’s SSG (discussed in the webinar recording) with two of mine and with Take Stock. I also examined if Sysco, with $2.468 Billion in Long-Term Debt and a Debt to Equity Ratio of 70.9% in 2009, has too much debt, looked at its ROE downtrend, and briefly reviewed its quality.
Company Background
– Sysco is organized into three segments, the most important of which are Broadline and SYGMA:
** Broadline, with 99 facilities, is its main division and distributes a broad line of food and non-food products to restaurants and other local customers. It accounted for 79.4% of SYY’s sales last year [2009 Annual Report, page 17, PDF page 37].
** SYGMA, with 20 facilities, distributes food and non-food products to chain restaurants such as Wendy’s/Arby’s, its largest customer. This segment accounted for 13.1% of FY 2009 sales.
– Morningstar reported that Sysco has made 145 acquisitions since its founding some 40 years ago. As a result, it has developed a wide-reaching distribution network that has allowed it to become a low price leader which no other competitor can match.
** This extensive distribution network and the breadth of its products and services give SSY a competitive advantage which Morningstar calls a “wide moat.” This slideshow could not be started. Try refreshing the page or viewing it in another browser.
Appraising Aeropostle (ARO)
April 9, 2010
Aeropostle (ARO) is a mall-based retail chain of specialty clothing stores that sells moderately priced apparel and accessories to teenagers. It operates 885 stores throughout the U.S. and 36 in Canada. A new initiative, P.S. from Aeropostle, targets children ages 7-12 with 14 stores currently and plans for 25 more this year.
Company Background:
– According to its latest Annual Report, ARO’s sales were up 19% in FY 2008, same-store sales increased by 8%, and EPS was up 28%. Young women accounted for 71% of sales.
– Morningstar reports that ARO differentiates itself from other teen retailers by selling similar clothes for less, often as much as half the price. The article also explained:
** While ARO did well during our current recession, it is likely to lose market share when the economy recovers and teens resume shopping at pricier stores like ANF and AEO.
** Other risks are selling fashion to fickle teens: some merchandising mistakes seem inevitable and financial results can be volatile.
** Morningstar estimates slightly more than 5% Sales growth over the long term with future growth likely to come from international expansion (as its domestic market is saturated) and from the new kids concept, P.S. from Aeropostle.
– ARO just completed FY 2009 and its press release described a very good year: Sales were up 18% and EPS increased 54%; e-commerce sales were up 48%; and the company had a 3 for 2 stock split effective 3-5-2010.
** In FY 2010, ARO plans to open 25 Aeropostle stores, 25-30 P.S. from Aeropostle stores, and to remodel some 40 existing stores.
SSG Discussion:
– I compared the SSG by BudS, which I got from BI’s First Cut page, with two of mine and with Take Stock.
** Armin-1 uses the identical judgments as Bud with one exception: I projected growth from the last quarter while Bud projected from the last FY. Armin-2 reflects my judgments totally, is much more conservative, and is still a SSG Buy.
| Aeropostle (ARO) | BudS | Armin-1 | Armin-2 | Take Stock |
| Date | 3-5 data 3-9 price | Same | Same | 3-20-10 |
| Data | Hemscott-Morningstar | Same | Same | Same |
| Price | $25.56 | Same | Same | $28.27 |
| 52 week High & Low Price | $29.90 & $14.62 | Same | Same | N/A |
| Last Quarter of Reported Data | Q3 ending 10-31-09 | Same | Same | Same |
| Software Used | TK 6 | Same | Same | TS Online |
| Project Growth From End of | Last FY | Last Q | Last Q | Last FY |
| Sales Growth | 15.00% | Same | 10.00% | 15.10% |
| EPS Growth | 15.00% | Same | 10.00% | 15.10%initial 14.79% final |
| High PE | 19.3 (5 year ave) | Same | 16.2 (from 2008) | 18.3 |
| High EPS | $2.96 | $3.97 | $3.18 | $2.84 |
| High Price | $57.10 | $65.90 | $51.50 | $53.89 |
| Value Line Estimated High Price = $50-80 as of 2-5-10 | ||||
| Low PE | 9.2 | Same | 10.6 (from 2008) | 7.4 |
| Low EPS | $1.47 (last FY) | Same | $1.98 (ttm) | $1.64 |
| Low Price | $14.40 (“other” option) | Same | $21.00 (low PE x low EPS) | $12.14 |
| Upside/Down | 2.8 | 3.6 | 5.7 | 1.6 (imputed) |
| Total Return | 17.4% | 20.9% | 15.0% | 13.8% |
| SSG Buy Under | N/A | $30.13 | $25.60 | $22.55 |
| RV/PRV | 87.8/76.4 | 87.8/79.8 (2008 low PE out) | Same | Not Used |
| RV/PRV (no outs) | 87.8/76.4 | 84.9/77.2 | Same | Not Used |
| Quality | N/A | TS = 7.9 | Same | Same |
| PTPM – 5 yr ave | 13.0% Trend even | Same Same | Same Same | Same |
| ROE – 5 yr ave Ending Year Equity | N/A | 39.7% Trend up | Same Same | Not Used |
| ROE – 5 yr ave Beginning Yr Equity | 47.6% Trend up | Same Same | Same Same | 47.5% |
| Debt to Equity – 5 yr ave | -0- Trend even | Same Same | Same Same | Not Used |
Bud’s SSG vs Armin-1
– The sole difference between Bud’s SSG and Armin-1 is that Bud projected future growth from the end of the last Fiscal Year while I projected from the end of the last quarter.
– All of our other judgments were identical and I made our current price the same.
– Bud got a 2.8 Upside/Downside while Armin-1 got a 3.6 U/D. That’s the difference between a SSG-Don’t-Buy (Bud) and a SSG Buy (Armin-1) as a minimum 3.0 is one of the required SSG Buy criteria.
Armin-2 vs Bud’s SSG
Estimating EPS:
– When I did my SSG, the seven analysts I always check for long-term EPS estimates were averaging 15.73% with Value Line high at 18.50% and S&P low at 12.80%. Without those extremes, the remaining five analysts were close and averaged 15.76%.
** Bud estimated 15.00% EPS which his First Cut write-up said was “conservative and realistic” and nothing more, but which is actually not “conservative” by comparison.
** For Armin-2, I decided to project 10.00% EPS growth based on the lowest of the 13 analysts at CNNMoney via FactSet CallStreet and the 12 at Reuters.com.
– For how I estimate EPS for all my SSGs, check out: Estimating EPS
Forecasting the High and Low PEs:
– Bud used 19.3 as his Forecast High PE, the 5-year historical average, whereas I used 16.2, from 2006 and the lowest High PE in the last 5 years.
– ARO’s 5.8 Low PE was atypically low in 2008 and I treated it as an outlier. For Armin-2, I used 10.6 as my Forecast Low PE (also from 2006) while Bud used 9.2 which he did not explain.
Forecasting the Low Price:
– Bud forecast $14.40 which, he wrote, was the lowest price in the past year, but his SSG shows that $12.20 was actually the low for 2007.
– Armin-2 used $21.20, the Low PE x Low EPS option, and the choice most appropriate for growth companies (BI/NAIC Stock Selection Handbook by Bonnie Biafore, page 108).
Final Results:
– Bud’s SSG did not satisfy the SSG Buy criteria which are a 3.0 Upside/Downside Ratio AND a 15.0% Total Return. Armin-1 and Armin-2 both resulted in a SSG Buy. Take Stock, like Bud, got a Don’t Buy
- Bud’s SSG got a 2.8 U/D and a 17.4% TR
- Armin-1 got a 3.6 U/D and a 20.9% TR
- Armin-2 got a 5.7 UD and a 15.0% TR
- Take Stock got a 1.6 U/D (imputed) and a 13.8% TR
Financial Condition
– Value Line reported no debt, $285.5 M in cash assets, and a Financial Strength rating of B++.
– Morningstar found ARO to be in good financial health with no debt and plenty of cash adequate to fund store expansion.
– The one-click Annual Report Analysis spreadsheet by Bob Adams gave ARO a 57 out of 100 (or 98 as two data items were missing) with 9 bullish and 8 bearish results:
** The bullish or good things include: no long-term debt, ROE is very good at 52.8%, and sales were up 18% and increasing faster than related costs.
** The bearish or not-so-goods include: inventories are increasing; free cash flow should be higher and gets a red-flag warning sign.
### You can get this free and easy-to-use spreadsheet, and a summary of its many features, by going to my Favorite Links page: click here.
Peers vs Competitors
– Peers are not competitors and, for sure, they are not close or direct competitors.
– The S&P data used by the Online SSG at the Better Investing website places ARO in the Women’s Clothing Store Industry and lists Reitmans (RET, Canada), The Dress Barn (DBRN) and The Cato Corp (CATO) as peers.
** Since ARO sells clothes to teenage young men and women, the Women’s Clothing Store Industry (and its three peers) seem like unsuitable comparisons;
** You can change these defaults to competitors, but you must first know what companies you want to switch to.
– YahooFinance places ARO in the All Apparel Stores Industry and lists American Eagle (AEO), The Gap (GPS) and Pacific Sunware (PSUN) as direct competitors.
– Morningstar places ARO in the Apparel Store Industry and list Abercrombie & Fitch (ANF), Zumiez (ZUMZ), AEO, and PSUN as close competitors.
Is ARO Better (or Worse) than its Competitors and/or its Industry Averages?
Comparisons using Hemscott-Morningstar Data:
– All four of the studies used Hemscott-Morningstar data which places ARO in the Apparel Store Industry (46 companies total):
** In terms of its Pre-Tax Profit Margin 5 year average, ARO is much better than its Industry Average (13.0% vs 8.0%)
** ARO’s 13.0% PTPM ranks #8 out of 46 companies and is better than three competitors (GPS #10.2%, ZUMZ @ 9.6% & PSUN @ 5.2%) and is not as good as two (AEO @ 18.7% & ANF @18.1%). ARO is also better than two peers (DRBN & CATO).
** In terms of its 5 year average Return On Equity, ARO is also better than its Industry Average (39.7% vs 30.1%). But, without JCG (680.1%) which is bizarre and a distorting outlier, ARO is much better than its Adjusted Industry Average (39.7% vs 13.9%).
Comparisons using S&P data:
– My S&P data subscription from BI places ARO in the Apparel Retail Industry.
** In terms of its Pre-Tax Profit Margin 5 year average, ARO is much better than its Industry Average (13.0% vs 7.4%).
** In terms of its 5 year average Return On Equity, ARO is also much better than its Industry Average (39.3% vs 25.9%).
## This Industry Average is also distorted by JCG’s bizarre ROE (488.3%), but there is no company-by-company listing, unlike the Morningstar-Hemscott data at Stockcentral.com, so I cannot adjust the Industry Average. [Kudos to Stockcentral for the best industry page on the web!!]
– I conclude that ARO is much better than its Industry Averages with Hemscott-Morningstar and also much better with S&P data, and is sometimes better and sometimes not as good as its direct or close competitors.
– For more on Investigating Industry Info, see: Investigating Industry Info
Armin
Connecting with Cisco (CSCO)
March 21, 2010
Cisco Systems (CSCO) is the world’s leading manufacturer of data networking equipment, and its products include switches, routers, access equipment, and network-management software. Switches connect computers to each other and routers connect them to the Internet.
Cisco Systems (CSCO) was the monthly Online Stock Study for March at the Better Investing website and was led by Suzi Artzberger, BI’s Director of Information Services. Study materials include handouts from Cisco, the Value Line report, presentation slides, and the recording of the Online Study.
A Consensus SSG was completed, but has not been made available. After the study, Suzi posted her SSG on BI’s First Cut page.
Company Background
– According to the S&P Stock Report, CSCO has four product segments: switches (41% of FY 2009 product sales), routers (22%), advanced technologies (32%), and other (5%).
** The primary driver of future growth, S&P believes, will be advanced technologies which includes home networking, unified communications, security, storage area networking, wireless technology, application networking services, and video systems.
– Morningstar considers that CSCO has a wide moat giving it a competitive advantage because customers are reluctant to switch vendors and due to Cisco’s reputation as the leading provider of networking equipment.
** CSCO’s share of the $21B switch market has remained at about 70% for the last five years while its nearest competitor, Hewlett-Packard, is far behind at 5%.
** CSCO’s routers, used by telecom and cable companies to move data, are also a market leader with Juniper Networks in second place.
– One week after the Online Stock Study, the New York Times reported that CSCO had produced a new, high speed router with speeds 12 times faster than competitive equipment, its first major improvement in six years.
– Acquisitions have been a major driver of CSCO’s growth and lists some 125 companies purchased in the past seventeen years, 27 in the last five [Cisco Corporate Overview, slide 24].
** Its most recent acquisitions were Tandberg (video communications) and Starent Networks (mobile systems), each for $3 B cash announced in October 2009.
– CSCO’s FY 2009 was dismal: Sales were down 9%, product revenues were down 12% and EPS declined 20% [Cisco 2009 Annual Report, pages 2-3 and 7].
– In CSCO’s most recent quarter (Q2, FY 2010), Sales & EPS were up 8% & 23%. Cisco’s recovery was so good that it announced plans to hire up to 6000 people in the next several months.
SSG Discussion
– I compared the Consensus SSG with Suzi’s and mine and with Take Stock. After the table, I discuss several issues identified by the comparison and then examine the downtrends in CSCO’s Pre-Tax Profit Margin and Return on Equity, and its overall financial condition.
| Cisco Systems(CSCO) | Consensus SSG | SuziA from BI’s First Cut | Armin | Take Stock |
| Date | 3-1-10 data 3-3-10 SSG | 3-1-10 price 3-9-10 SSG | 3-2-10 | Same |
| Data | S&P | S&P | Same | Hemscott-Morningstar |
| Price | $24.33 | $24.60 | $29.60 | Same |
| 52 week High & Low Price | N/A | $25.10 & $13.61 | Same | Not Used |
| Last Quarter Reported Data | Q2 ending 1-31-10 | Same | Same | Same |
| Software Used | Online SSG | Same | TK 6 | TS Online |
| Project Growth From End of | Last FY | Same | Last Q | Last FY |
| Sales Growth | 10.00% | 13.00% | 10.00% | –08.00% |
| EPS Growth | 10.00% (PP= 10.70%) | 13.00% (PP = 13.60%) | 10.00% | -15.10% |
| High PE | 25.0 (5 year ave) | 24.0 | 25.0 (5 year ave) | 24.9 |
| High EPS | $1.72 | $2.02 | $1.72 | $0.47 |
| High Price | $43.09 | $48.48 (21% > VL) | $43.00 (7.5% > VL) | $11.71 |
|
Value Line Estimated High Price = $30-40 as of 12-25-09 |
||||
| Low PE | 16.35 (default) | 16.35 (5 year ave) | 17.3 (09 Lo PE out) | 16.2 |
| Low EPS | $1.07 (default) | Same | $1.07 (ttm) | $0.97 |
| Low Price | $17.02 (ave low price last 5 years) | $17.40 (low PE x low EPS) | $18.50 (low PE x low EPS) | $15.71 (low PE x low EPS) |
| Upside/Down | 2.57 | 3.22 | 3.0 | Impossible to calculate |
| Total Return | 12.11% or 13.02% | 14.31% | 11.80% | -13.80% |
| SSG Buy Under | Not Used | Not Used | $19.14 | $5.86 |
| RV/PRV | Not Used | Not Used | 111.7/103.8 (2009 Low PE out) | Not Used |
| RV/PRV (no outliers) | Not Used | Not Used | 109.0/101.4 | Not Used |
| Quality | N/A | N/A | B+ | 0.50 unacceptable |
| PTPM – 5 yr ave | 26.87% Trend down | 26.87% Trend N/A | 26.9% Trend down | Same Same |
| ROE – Ending Yr Equity, 5 yr ave | 21.44% Trend NA | 21.44% Trend N/A | 21.4% Trend down | Not Used |
| ROE – Begin Yr Equity, 5 yr ave | Not Used | Same | 24.0% Trend down | 24.2% Same |
| Debt to Equity – 5 yr ave | 15.12% Trend N/A | Not Used | 18.4% Trend up | Not Used |
Estimating Future Sales and EPS Growth for the Next 5 Years
(A) Consensus SSG:
– Suzi gave the group five choices to estimate future Sales growth: 8.00%, the most recent quarter; 10.00%, estimate for 2010 from S&P’s report; 11.40%, CSCO’s Sales growth last 5 year average; 12.00%, organic growth estimate for the next 5 years from Morningstar’s report; and 14.50%, mid-range of CSCO’s guidance according to Morningstar.
** The Consensus choice was 10.00%, S&P’s one-year estimate (37% of the votes).
– Suzi offered five choices to forecast future EPS growth: 8.00%, CSCO’s EPS growth last 5 year average; 10.00%, S&P’s estimate from the BI data files; 10.70%, Suzi’s estimate using the BI/NAIC Preferred Procedure; 12.00%, CSCO’s guidance; and 23.1%, the most recent quarter.
** The Consensus choice was 10.00%, S&P’s estimate (42% of the votes).
(B) Suzi’s SSG:
– Her SSG from BI’s First Cut estimated 13.00% Sales and 13% EPS growth based on CSCO’s 12-17% guidance for the next several years plus her optimism about the company’s market position.
(C) Armin’s SSG:
– When I did my SSG, the seven analysts I always check were estimating long-term EPS at an average of 10.58% with CNNMoney via FactSet CallStreet high at 12.00% and Value Line low at 7.50%.
** The 12 analysts at CNNMoney ranged from 20.00% high to 10.00% low while the 11 analysts at Reuters.com ranged from 16.00% high to 2.00% low.
** I used 10.00%, the lowest estimate by CNNMoney’s 12 analysts.
### For how I estimate EPS for all my SSGs and the names of the seven different estimates I review, see Estimating EPS; click here
(D) Take Stock:
– Take Stock estimated -8.00% Sales and -15.1% EPS growth (both are negative forecasts) for the next 5 years and both seem foolish as well as unreasonable to me.
Estimating the High and Low PEs for the next 5 years
Consensus SSG:
– Participants were given five options to choose the Forecast High PE: 25.0, five year average High PE; 24.0, an intermediate value (unexplained); 23.6, most recent year average High PE; 23.0, current PE; and 28.7, average PE for the last 5 years.
** The Consensus chose 25.0, the five year average High PE (22% of the votes), but 24.0, an unexplained, intermediate value was close behind in second place (21%).
– Participants were not asked to select a Forecast Low PE and Suzi chose 16.35, the Online SSG’s default value.
Forecasting the Low Price
Consensus SSG:
– Suzi gave the group 5 options to choose the Forecast Low Price: $19.68, 80% of the current price; $17.49, Low PE x the Low EPS; $17.02, average Low Price in the last 5 years; $15.00, an intermediate value (unexplained); and $13.61, the recent severe low price.
** The Consensus chose $17.02, the average Low Price (35% of the votes).
Final Results
– None of the four studies found that CSCO was a SSG Buy which requires a 3.0 Upside/Downside Ratio AND a 15.00% Total Return:
- The Consensus SSG got a 2.59 U/D and a 12.11% TR
- My SSG got a 3.00 U/D and a 11.80% TR
- Suzi’s SSG came close with a 3.22 U/D and a 14.31% TR
- Take Stock doesn’t use the U/D concept and got a –13.80% TR
– Note that the Consesus SSG and mine used the same EPS estimate and High PEs, but my Forecast High Price was higher than the Consensus ($43.00 vs $38.50) solely because I chose to project growth from the end of the last quarter whereas the Online SSG is limited to projecting from end of the last FY.
– The Consensus SSG’s Forecast High Price was close to VL’s estimated High Price as was mine while Suzi’s was 21% greater and Take Stock’s was way, way out-of-whack ($11.71 vs VL’s $30-45 when CSCO was selling at $24.60).
Pre-Tax Profit Margin (PTPM) and Return on Equity (ROE)
– CSCO’s PTPM and ROE both are trending down which typically indicate red-flag warning signs of deteriorating quality. Some SSGers would go no further and stop their analysis because of the downtrends. Suzi saw the PTPM downtrend, but thought it still looked robust compared to its competitors. She did not comment on (or spot) the ROE downtrend This slideshow could not be started. Try refreshing the page or viewing it in another browser.
Checking Up on Church & Dwight (CHD)
March 4, 2010
– Church & Dwight (CHD) is a mid-sized manufacturer of household products, some 35% of which are sold under its Arm & Hammer brand (baking soda, laundry detergent, carpet cleaner, toothpaste, cat litter). CHD also makes Brillo scouring pads.
– Acquisitions in the last ten years have added other major brands: in 2001, Arrid antiperspirants, Trojan condoms, Nair depilatories, and First Response pregnancy tests; in 2003, Mentadent, Pepsodent and Aim toothpastes; in 2006, Qxi Clean, Kaboom, and Orange Glo household cleaners; and in 2008, Orajel oral analgesics.
– To fund these acquisitions, CHD’s Long-Term Debt increased from $20.1M in 2000, to $406.6M in 2001, to $754.7M in 2005, to $835.5M as of 9-30-09 according to Value Line.
Does CHD Have Too Much Debt?
– With S&P data, TK 6 shows Total Debt currently at $816.3 M ($781.4M long-term), a Debt to Total Capital Ratio of 37.9%, and a 2008 Debt to Equity Ratio of 58.7%. Can CHD safely manage its debt, here’s what I uncovered:
– CHD’s 2008 Annual Report:
** CHD must satisfy two ratios imposed by the company’s primary creditor: an Interest Coverage Ratio [defined, see note A below] that was 9.8 for 2008 and better than the minimum 3.0 permitted, and a Leverage Ratio [B] that was 1.9 and also better than the maximum 3.5 allowed (2008 A.R., PDF page 51).
** CHD generated $336M Cash from Operations last year and, after capital expenditures, had $238M of Free Cash Flow (PDF page 5).
– The one-click Annual Report spreadsheet by Bob Adams:
** The Long Term Debt to Equity Ratio [C] from the latest A.R. was 37% and gets a red flag warning as it may be excessive. The spreadsheet explains that a normal LT Debt/Equity Ratio should be under 25%;
** It also shows that LT Debt decreased by 24% in 2008, which is good, but that Debt/Equity is still high;
** Cash Flow Growth [D] is up 19% and is very good; Free Cash Flow Margin [E] is 9%, but the spreadsheet wants 10% minimum
** Total Interest Coverage [F] is not available because there is an error by MSN, the spreadsheet’s data source;
### You can get a link to this free, easy to use spreadsheet and an explanation of its many features by going to my Favorite Links page, click here.
– Value Line:
** VL shows the amount of Total and LT Debt as of 9-30-09 with LT interest at $30.0M and Total Interest Coverage at 10.6x;
** VL estimates that LT Debt will decrease from $835.5M to $400M in the next 3-5 years which I think is a positive sign.
– Morningstar:
** The narrative report says that LT Debt more than doubled between 2003 and 2008 in order to fund acquisitions;
** Morningstar is not “overly concerned” about CHD’s ability to service its debt given its cash flow and that its interest coverage ratio was more than 11x through the first half of 2009.
Company Background:
– CHD is organized into three segments: Consumer Domestics (71% of 2008 sales); Consumer International (17%); and Specialty Products (12%).
– CHD has 8 major brands (Arm & Hammer, Trojan, Oxy Clean, Spinbrush, First Response, Nair, Orajel, and Xtra) which account for 80% of its sales and profits.
– Wal-Mart is its largest customer representing 22% of its annual sales.
– CHD’s 2008 Annual report says that its Total Return to shareholders (appreciation plus dividends) has been close to 18% annually for the last 10 years.
– Close or direct competitors are Clorox (CLX), Proctor & Gamble (PG) and Sun Products (private) according to Yahoo Finance and Hoovers.com.
SSG Discussion:
– The following table compares KamieZ’s SSG, which I got from BI’s First Cut page, with two of mine and with Take Stock. Armin-1 uses the same basic data as Kamie, but with my judgments. Armin-2 uses current data, including a later Quarter that was reported after Kamie did her SSG, and my same judgments.
– Kamie Zaracki is the new CEO of Better Investing and I think it’s terrific that she makes her SSG available to all BI members. Here’s hoping for many more and her bio is also available: click here .
| Church & Dwight (CHD) | KamieZ | Armin-1 | Armin-2 | Take Stock |
| Date | 2-5-10 | Same | 2-19-10 | Same |
| Data | S&P | Same | Same | Morningstar-Hemscott |
| Price | $61.10 | Same | $65.90 | Same |
| 52 week High & Low Price | $64.09 & $45.41 | Same | $65.92 & Same | Not Available |
| Last Quarter of Reported Data | Q3 ending 9-30-09 | Q3 ending 9-30-09 | Q4 ending 12-31-09 | Q3 ending 9-30-09 |
| Software Used | TK 6 | Same | Same | TS Online |
| Project Growth From End of | Last FY | Last Q | Same | Last FY |
| Sales Growth | 8.00% | 10.00% | Same | 8.70% |
| EPS Growth | 8.00% (PP = 8.9%) | 10.00% | Same | 5.98% |
| High PE | 19.0 | 17.0 | Same | 21.6 |
| High EPS | $4.28 | $5.69 | $5.85 | $3.67 |
| High Price | $81.30 | $96.70 | $99.40 | $79.07 |
| Value Line Estimated High Price = $75-95 as of 1-1-10 | ||||
| Low PE | 15.0 | 12.5 | Same | 14.8 |
| Low EPS | $2.91 (last FY) | $3.53 (TTM) | Same | $2.92 |
| Low Price | $42.40 (recent severe low) | $45.40 (low PE x low EPS) | Same | $43.22 (low PE x low EPS) |
| Upside/Down | 1.1 | 2.1 | 1.6 | 0.58 (implied) |
| Total Return | 6.5% | 10.3% | 9.3% | 4.2% |
| SSG Buy Under | N/A | $49.60 | $50.99 | $40.41 |
| RV/PRV (no outliers) | 94.0/87.1 | 91.3/85.5 | 98.9/87.1 | Not Used |
| Quality | S&P = A+ | Same | Same | TS = 3.2 unacceptable |
| PTPM – 5 yr ave | 12.0% Trend up | Same Same | Same Same | 11.2% Trend N/A |
| ROE – 5 yr ave Begin yr Equity | 20.7% Trend down | Same Same | Same Same | 19.0% Trend N/A |
| Debt to Equity – 5 yr ave | 88.4% Trend down | Same Same | Same Same | N/A N/A |
Estimating Future Sales and EPS
Kamie’s SSG:
– Kamie used the BI/NAIC Preferred Procedure that began with her Sales Growth estimate of 8.00% which, she wrote, was 1% more than CHD’s organic growth. She then made one change in the default PP and used 14.0% (instead of 12.0%) for CHD’s future Pre-Tax Profit Margin. That resulted in an 8.90% EPS estimate which she lowered to 8.00%.
** Zacks.com was estimating 12.00% Sales growth in the next 5 years and Morningstar was estimating organic sales growth (no acquisitions) of 4%-6% annually over the next five years.
** CHD’s historical Sales & EPS growth has been 13.4% & 13.2% for the last five years, 11.6% & 15.3% for the last three, and 9.1% & 19.8% for the last two. Its several acquisitions make this history difficult to rely on.
Armin’s SSG:
– When I did my SSG, the seven analysts I always check were closely estimating long-term EPS at an average of 12.29% with S&P high at 13.00% and Reuters.com, Morningstar.com, and Value Line all low at 12.00%;
** I used 10.00% for my estimated EPS, the very lowest of the estimates by the 5 analysts at CNNMoney via FactSet CallStreet and by the 3 analysts at Reuters which, by comparisn, is a conservative estimate.
** For how I estimate EPS for all my SSGs, see: Estimating EPS
Return on Equity (ROE)
– CHD’s 5 year average ROE is trending down which is usually a red-flag warning sign of deteriorating quality:
** With Hemscott-Morningstar data, CHD initially appears worse than its industry average (15.6% vs 48.5%, Household Products Industry), but the average is distorted by CLX’s 290.2% ROE. After I remove Clorox, CHD is better than its adjusted industry average (15.6% vs 12.2%) and we get a more realistic comparison as a result.
** With S&P data, CHD is worse than its industry average (20.7% vs 29.2%, Household Products Industry). However, CLX’s 179.9% ROE also distorts this average, but a company-by-company breakdown is not available so I cannot adjust the industry average to remove outliers.
** With CHD’s company data, the Bob Adams spreadsheet shows CHD with a 15.2% ROE (Net Income / Total Equity, debt not included) which it considers very good.
** For more on using Industry data, see Investigating Industry Info .
What Can We Learn from the Quarterly Trend Analysis/ PERT-A?
– The Quarterly Trend Analysis in Toolkit 6 is the same as the PERT-A in TK 5.
– Sales Growth quarterly TTM % change (Worksheet, column S) has declined for 10 consecutive quarters from 17.1% in September 2007 to 4.1% in December 2009. This looks like a worrisome red-flag warning to me.
– EPS Growth quarterly TTM % change (column R) has increased during the same 10 quarters from 18.0% to 24.3%. This looks good historically, but is not indicative of future EPS given CHD’s declining TTM Sales Growth.
Quality
– S&P gives CHD an A+ for quality, its highest of 8 grades, whereas Take Stock gives CHD a 3.2 which is unacceptable (with 3.4 the minimum required to pass muster and 6.7 is desired).
– Take Stock seems goofy to me as a whopping 7536 stocks out of 7773 total (97%) fail and get under 3.4 with 4218 (46%) getting a grade of Z-E-R-O.
– Armin
==============
Notes:
A: Interest Coverage Ratio (from 2008 A.R.) = Adjusted EBITDA as per loan agreement / Total Interest Expense
B: Leverage Coverage Ratio = Total Debt / Adjusted EBITDA
C: LT Debt to Equity Ratio (from Bob Adams’ spreadsheet) = Long Term Debt / Total Equity
D: Cash Flow Growth = Current Year Cash from Operations / Prior Year Cash From Operations
E: Free Cash Flow Margin = Net Cash from Operations – Property, Plant & Equipment – Dividends / Sales
F: Total Interest Coverage = Pretax Profit + Total Interest Paid / Total Interest Paid
Measuring Medtronic (MDT): Part 2
January 22, 2010
– Medtronic (MDT) is a large medical technology and equipment company with $14.6 B in revenues last year. MDT currently operates in seven segments:
** Cardiac Rhythm Disease Management (34% of FY 09 revenues: pace-makers and implantable defibrillators);
** Spinal (23%: artificial spinal discs);
** Cardiovascular (17%: heart valves, stents);
** Neuromodulation (10%: neurological and urological devices);
** Diabetes (8%: insulin pumps);
** Surgical Technologies (6%: minimally invasive ENT products);
** Physio-Control (2%: defibrillators for hospitals and public access).
– Medtronic was the Online Stock Study for January 2010 at the Better Investing website. It was led by Avi Horwitz, a Director of the BI Volunteer Board and was different from prior studies in several respects:
** Avi used his completed SSG as the primary reference for polling the study participants, neither MDT’s business nor participant voting was set forth in the study’s Presentation Slides, and (sadly) there was no Consensus SSG.
** Questions about the Study may be answered by the recorded session which is not available at this time. Sooooo, I decided to discuss MDT in more depth (including its quality, competitors, and legal battles) and this post is longer than usual as a result.
Discussion:
– The table below compares Avi’s completed SSG with two of mine and with Take Stock. Armin-1 was part of “Measuring Medtronic”, a post I did here in September 2009, while Armin-2 is current. Take Stock is a computerized one-click program at the Stock Central website that is designed to produce a conservative result.
| Medtronic (MDT) | Avi’s SSG | Armin-2 (new) | Armin-1 (old) | Take Stock |
| Date | 12-23-09 | 1-8-10 | 9-23-09 | 1-8-10 |
| Data | S&P | Same | Same | Hemscott-Morningstar |
| Price | $44.40 | $45.99 | $32.04 | $45.75 |
| 52 week High & Low Price | $44.43 & $24.06 | $45.81 & Same | $52.97 & Same | Not Included |
| Last Q of Reported Data | Q2 ending 10-31-09 | Same | Q1 ending 7-31-09 | Q2 ending 10-31-09 |
| Software Used | TK5 | Same | Same | Online TS |
| Project Growth From End of | Last FY | Last Q | Same | Last FY |
| Sales Growth | 9.00% | 10.00% | Same | 7.90% |
| EPS Growth | 8.90% (from PP) | 10.00% | Same | 7.90% |
| High PE | 18.0 | 20.4 (from 2008) | Same | 23.1 |
| High EPS | $4.29 | $4.67 | $4.56 | $4.65 |
| High Price | $77.20 | $95.30 | $93.00 | $107.19 |
|
Value Line Estimated High Price = $80-100 as of 11-27-09 |
||||
| Low PE | 9.0 | 8.6 (from 2008) | Same | 17.3 |
| Low EPS | $2.90 (ttm) | Same | $2.83 (ttm) | $3.29 |
| Low Price | $26.10 (low EPS x low PE) | $24.30 (low EPS x low PE) | $22.20 (60% x curr price) | $56.82 (higher than current price) |
| Upside/Down | 1.8 | 2.3 | 3.8 | Impossible to Calculate |
| Total Return | 12.8% | 11.6% | 21.1% | 20.2% |
| SSG Buy Under | N/A | $42.05 | N/A | $57.49 |
| RV/PRV | 72.5/66.6 (no outliers) | 87.8/79.7 (04 & 05 out) | 72.4/65.7 (same) | Not Included |
| RV/PRV (no outliers) | 72.5/66.6 | 75.4/68.3 | N/A | Not Included |
| Quality | N/A | S&P = A- | S&P = A- | TS = 3.2 unacceptable |
| PTPM – 5 yr ave | 30.00% trend down | Same | Same | 30.50% trend N/A |
| ROE – 5 yr ave Ending Equity | 24.70% trend even | Same | Same | Not Included |
| ROE – 5 yr ave Starting Equity | N/A | 26.90% trend even | Same | 28.50% trend N/A |
| Debt to Equity – 5 yr ave | N/A | 46.10% trend up | Same | Not Included |
(1) Future Growth Projected From:
– SSG Software allows us to project future growth from the end of the last Fiscal Year, the last Quarter, or the Trend Line. The Online SSG only projects growth from the end of the last FY.
– Avi’s SSG used the Toolkit 5 software, not the Online SSG, but chose to project growth from the last FY. Armin-1 and Armin-2, on the other hand, projected from the last Q.
(2) Estimating Future Sales Growth:
– Avi’s SSG estimated 9.00% Sales growth and offered the study participants five choices to make their estimate: much higher, at least 13.00%; a little higher, 10-12%; 9.00%, seems good; a little lower, 6-8.00%; and no higher than 5.5%.
** Morningstar was estimating 6.00% Sales growth through FY 2014 and Zacks.com 9.57% for the next 5 years, neither of which Avi mentioned. The Presentation Slides also don’t explain why Avi estimated 9.00%.
[** The recorded session, which became available after I posted this write-up, reveals that Avi’s 9.00% estimate was based on MDT’s recent sales growth (8.00% last FY, 7.5% last Q) plus a little extra to reflect his optimism.]
(3) Estimating Future EPS Growth:
Consensus SSG & Avi SSG
– Avi used the NAIC/BI Preferred Procedure to estimate future EPS growth and the PP involves four estimates for the next 5 years: Sales Growth [less] Pre-Tax Profit Margin [less] Taxes [divided by] Shares Outstanding [equals] EPS growth. His PP worked out to be 8.90% and that was what he used for his SSG.
– To estimate future EPS growth, Avi offered four choices to the participants: much higher than his estimate, at least 13.00% (the ten-year historical growth rate); a little higher, 10-13.00% (the S&P estimate was $4.76 or 11.00%); 8.90%, Avi’s estimate; and no higher than 8.00%.
Armin’s SSGs
– When I did Armin-2, the seven analysts I always check were closely estimating long-term EPS, averaging 10.90% with Zacks.com high at 11.18% and Value Line low at 10.50%. That’s a very small spread of .68% between the highest and lowest of the seven estimates.
– The 10.90% average was slightly higher than when I did Armin-1 three months earlier. Armin-1 estimated 10.00% EPS and I decided to use the same for Armin-2.
– For how I estimate EPS for all my SSGs, see Estimating EPS.
(4) Forecasting Future High and Low PEs:
Avi’s SSG
– Avi used 18.0 as his Forecast High PE (down from the historical average of 24.5) and 9.0 as his Forecast Low PE (down from the 11.8 average), and gave the group three choices for their forecast: too high, too low, or just about right.
** The Presentation Slides do not indicate how Avi determined his 18.0 & 9.0. Slide 54 does show that both High & Low PEs have been trending down each year for the last 5 years with 2008 the lowest at 20.4 & 8.6.
Armin’s SSGs
– Armin-1 and Armin-2 both used 20.4 & 8.6 as the Forecast High & Low PEs, from 2008 and the lowest PEs in the last 5 years.
** When PEs are trending down, I most often use the lowest High and Low PEs in the last 5 years (and when trends are up, I usually begin with TK 5’s Alt-M command, especially when I know nothing about the company).
(5) Final Results:
Avi’s SSG
– His Forecast High Price in the next 5 years (Forecast High PE x High EPS) was $77.20, slightly below the low end of Value Line’s estimated $80-100 High Price.
** I never want to substantially exceed or fall below VL’s estimate, at least not without a very good reason. For how I determine what’s reasonable for my SSGs, see: Determining What’s Reasonable and What’s Not: An Update.
– Avi got an Upside/Downside Ratio of 1.8 which does not satisfy the minimum SSG Buy criteria of 3.0. His Total Return was 12.8% which does not satisfy the second, minimum Buy criteria of 15.0%.
[** The recorded session also reveals that the Consensus agreed with each one of Avi’s 5 judgments (Sales and EPS growth, High & Low PEs, and Low Price), perhaps largely because Avi labeled each one as “seems good” or “just about right.”]
[** And, at the very end of the recording, Avi reveals that his SSG was probably “a little too conservative.”]
Armin’s SSGs
– Armin-1 got a 3.8 U/D and a 21.1% TR which do satisfy the SSG Buy criteria. However, Armin-2, with essentially the same judgments, got a 2.3 U/D and an 11.6% TR which do not satisfy the minimum Buy criteria.
– The reason for this dramatic change is that MDT’s price increased from $32.04 in Armin-1 to $45.99 in Armin-2, up some $13.95 or 43% per share in three months.
Take Stock
– Take Stock got a $107.14 Forecast High Price that was slightly higher than the high end of VL’s estimated High Price of $80-100.
– However, it’s Forecast Low Price was $56.82 and substantially exceeded MDT’s current price of $45.75. This is a SSG NO-NO according to the BI/NAIC SSG Manual, but this is one of several issues where Take Stock is deliberately designed to be different.
** I think a Low Price that’s not low but high is a serious defect and, when it exceeds the stock’s current price, is especially nutsy!
(6) Quality:
– S&P rated MDT an A- for Quality which is third highest out of its 8 rankings.
– Take Stock gave MDT an unsatisfactory Quality Rating of 3.2 as a minimum of 3.4 is required to pass muster, 6.7 is desired and 10.0 is the max.
(7) Pre-Tax Profit Margin (PTPM) and Return on Equity (ROE):
PTPM
– MDT’s Pre-Tax Profit Margin is trending down which is usually a red-flag warning sign to consider abandoning the SSG. Avi did not show this downtrend in the Presentation Slides, but did show it in the Extra Handout Slides.
** Avi did point out the so-called barbed-wire fence (Slide 49) which is not to be crossed if the company’s Quality is questionable. Why he crossed the barbed-wire fence was not explained.
– However, I determined that MDT’s PTPM is way better than its industry average using S&P data (30.0% vs 15.9%, Health Care Equipment industry) and also way better with Hemscott/Morningstar data (30.0% vs 16.2%, Medical Appliances & Equipment industry). Moreover, MDT ranks 8 out of 118 companies with Hemscott data.
** Soooooo, I would not cease any analysis just because of MDT’s PTPM trend.
– To learn more about using Industry Info, see: Investigating Industry Info.
ROE
– No problems are indicated by the ROE trends as they are even and not going down. Although MDT is better than its industry average with S&P data (24.7% vs 13.3%), it is well below its industry average with Hemscott/Morningstar data (26.2% vs 68.7%). Here, the problem is the industry average, not MDT.
** The Hemscott/Morningstar industry average is distorted by one company (KCI, 2430% ROE) and when that one company is removed, MDT is much better than the adjusted industry average (26.2% vs 16.2%).
** Hemscott data at the StockCentral website allows us to easily spot outliers and adjust any industry average because it includes the data for each company in the industry as well as the industry averages.
(8) Competitors:
– According to YahooFinance and Hoovers.com, MDT’s direct competitors are BSX, JNJ and STJ.
– MDT’s latest 10K report lists competitors in each of its seven segments and BSX, JNJ and STJ are mentioned most often:
** BSX and STJ in the CRDM segment; JNJ in spinal; BSX and JNJ in cardiovascular; BSX and STJ in neuromodulation; JNJ in diabetes; and JNJ in surgical technologies.
(9) Legal Problems:
– In October 2007, MDT volintarily stopped the worldwide sale and distribution off its Sprint Fidelis leads which the FDA classified as a Class 1 recall. Leads are sophisticated wires that directly connect the heart to a defibrillator. Some Fidelis leads had broken and been involved in unnecessary shocks and at least 16 deaths acknowledged by MDT.
** By August 2009, according to MDT’s latest 10K report, some 1250 lawsuits had been filed against the company including 37 class actions involving 2300 individual personal injury cases. These suits seek money damages and allege negligence, breach of warranty and other claims.
– In October 2009, after MDT’s 10K had been filed, a Hennepin County (MN) court dismissed 600 of these suits. Its ruling was based on a 2008 US Supreme Court decision that federal law, the Medical Device Amendments of 1976, explicitly preempts and essentially prohibits litigation after the FDA has approved a medical device as safe and effective following a full review.
** An article in the New England Journal of Medicine summarized the meaning of this Supreme Court decision: “Patients injured by poorly designed but FDA-approved medical devices now have no recourse.” [emphasis added]
– If you’re interested in learning more about MDT’s other legal problems as well as its business and growth plans, checkout my 10/3/09 post: Measuring Medtronic (MDT)
Armin
*** [I’d appreciate some feedback about this post, especially if you think it’s too long. Other suggestions, of course, are also welcome] ***
Scrutinizing Stryker (SYK)
December 22, 2009
[AF: The Online Stock Study of Stryker Corp, discussed below, is also summarized in the March 2010 issue of Better Investing magazine.]
Two months ago, Stryker Biotech LLC and its top executives were indicted by a federal grand jury. The core charges involve marketing a new bone growth product for uses not approved by the FDA.
The parent, Stryker Corp (SYK), is a large and highly regarded medical technology and equipment company that was the subject of the Online Stock Study for December at the BI website. The SYK study was conducted differently than prior studies as no Consensus SSG was produced and Ann Cuneaz, who led the study, made all the judgments. Ann is a very well respected volunteer educator and, most recently, the Education Program Manager for Better Investing.
The Presentation Slides, Completed SSG, Value Line reports, and handout materials are all available to BI members for downloading. A recording of the entire session should be available sometime soon.
Company Background:
– The 2008-2009 Stryker Fact Book explains that the company consists of two segments: Orthopedic Implants (59% of 2008 Sales, up 11%) and Medical Surgical Equipment (41%, up 14%). Orthopedic Implants include artificial knees, hips, trauma and cranio-maxillofacial, and spine. Med Surg Equipment includes operating room equipment, endoscopy, beds and stretchers.
– The Fact Book estimates the worldwide orthopedic market at $35.6B and 10% growth in dollars with Stryker ranked first in terms of orthopedic sales and market share ($5.5B, 15%) followed by JNJ ($4.5B, 13%), ZMH ($3.9B, 11%), and MDT ($3.7B, 10%).
– With almost $3B in cash assets, Stryker has made several recent acquisitions: $525M to acquire privately held Ascent Health Care Solutions (2008 sales of $100M) which reprocesses and remanufactures medical devices; and $67M (plus up to $36M more) to acquire the assets to produce and sell Sonopet Ultrasonic equipment.
– Stryker has also raised its divided to $0.10 per share in 2009 and to $0.15 in 2010, and will now pay on a quarterly basis.
– Stryker is a favorite holding of BI investment clubs, ranking second out of the top 100 companies in 2009, behind GE with JNJ third, WAG fourth and MSFT fifth.
Legal Problems:
– Stryker announced in late October that one of its units, Stryker Biotech LLC, had been indicted along with several current and former top executives by a federal grand jury in Massachusetts. The charges involve wire fraud, conspiracy to defraud the FDA, distribution of a misbranded device involving its OP-1 bone growth product, and false statements to the FDA.
** One allegation is very troubling, that patients were harmed by the use of the untested and unauthorized bone growth product;
** SYK’s press release did not deny the charges and acknowledged that conviction could result in significant fines and exclusion of the unit from federal and state health programs.
** Morningstar reported that the OP-1 bone growth product may be discontinued, given the FDA’s repeated concerns, and that it was excluding the product’s sales from its forecasts as well as including provision for a substantial fine or settlement.
** In March, I tried to assess the implications of the initial grand jury subpoena at: Studying Stryker, Part 2
– Value Line reported that Stryker has received four warning letters from the FDA involving quality and compliance issues at it plants in Ireland, New Jersey and Massachusetts.
** The company is spending some $200 M at all 21 of its facilities to improve quality and compliance, and VL thought SYK would continue its spending even after all the FDA letters were resolved (three remain open).
SSG Discussion:
– The table below compares Ann’s SSG with two of mine and with Take Stock. My two SSGs are identical except Armin-1 uses S&P data (like Ann did) while Armin-2 uses Hemscott-Morningstar data. Take Stock is a one-click, computerized program at the Stock Central website that is designed to produce a conservative result..
– After the comparison table that follows, I discuss several issues that were identified by the comparisons.
| Stryker (SYK) | AnnC | Armin-1 | Armin-2 | Take Stock |
| SSG Date | 12-2-09 | 12-7-09 | Same | 12-4-09 |
| Data | S&P | S&P | Hemscott-Morningstar | Same |
| Price | $51.20 | $51.61 | Same | $51.81 |
| 52 week High & Low Price | $51.32 & $30.82 | $52.62 & Same | Same & Same | Not Included |
| Last Q of Reported Data | Q3 ending 9-30-09 | 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 | 08.00% | 11.00% | Same | 11.10% |
| EPS Growth | 08.00% | 10.40% | Same | 11.10% initial 09.46% final |
| High PE | 22.0 | Same | Same | 30.0 |
| High EPS | $4.16 | $4.71 | $4.70 | $4.46 |
| Forecast High Price | $91.52 (3.6% < VL) | $103.60 | $103.40 | $133.67 (16% > VL) |
|
Value Line Estimated High Price = $95-115 as of 11-27-09 |
||||
| Low PE | 11.0 | 12.0 | Same | 19.8 |
| Low EPS | $2.83 | $2.87 | $2.86 | Same |
| Forecast Low Price | $31.13 | $34.40 | $34.30 | $56.63 Higher than Current Price |
| Upside/Down | 2.0 | 3.0 | Same | Impossible to Calculate |
| Average Payout | 15.0% | Same | Same | Unknown |
| Total Return | 12.98% | 15.6% | Same | 21.5% |
| SSG Buy Under | Not Included | $51.70 | $51.58 | $68.61 |
| RV/PRV (no outliers) | Not Included | 67.9/61.5 | 67.7/61.4 | Not Included |
| Quality Rating | S&P = Not Available | S&P = A+ | Hemscott = Not Included | TS= 2.6 Unacceptable |
| PTPM – 5 yr ave | 21.84% Trend N/I | 21.8% Trend up | 22.3% Trend up | 22.3% Trend N/A |
| ROE – 5 yr ave with End Equity | 20.29% Trend N/I | 20.3% Trend even | 20.1% Trend up | Not Included |
| ROE – 5 yr ave with Start Equity | Not Included | 24.5% Trend down | 24.2% Trend down | 24.2% Trend N/A |
| Debt to Equity – 5 yr ave | Not Included | 01.1% Trend down | 01.1% Trend down | Not Included |
Ann’s SSG:
Estimating Future Sales Growth:
– Ann identified SYK’s historical Sales growth as 14.6% over the past 10 years, 12.0% over the last 5, and zero over the past quarter.
** Alhough not mentioned by the Presentation Slides, SYK’s sales growth also has held up well during our current recession averaging over 11.0% for the last 3 and 2 years.
– Ann also found several estimates of future Sales growth: Value Line at 8.5%; Morningstar, flat in 2009 & up to 12% through 2014; ACE, zero in 2009 & 7.0% in 2010; and Manifest Investing, 10.1%.
** VL’s 8.5% estimate is for Sales/share, not Sales; the ACE, or Analyst’s Consensus Estimate, was not identified, but it looks like it was derived from S&P’s Stock Report.
[** The recorded session, which was made available at the BI website long after I wrote this post, reveals that the Analyst’s Consensus Estimate was from Yahoo Finance, not S&P.]
– Ann decided to estimate 8.00% which became the first factor in her NAIC/BI Preferred Procedure.
Estimating Future EPS Growth:
– Ann’s PP consisted of: 8.00% Sales growth [less] 23.0% Pre-Tax Profit Margin, up from 21.8% and the only change in the default values [less] 27.5% Taxes [divided by] 397.7 M shares outstanding [equals] 7.9% EPS
– She identified SYK’s historical EPS growth as 24.1% over the past 10 years, 18.0% over the last 5, and 4.5% over the past quarter;
** SYK’s EPS growth also has held up well during this recession averagibg over 17.0% over the last 3 and 2 years
– She also found several estimates of future EPS growth: Value Line at 12.0%; Morningstar at 11.0%; ACE at 4.0% for 2009, 11.0% for 2010, and 10.6% for the next 5 years; and MI at $4.72 or 10.5%.
– Ann decided to estimate 8.00% future EPS growth which was almost the same as her PP.
Estimating the Forecast High and Low PEs:
– Presentation slide #37 shows the 5 year Average PE as 26.47 and the Current PE as 16.98. This indicates a downtrend which Ann did not comment on.
– Slide #37 also mentioned several estimates that Ann uncovered: 22 average PE by VL for the next 3-5 years, 21 by MI, and 17 x 2010 one year target by S&P.
– Ann decided to use 22.0 as the Forecast High PE and 11.0 as the Forecast Low PE.
Final Results:
– There is a conflict between the Presentation Slides and the Completed SSG because the Slides are based on a price $48.73, as of 11-23 when they were created, while the SSG uses a higher price of $51.20 as of 12-2 when the Online Study was conducted.
** Slide 34 shows a Upside/Downside of 2.43 while the SSG shows a U/D of 2.00;
** Slide 41 shows a Total Return of 14.12% while the SSG shows a TR of 12.98%
** What’s important here is that neither the Slides nor the SSG satisfy the minimum Buy criteria of 3.0 U/D and a 15.0% TR
** What’s also important is that SYK was selling close to its 52 week high and would be a SSG Buy with Ann’s judgments if it dropped to $46 per share.
[** The recording also has a panel discussion that followed the Study and the two panelists both thought Anne’s SSG was too conservative.]
Armin’s SSG:
Estimating Future EPS Growth:
– When I did my SSG, the seven analysts I always check were closely estimating long-term EPS growth an average at 11.20% with Reuters.com high at 12.10% and FactSet CallStreet via CNNMoney.com low at 10.00%. S&P was 10.40%, Thomson Reuters via YahooFinance was 10.68%, Zacks was 11.63%, FactSet via Morningstar.com was 11.70%, and Value Line was 12.00%.
** The nine analysts at FactSet CallStreet via CNNMoney ranged from a high of 20.0% to a low of 5.0% as did the 11 analysts at Reuters.com.
** The average less 1 Standard Deviation was 10.38% and less 2 SDs was 9.54%.
– I decided to estimate 10.4% which was based on the average less 1 Standard Deviation (rounded).
Estimating the Forecast High and Low PEs:
– Stryker’s High & Low PEs have fallen from 40.3 & 28.2 in 2004 to 26.5 & 17.5 in 2008.
** Forecasting downtrends is largely a matter of guesswork since no one can foresee when and to what extent those trends will change direction.
– I decided to use 22.0 as my Forecast High PE, the same as Ann, and 12.0 as my Forecast Low PE, close to her 11.0.
Final Results:
– Unlike Ann, I satisfied the SSG Buy criteria: with Armin-1 (S&P data), I got a 3.0 U/D and 15.6% TR and with Armin-2 (Hemscott data) using the same judgments, I got the same results.
– The primary difference between our SSGs was that I estimated a higher EPS growth rate for the next 5 years (10.4% vs her 8.0%). The seven analysts I checked were averaging 11.2% and I think any over-optimism was wrung out by reducing the average by 1 Standard Deviation.
** For how I estimate EPS for all my SSGs, see Estimating EPS
** For how I determine what’s reasonable and what’s not, see Determining What’s Reasonable and What’s Not: An Update
– Another difference, although not as significant, was that I projected growth from the end of the last Quarter while Ann, who used the BI Online SSG, had no option but to project from the end of the last Fiscal Year.
Pre-Tax Profit Margin (PTPM) and Return on Equity (ROE):
– The calculation of the annual averages and the 5-year averages for PTPM and ROE involve no judgment as the software automatically calculates them from the raw data.
** However, the assessment of those averages does involve judgment: does a downtrend indicate a red-flag warning sign of deteriorating fundamentals or, on the other hand, an unsustainable high average that’s becoming less extreme.
– Hemscott data at the StockCentral website provides the most complete picture. It places Stryker in the Medical Instruments and Supplies Industry along with 115 companies total.
** Without the one company (DXR) that skews the PTPM industry average, Stryker’s 5 year PTPM average is substantially better than its adjusted industry average (21.8% vs 15.533%) and ranks 10th out of 114 companies.
** And, without the two companies that skew the ROE industry average (EYE and REPR), Stryker’s 5 year ROE average is also way better than its adjusted industry average (20.1% vs 13.264%) and ranks 9th out of 113 companies.
– S&P places Stryker in the Health Care Equipment Industry, but the data is not broken down by individual companies and it seems likely that those averages are skewed by the same 3 companies and maybe by others as well.
Questions:
– What do you think: are you troubled by SYK’s downtrend in ROE with Starting Equity or is my analysis satisfactory? If not, what else would you want to look at??
– How do you estimate Future EPS Growth and would you estimate more or less than Ann’s 8.00% or my 10.40%? How do you decide??
– Armin
Fundamental Investing Using the Stock Selection Guide (SSG) by armin fields 