SSG | Fundamental Investing Using the Stock Selection Guide (SSG) by armin fields

Counting On Coach (COH)

August 1, 2010

Coach (COH) sells expensive handbags and accessories that it designs and has made by independent manufacturers according to COH standards and controls.

The recession has been tough on Coach: three years ago, it was Better Investing’s Growth Company of the Year, but its sales slumped to 1.6% last year. Coach has fought back by dropping prices, launching a new line of more affordable handbags, and expanding further into China.

With a recovery in the U.S., Morningstar expects solid sales growth and increased profit margins this year. Value Line also gave a glowing report and forecasts healthy EPS increases for the foreseeable future.

I just compared AnnC’s SSG, which I got from BI’s First Cut page, with mine and with Take Stock. I also assessed Coach’s downtrends in Pre-Tax Profit Margin and Return on Equity, its financial condition, and its competitors.

Company Background:

– In FY 2009, handbags accounted for 62% of COH’s sales while accessories were 29%; the U.S. accounted for 72% of sales and Japan 21%.

– According to Coach’s latest 10K annual report, the company is organized into two segments: Direct-to-Consumer and Indirect.

** Direct-to-Consumer consists of Coach stores in North America, Japan, Hong Kong, Macau, and mainland China as well as the Internet and the Coach catalog. This segment represented 89% of FY 2009 sales, with the North American stores accounting for 61%.

### In North America, COH had 330 full-price retail stores and 111 factory stores at the end of FY 2009. Coach Japan consisted of 155 stores and Coach China 28.

** The Indirect segment represented 16% of FY 2009 sales with COH products sold at more than 930 department stores (wholesale customers) in the US, in over 20 countries at some 160 department stores, and at 155 in Japan.

### U.S. indirect sales have been flat at around 10% for several years.

** The company has identified four key growth initiatives:

Increase market share re North American women’s accessories;
Grow North American retail stores, in both new and existing markets;
Expand market share in Japan by opening new locations; and
Raise brand awareness in China by opening new locations.

– Morningstar explained that COH fills a void between designer labels and moderate brands with its high-quality, smartly priced goods. “Accessible luxury” is how Coach describes its products.

** COH recently reduced its handbag prices from the $300-400 range to $200-300 and also launched its Poppy line which sells for an average handbag price of $260.

** In 2010, the company has plans to open 20 stores in North America, 10 in Japan, 15 in China and 30 wholesale stores in international markets.

– Value Line reported that COH’s stock price has risen 25% since its February report, mostly on the basis of its third quarter results with Sales up 12% and EPS up 28% (based on S&P data).

** The company has announced plans to open 14 stores in France over the next three years and, within the next year, new stores in the U.K., Ireland, Spain, and Portugal.

** These plans, together with COH’s doubling of its quarterly dividend, prompted VL to substantially raise its estimates in May for the next 3-5 years by 24% for EPS and its High Price estimate from $45-65 to $55-80.

SSG Discussion:

– Armin-1 used the same judgments and price as Ann except that I projected future growth from the end of the last quarter while she projected from the end of the last FY. I got a SSG Buy, but Ann did not.

– Armin-2 used a slightly lower EPS estimate (12.00% instead of 12.90%) and still got a SSG Buy.

Coach (COH)	AnnC	Armin -1	Armin-2	Take Stock
Date	7-9-10	Same	Same	7-14-10
Data	S&P	Same	Same	Hemscott-Morningstar
Price	$36.50	Same	Same	$37.16
52 week High & Low Price	$44.37 & $22.94	Same	Same	Not Used
Last Quarter of Reported Data	Q1 ending 3-31-10	Same	Same	Same
Software Used	Online SSG	TK 6	Same	TS Online

Project Growth From End of	*Last FY*	*Last Q*	Same	Last FY
Sales Growth	10.00%	Same	12.00%	1.5%
EPS Growth	12.90% (from PP)	Same	12.00%	*-10.8%*
High PE	21.0 (ave 2008-09)	Same	21.1	24.8
High EPS	$3.50	$3.87	$3.72	$1.08
High Price	$73.50	$81.30	$78.50	$26.70 (51% < VL)
*Value Line Estimated High Price = $55-80 as of 5-7-10*
Low PE	11.0 (ave 2007-09)	Same	10.7	10.2
Low EPS	$2.11 (ttm)	Same	Same	$1.76
Low Price	$23.21 (low PE x low EPS)	Same (Same)	$23.60 (Same)	$17.96 (Same)
Upside/Down	*2.71 (under 3.0 criteria)*	*3.4 (satisfies 3.0 criteria)*	3.0	Not Used and Impossible to Calculate
Estimated Payout Ratio	24.0%	Same	Same	Not Used
Total Return	16.17%	18.5%	17.7%	*– 6.2%*

SSG Buy Under	N/A	$37.73	$38.20	$13.47
RV/PRV (outliers eliminated)	N/A	108.8/96.4 (3 high PEs out & 2 low out)	111.5/98.7 (Same)	Not Used
RV/PRV (no outliers)	N/A	83.9/74.3	82.8/73.3	Not Used
Quality	N/A	S&P = B+	Same	*TS = 1.1 (fails)*

PTPM – 5 yr ave	36.74% trend N/A	Same trend down	Same Same	36.2% trend N/A
ROE – 5 yr ave End Yr Equity	38.02% trend N/A	Same trend down	Same Same	Not Used
ROE – 5 yr ave Begin Yr Equity	N/A	45.9% trend down	Same Same	46.5% trend N/A
Debt to Equity – 5 yr ave	N/A	0.5% trend up	Same Same	Not Used

Estimating Future Sales and EPS Growth:

Ann’s SSG:

– Ann estimated 10.00% future Sales growth for the next 5 years based on COH’s expansion into international markets, especially China, but mentioned nothing to support her 10.00% estimate.

** COH’s Sales Growth has been declining during our recession and was 20.6% for the last five years, 15.9% for the last three and 1.6% for the last two.

** Morningstar was estimating long-term Sales growth in the mid to high single digits while Zacks.com was forecasting 15.99% for the next five years.

– Ann used BI’s Preferred Procedure to estimate future EPS growth for the next 5 years.

** The PP involves 4 other estimates: Sales growth (Ann used her 10.00% estimate); Pre-Tax Profit Margin (33.00%, down from the 38.0% default which is the last 5 year average); Tax Rate (38.0% default); and Shares Outstanding (current shares default, 304.2M).

** Ann’s estimate of a 5% decline in Pre-Tax Profit Margin was a guess unsupported by any guidance. VL, for example, expects COH’s Net Profit Margin to decline slightly from 19.3% actual to 19.1% in the next 3-5 years.

** Moreover, VL was estimating 275.0M future Shares Outstanding and that one change would have substantially increased Ann’s PP from 12.90% to 16.80%.

** I no longer use the PP because it involves too many estimates and too much guesswork; see: Pondering The Preferred Procedure.

Armin’s SSG:

– When I did my SSG, the SEVEN analysts I always check were estimating long-term EPS at an average of 13.96% with Morningstar high at 16.00% and VL low at 10.00%.

** YahooFinance and Zacks.com were both at 14.00%, Reuters was 14.25%, S&P was 14.50%, and CNNMoney was 15.00%. Reuters 8 analysts ranged from a low of 12.00% to a high of 15.00%.

** Armin-1 used Ann’s estimate of 12.90% EPS growth while Armin-2 used 12.00%, the very lowest estimate by one of the Reuters analysts.

** To learn more about estimating EPS, see: Estimating EPS.

Final Results:

– Of the four studies, only Armin-1 and Armin-2 satisfied the SSG BUY criteria of a minimum 3.0 Upside/Downside Ratio and a 15.0% Total Return.

– The only difference between Ann’s SSG and Armin-1 is that I projected growth from the last quarter while Ann projected from the end of the last fiscal year. In all other respects, we used the identical judgments, data and price.

Ann got a 2.78 U/D and a 16.17% TR;
Armin-1 got a 3.4 U/D and a 18.5% TR;
Armin-2 got a 3.0 U/D and a 16.6% TR; and
Take Stock got a -6.2% TR and the U/D was impossible to calculate because its Forecast High Price for the next 5 years was lower than COH’s current price (a SSG NO-NO).

– Ann used the Online SSG at the Better Investing website which only projects future growth from the end of the last FY whereas I used SSG software which offers three options for projecting future growth (from the end of the last Q, last FY, or the end of the EPS trend line).

Pre-Tax Profit Margin (PTPM) and Return on Equity (ROE):

– Both PTPM and ROE are trending down which are often red-flag warning signs of deteriorating fundamentals.

** The SSG software I use provides an explicit indication of these trends, but Ann used the Online SSG which does not. Maybe that’s why she did not comment on them in her First Cut write-up.

– These downtrends don’t bother me because COH’s metrics remain outstanding:

** Morningstar-Hemscott data places COH in the Textile: Apparel, Footwear & Accessories Industry with 14 companies total:

COH’s PTPM is way, way better than its industry average (36.5% vs 13.0%) and ranks 2^ndout of 14; and
COH’s ROE is also way, way better than its industry average (38.6% ending/46.5% starting equity vs 15.2% industry) and also ranks 2^nd.

** S&P places COH in the Apparel, Accessories and Luxury Goods Industry. There’s no company-by company listing so no ranking is possible:

COH’s PTPM is again way, way better than its industry average (36.7% vs 10.4%); and
COH’s ROE is again way, way better than its industry average (38.0% ending/45.9% starting equity vs 18.1% industry).

– I conclude that COH’s PTPM and ROE are trending down because they are unsustainably high and do not represent a troubling decline.

– This is the third time I have reported on Coach and its PTPM and ROE have always been high. See:

** Checking Out Coach (COH), November 5, 2009;

** Coach (COH): Better Investing’s Growth Company for the Year 2007 , September 3, 2007.

Financial Condition:

– Value Line gives COH an “A” for Financial Strength with $907M in cash and $25M in debt as of 3-27-10.

– Morningstar concludes that COH is in excellent financial health with little debt and the ability to turn 20% of its sales into free cash flow.

– The super-duper one-click spreadsheet by Bob Adams gives COH’s latest Annual Report a 52 out of 100 with 11 Bullish results (good things) and 10 Bearish (not-so-goods):

** The Bullish, good stuff includes: ROE, free cash flow, and long term debt to equity all rate a green flag (tops), and sales are increasing while shares outstanding are decreasing;

** The Bearish, not-so-goods include: accounts receivable, inventories and long term debt are all increasing, and the cost of sales is increasing faster than sales.

Competitors:

– No competitors are named in COH’s latest 10K report and the company says that it “competes with European luxury brands as well as private label retailers, including some of Coach’s wholesale customers.” [page 9, PDF page 12]

– According to YahooFinance, COH’s direct competitors are Dooney & Burke, kate spade, and Michael Kors, all three of which are privately held.

– Dooney & Burke’s website shows handbags selling for $165 to $395, kate spade from $195 to $695, and Michael Kors from $148 to $2295. Cole Haan, still another private company, sells handbags for $129.95 to $498.

– On the other hand, Coach’s website shows handbags selling from $118 to $1200 with the Poppy line ranging from $118-$598.

– The unnamed European competitors referred to in Coach’s 10K are probably Louis Voitton (French and one division of LVMUY, handbags from $500 to $4260), Gucci (Italian, croodile handbag at $29,900, crocodile trim at $2450), and Prada (Italian, handbags from $410 to $3200).

** It may be wishful thinking by Coach to consider “European luxury brands” as competitors since their purses are way more expensive.

Armin

Posted by arminfields

Filed in COH, Estimating EPS, Preferred Procedure, PTPM, ROE ·Tags: COH, EPS, Estimating EPS, PTPM, ROE, SSG

3 Comments »

Auditing Abbott Labs (ABT)

June 25, 2010

Abbott Laboratories (ABT) is a large, global and uniquely diversified drug company that consists of four, main segments: Pharmaceutical Products, $16.5 billion in 2009 sales (54% of total); Nutritional Products, $5.3 billion (17%); Diagnostic Products, $3.6 billion (12%); and Vascular Products, $2.7 billion (9%).

Its strong and diverse product line-up led Morningstar to conclude that the company had a wide economic moat and, as a result, a competitive advantage.

ABT was the Stock To Study in the May/June 2010 issue of Better Investing magazine. The STS is expected to double in investment value (appreciation and dividends) within five years which is Better Investing’s goal.

I just compared CarolT’s SSG, 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 Carol did) while Armin-2 uses Morningstar-Hemscott data. Carol’s SSG and First Cut write-up were also reprinted in the May/June issue of BI.

Company Background:

– Acquisitions are a major driver of ABT’s growth. In recent years, the company has substantially invested in increasing its low-cost drugs and broadening its geographic presence, especially in underserved growth markets:

May 2010: announced that it would buy the Indian drug company Pirmal Healthcare for $3.7 Billion. Pirmal does contract manufacturing and research for other drug companies and also makes 350 generic drugs;
April 2010: bought Facet Biotech for $722 Million which had an experimental drug for multiple sclerosis and several treatments for cancer;
Feb 2010: bought Solvay Pharmaceuticals, a unit of the Belgian company Solvay, for $6.2 Billion which is expected to add nearly $3 Billion to ABT’s 2010 Sales, mostly outside the U.S.;
Nov 2009: acquired the remaining stake in Evalve, a leader in the non-surgical treatment of structural heart disease, for $320 Million;
Oct 2009: bought Visogen, a privately-held company specializing in intraocular lens technology for cataract patients, for $400 Million;
Feb 2009: acquired the remaining stake in Advanced Medical Optics, the leading seller of LASIK surgical devices, for $2.8 Billion;
Jan 2009: bought Ibis Biosciences, a maker of diagnostic products to detect infectious diseases, for $175Million.

– Humira, ABT’s best selling drug and a treatment for rheumatoid arthritis, generated $5.5 Billion in 2009 sales, up about 22% from 2008.

** Humira is approved for six uses and is a leading therapy for autoimmune diseases.

– Depakote, once one of Abbott’s blockbuster drugs, lost its patent protection in 2008 and accounted for only $331 Million in 2009 sales, down 74.5% from 2008;

– ABT’s nutritional products are leaders in the infant formula market (Similac and Isomil) as well as in the adult nutritional market (Ensure and Glucerma);

– ABT’s Xience line of drug-coated stents was approved for sale in July 2008 and its Model V reportedly became the top seller in the U.S in 2009;

** ABT acquired the vascular business and the Xience stent from Guidant Corp as part of its acquisition by BSX which, by agreement, also sells the Xience under the Promus name.

** ABT is developing a new type of stent made of an absorbable material rather than metal and could be three years ahead of its competitors.

– Much of the info in this Company Background section came from the STS article in Better Investing magazine supplemented by ABT’s latest Annual Report and Wikipedia.

– ABT’s direct competitors according to Yahoo Finance are Merck (MRK), Sanofi –Aventis (SNY), and Roche Holding (RHHBY) while Morningstar reports its close competitors as Pfizer (PFE), Baxter International (BAX) and Johnson & Johnson (JNJ).

Legal Problems:

– ABT’s 2009 Annual Report mentions numerous lawsuits, mostly in a vague and unsatisfying manner:

An (unspecified) number of patent infringement lawsuits are pending and ABT is also appealing a $1.67 Billion judgment against it in a federal jury trial regarding its Humira drug;
In May 2006, the U.S. Department of Justice intervened in a civil whistle-blower lawsuit claiming that ABT had wrongfully inflated prices for drugs paid by Medicare and Medicaid (potential liability unspecified);
Several civil actions by State Attorney Generals are pending seeking to recover damages on behalf of state Medicaid programs (number of lawsuits, issues and potential liability unspecified);
Several other civil actions are also pending that claim ABT and other drug makers reported false pricing info (number of lawsuits, issues and potential liability unspecified);
The company has identified its potential liability for environmental cleanup at not more than $3 Million per site and $15 Million total;

– ABT estimates its possible loss from these legal matters at around $170-310 Million, and has recorded $215 Million as a reserve. [2009 Annual Report, page 55]

** Apparantly, this reserve does not include anything for the $1.67 Billion judgment against the company and Abbott seems to be hiding much of the potential bad news.

SSG Discussion:

– After the comparison table that follows, I discuss several key SSG issues, ABT’s declining ROE, its high Debt, and overall Financial Condition.

Abbott Labs (ABT)	Carol	Armin-1	Armin-2	Take Stock
Date	5/3/10	5/4/10	Same	Same
Data	S&P	Same	MStar-Hemscott	Same
Price	$50.87	$50.79	Same	$50.19
52 week High & Low Price	$66.79 & $42.10	Same & $42.00	Same & Same	Not Used
Last Quarter of Reported Data	Q1 ending 3/31/10	Same	*Q4 ending 12/31/09*	*Same*
Software Used	TK6	Same	Same	TS Online

Project Growth From End of	Last Quarter	Same	Last Quarter	*Last FY*
Sales Growth	6.00%	10.00%	Same	4.00%
EPS Growth	4.80% (from PP)	10.00%	Same	4.00% initial 1.09% final
High PE	18.4	15.3 (from 2009)	15.0 (Same)	19.9
High EPS	$4.81	$6.14	$6.16	$4.04
High Price	$88.50 (7% < VL)	$93.90 (1% < VL)	$92.40	*$80.17 (16% < VL)*
*Value Line Estimated High Price =$95-115 as of 4/16/10*
Low PE	11.0 (from 2009)	Same	10.9	15.4
Low EPS	$3.81 (TTM)	Same	Same	Same
Low Price	$41.90 (Low PE x Low EPS)	Same	$41.50 (Same)	*$58.67 (exceeds curr price)*
Upside/Down	4.2	4.8	4.9	*Impossible to Calculate*
Total Return	14.0%	16.2%	Same	12.9%

SSG Buy Under	N/A	$52.95	$51.93	$45.96
RV/PRV (outliers removed)	83.2/79.2 (2007 out)	(no outliers)	Same	Not Used
RV/PRV (no outliers)	N/A	79.0/71.7	Same	Not Used
Quality	A (2^nd highest)	Same	Same	2.6 (fails)

PTPM – 5 yr ave	22.00% Trend even	Same Same	20.90% Trend up	Same Trend N/A
ROE – 5 yr ave Ending Year Equity	26.70% Trend down	Same Same	24.60% Trend up	27.1% Trend N/A
ROE – 5 yr ave Beginning Yr Equity	N/A	29.40% Trend up	29.10% Trend up	Not Used
Debt to Equity – 5 yr ave	46.80% Trend up	Same Same	46.60% Trend up	Not Used

Carol’s SSG:

Estimating Future Sales and EPS Growth:

– Carol checked three estimates of future Sales growth (from Morningstar, Value Line, Manifest Investing) and used the lowest of the three (6.00%) from Morningstar.

** Value Line’s 7.50% was for Sales per Share (not Sales) and VL makes no estimate of future Sales growth.

** Overlooked was Zacks.com which estimated 9.59% Sales growth for the next 5 years.

– Carol then used the Preferred Procedure to estimate future EPS growth which involves four estimates for the next 5 years: Sales growth, Pre-Tax Profit Margin, Taxes, and Shares Outstanding.

** Carol relied on her 7.50% Sales estimate and made no changes in the PP’s defaults which resulted in 4.80% EPS estimate.

** Had she checked some analysts, Carol might have seen that her 4.80% EPS estimate seems unduly low.

Armin’s SSGs:

Estimating Future Sales and EPS Growth:

– When I did my SSG, the seven analysts I ALWAYS check were estimating long-term EPS at an average of 11.06% with the high at 12.00% (S&P and CNNMoney via FactSet CallStreet) and the low at 9.90% (YahooFinance via Thomson First Call).

** Value Line was 10.00%, Reuters.com was 10.34%, and Morningstar and Zacks.com were 11.60%. The seven analysts at Reuters ranged from 13.00% high to 4.20% low.

** I decided to estimate future EPS growth at 10.00% based on the estimate from Zacks (rounded), the lowest of the seven.

### To learn more about Estimating EPS, click here

Final Results:

– Only Armin-1 and Armin-2 satisfied the SSG Buy Criteria of a minimum 3.0 Upside/Downside and a 15% Total Return. Moreover, I add another requirement: not to substantially exceed or fall below Value Line’s High Price estimate:

Carol (with S&P data) got a 14.00% TR and a 4.2 U/D with a Forecast High Price that was 7% below the low end of VL’s $95-115 High Price estimate;
Armin-1 (with S&P data) got a 16.2% TR and a 4.8% U/D with a Forecast High Price that was 1% below VL;
Armin-2 (Hemscott-Morningstar data, but with the same judgments as Armin-1) got a 16.2% TR and a 4.9 U/D with a Forecast High Price that was 1% below VL; and
Take Stock (Hemscott-Morningstar data) got a 12.9% TR, doesn’t use the U/D concept, and a Forecast High Price that was 16% below VL.

– Carol considered ABT a Buy even though her SSG got a 14.00% TR:

** BI’s Stock Selection Handbook says that 15.00% is only a goal for our entire portfolio and not something that every stock must achieve. [Handbook, pages 65-66, 2003 edition].

** I disagree and seek a 15% TR for every SSG Buy: that way, my criteria are clear and unambiguous, and don’t depend on the vagaries of my (unspecified) portfolio.

Return on Equity (ROE):

– ROE with Ending Equity (26.70%) is trending down with S&P data and any downtrend is often a red-flag warning sign of deteriorating fundamentals.

** However, this downtrend does not trouble me for several reasons:

ROE with Starting Equity (27.10%) is trending up;
The difference between the two ROEs is insignificant;
ROE with Ending Equity is better than its S&P Industry Average (26.70% vs 19.80%, Pharmaceutical Industry); and
Both ROEs with Morningstar-Hemscott data are trending up.

DEBT:

– ABT had $16.5 Billion in total debt as of 12/31/2009, according to the company’s latest Annual Report, largely incurred to finance recent acquisitions. [2010 A. R., PDF page 63]

– Carol was not concerned with ABT’s Debt and her First Cut write-up mentioned: “Debt and Return on Equity may be a cause of concern for some. Interest coverage of about 15; they have managed well over 10 years with this higher level of debt.”

– However, ABT’s Debt to Capital Ratio (40.49% with S&P data) is much higher than five of its direct or close competitors: MRK @ 28.22% and SNY @ 14.32% identified by YahooFinance and PFE @ 21.30%, JNJ @16.63% and BAX @ 35.93%) identified by Morningstar.

** Moreover, ABT’s 40.49% Debt to Capital Ratio is also higher than its 38.70% S&P Industry Average (Pharmaceuticals).

– The one-click Annual Report spreadsheet by Bob Adams found that ABT’s Debt was a concern, but not it’s Interest Coverage:

** The 49% Long-Term Debt to Equity Ratio got a red-flag warning and may be excessive since normal is less than 25%;

** The Interest coverage at 14.8x (Pre-Tax Profit exceeds interest paid on LT Debt) got a green flag or very good.

Financial Condition:

– VL rated ABT an A++ for Financial Strength, its highest grade, with $16.5 Billion in Debt ($11.3 Billion Long-Term) and $8.8 Billion in Cash as of 12/31/09.

– Morningstar observed that ABT held less cash than its peers because of acquisitions, but that its cash flow was more than adequate to meet interest expenses.

– The Bob Adams’ one-click spreadsheet gave ABT’s 2009 A.R. a 41 out of 100 with 9 Bullish and 8 Bearish results:

** The Bullish-good things included: Sales are increasing and increasing faster than Cash Flow; ROE and Free Cash Flow/Sales are very good.

** The Bearish not-so-goods included: Accounts Receivable and Inventories are increasing and the Cost of Sales is increasing faster than Sales.

### You can get this super-duper, free and easy-to-use spreadsheet, and a summary of its many features, by going to my Favorite Links page: click here

Armin

Posted by arminfields

Filed in ABT, EPS, Estimating EPS, PTPM, ROE, SSG ·Tags: ABT, EPS, Estimating EPS, PTPM, ROE, SSG

6 Comments »

Admiring Apple (AAPL)

June 5, 2010

– Apple Inc (AAPL) makes the Macintosh personal computer, iPod music player, iPhone smart cell phone and, two months ago, began selling its iPad device (a book reader/web surfing tablet).

– These products are all elegantly designed, sold in Apple retail stores that are fun to shop in and buzz with excitement, and the company has the CEO of the Decade, according to Fortune magazine, Steve Jobs.

– AAPL was the Online Stock Study in May at the Better Investing website that was led by Mike Torbenson, education director at the BI Puget Sound chapter.

** Mike’s presentation slides, the recorded webinar (78 mins), the latest 10K and 10Q reports, and the Value Line report are all available to BI members.

Company Background:

S&P Stock Report:

– S&P reported AAPL’s CY 2009 sales as: 35% Macintosh computers (11 Million units shipped), 26% iPhones, 20% iPods (over 25 Million sold), and 10% music related.

Mike’s Presentation:

– In the last 15 months (1/09 to 3/10), AAPL’s price rose 350%, from $78 per share to $272.

– In 2009, revenue by product grew (or declined) as follows: iPod down (-2.5%), Mac up 7%, and iPhone up a whopping 93%.

** AAPL has 11% of the smart-phone market with NOK at 41% and RIM at 20% which Mike thought left lots of room for growth.

– The iPad was introduced in April 2010 and sold 1 million units faster than the iPhone. The iPad is now in the “early adopters” phase of growth with lots more room to grow.

Fortune magazine’s CEO of the Decade:

– In the past 10 years, Fortune wrote, Steve Jobs “has radically and lucratively reordered three markets — music, movies, and mobile telephones — and his impact on his original industry, computing, has only grown.”

– In addition, he has “creat[ed] more than $150 billion in shareholder wealth….and profoundly influenc[ed] the worlds of retail and design.”

– AAPL was worth about $5 billion in 2000, according to Fortune, just before Jobs implemented its “digital lifestyle” strategy, and today, at about $170 billion, it is slightly more valuable than GOOG.

The New York Times:

– On May 26, the Times reported that AAPL had passed MSFT to become the world’s most valuable technology company.

– Calling it the end of one era and the beginning of the next, the Times profoundly realized that the “most important technology product no longer sits on your desk but rather fits in your hand.”

– On May 30, the Times reported that the iPad had sold 2 million devices in less than two months, an average of 35,000 per day since its April debut.

Value Line:

– VL was so impressed with AAPL’s growth prospects that it raised its EPS estimate by 40.00% for this year (FY 2010).

– VL also thought that Apple’s long-term prospects looked “exceptionally bright.”

Morningstar:

– In April, Mstar raised its fair value estimate from $202 to $238 (with AAPL selling at $263.95) to reflect the iPad’s initial success.

– Still, the star of Apple’s show, according to Morningstar, remains the iPhone given its large global market and infrastructure (175,000 apps and growing).

SSG Discussion:

– The following table compares SSGs by Mike (found only in the webinar recording) with mine, the Investment Advisory Service, and with Take Stock.

** After the table, I discuss AAPL’s quality and several key SSG judgments as well as its financial condition.

Apple Inc (AAPL)	MikeT	ArminF	Take Stock	Investment Advisory Service (IAS)
Date	4-20-10	5-11-10	Same	3-10-10
Data	S&P	Same	Morningstar-Hemscott	S&P
Price	$270.83	$258.08	Same	$224.84
52 week High & Low Price	$272.18 & $119.38	$272.46 & $119.38	Not Used	$224.48 & $89.58
Last Quarter of Reported Data	Q2 ending 3-31-10	Same	Same	Q1 ending 12-31-09
Software Used	TK 6	Same	TS Online	TK6

Project Growth From End of	Last Quarter	Same	Last FY	Last Quarter
Sales Growth	15.00%	17.00%	12.20%	17.00%
EPS Growth	15.00% (PP)	17.00%	12.20% initial 08.23% final	17.00%
High PE	25.0	20.8 (from 2009)	30.0	25.0
High EPS	$23.69	$25.83	$9.34	$19.91
High Price	$592.30 (20% > VL on 4-9-10)	$537.30 (8.5% > VL on 4-9-10)	*$280.24 (23% < VL on 4-9-10)*	$497.70 (8.2% > VL on 1-8-10)
*Value Line Estimated High Price =* *$365-495 on 4-9-10 and* *$305-460 on 1-8-10*
Low PE	16.0	9.5	13.1	15.0
Low EPS	$11.78	Same	$6.66	$9.08
Low Price	$125.90 (PVQ option)	$111.90 (Low PE x Low EPS)	$87.25 (Same)	$136.20
Upside/Down	2.2	1.9	*0.13 (imputed)*	3.1
Total Return	16.9%	15.8%	2.0%	17.1%

SSG Buy Under	N/A	$218.25	$135.50	N/A
RV/PRV (no outliers)	90.6/78.7	86.2/73.7	Not Used	96.6/73.9
Quality	N/A	S&P = B	TS = 6.3	IAS = 1.0

PTPM – 5 yr ave	19.6% Trend up	19.6% Same	18.3% Trend N/A	19/6% Trend up
ROE – 5 yr ave Ending Year Equity	N/A	21.5% Trend up	Not Used	N/A
ROE – 5 yr ave Begin Year Equity	30.4% Trend up	Same Same	28.4% Trend N/A	30.4% Trend up
Debt to Equity – 5 yr ave	-0- Trend even	Same Same	Same Same	Same Same

Quality:

– Before beginning his SSG, Mike evaluated whether AAPL was a quality company by looking at its past performance in SSG Sections #1 and #2.

** For historical Sales and EPS, he found that the last 5 years looked very good and the results from the most recent quarter (Sales up 49%, EPS up 86%) were excellent.

** For historical Pre-Tax Profit Margin (PTPM) and Return on Equity (ROE), he saw that the last 5 years were trending up and looked good while AAPL’s zero debt looked very good.

** Mike also compared APPL to other technology companies and to its Value Line industry (Computer and Peripherals), and concluded that Apple was a quality growth company.

– A typical BI/NAIC approach to quality is to assess whether the graph lines in Section #1 are up (growth), straight and parallel (consistency) and also whether the trends in Sections #2A and #2B are up or even.

– And, S&P rates AAPL a B for Quality, 5^th out of eight grades, while IAS rates its Quality a 1 out of 5, most favorable.

Mike’s SSG:

Estimating Future Sales and EPS Growth:

– Mike looked at several indicators to estimate Apple’s future Sales growth: its last 5 years growth (31.9%); VL’s 3-5 year estimate (15.5%); its last quarter’s growth (48.6%); and TTM Sales growth (40.7%).

** Mike thought 15-20% seemed justified, so he chose 15.00% (presentation slides, PDF pages 24 & 25).

** Value Line’s 15.5% estimate was actually for Sales per Share and VL does not make a Sales growth estimate.

** 12.00% was Morningstar’s long-term Sales growth estimate and 28.17% was Zacks.com’s.

– To estimate future EPS growth, Mike used the Preferred Procedure (PP) which involves making four other estimates for the next 5 years: Sales Growth, Pre-Tax Profit Margin, Taxes, and Shares Outstanding.

** Relying on his 15.00% Sales growth estimate, he changed only one of the defaults: PTPM from its five-year average of 19.6% to last year’s 28.0%, a huge increase of nearly 8.5%.

** His PP came to 15.40% EPS which he rounded to 15.00% to match his Sales estimate.

** Instead of estimating 28.0% for the next 5 years, his PP would have been considerably different had Mike used 21.0% PTPM (last 2-year average), or 23.4% (last 3-year average).

** Moreover, Mike could have also used VL’s estimated Taxes of 30.0% (instead of the default 31.7%), or VL’s estimated Shares Outstanding of 975.0M (instead of the default 969.6M).

### I no longer use the PP because it involves too many estimates and too much guesswork for me: see Pondering The Preferred Procedure

Armin’s SSG:

Estimating Future EPS Growth:

– When I did my SSG, the SEVEN analysts I ALWAYS check were estimating long-term EPS at an average of 18.85% with Value Line high at 23.00% and Yahoo Finance via Thomson Financial low at 17.10%.

– Reuters.com was 17.69%, Zacks.com and CNNMoney via FactSet CallStreet were both 18.00%, Morningstar.com was 18.20%, and S&P via BI was 20.00%. Reuters 11 analysts ranged from a high of 30.0% to a low of 5.00%.

– I decided to use 17.00%, the lowest estimate (rounded) of the seven.

### To learn more about Estimating EPS, click here.

Forecasting the High and Low PEs:

– Even though 2009 was unusually low (and well below the five-year average of 34.8), I chose to use its 20.8 as my Forecast High PE.

– I thought 2009’s Low PE of 8.6 was too low to use for the next 5 years, so I used 9.5 for my Forecast Low PE which was proportional to my Forecast High PE (5 year average High PE / 5 year average Low PE = Forecast High PE / Forecast Low PE or “X”).

Take Stock:

– TS initially estimated 12.2% based on AAPL’s historic growth, but reduced that to 8.23% EPS by mechanically applying its version of the Preferred Procedure.

– TS also used 30.0 as its Forecast High PE, the maximum it is designed to permit.

Investment Advisory Service:

– IAS is a pay service from IClubCentral which delivers three SSGs each month that satisfy the BUY criteria along with an explanatory narrative. Its AAPL SSG was made available for free (but without the narrative explanation) at the StockCentral website.

– IAS used 17.00% estimated EPS (which seems reasonable to me since I used the same value <grin>) and 25.0 & 15.0 Forecast High & Low PEs) which seem moderately conservative since 30.0 & 20.0 are often used as maximum limits.

Final Results:

– Of the four studies, only IAS satisfied the SSG Buy Criteria in March, but today, or even 3-4 weeks ago, its SSG would not:

Mike got a 2.2 U/D (min 3.0 required) and a 16.9% TR with a Forecast High Price that was 20% greater than VL’s estimate;
I got a 1.8% U/D and a 15.8% TR with a Forecast High Price that was 8.5% greater than VL’s estimate;
Take Stock got a .13 imputed U/D and a 2.0% TR with a Forecast High Price that was 23% less than VL’s estimate; and
IAS got a 3.1 U/D and a 17.1% TR (last March when AAPL was selling for $224.84) with a Forecast High Price that was 8.2% greater than VL’s January estimate.
However, IAS’s SSG would not satisfy the Buy criteria at the price I used ($258.08) or at AAPL’s current price ($263.95 on 6/3).

– I analyzed Apple some 30 months ago (on 1/18/08) when it was selling for $171.25 per share and, unlike now, it was then not close to a SSG Buy; if you’re interested, click here.

Financial Condition:

– Value Line gave Apple an A++ for Financial Strength, its highest grade. The company had no debt and $2.5 billion of cash assets as of 12-26-09.

– Morningstar found that Apple had a cash “hoard” of $34 Billion and an annual cash flow of almost $10 Billion which means, Mstar believed, almost unlimited financial flexibility.

– The Bob Adams one-click Annual Report spreadsheet gave Apple a 60 out of 100 with 11 Bullish and 7 Bearish results:

** The Bullish-good things include: no debt; sales are increasing and increasing faster than related costs; ROE gets a green flag (excellent); and free cash flow margin is also excellent.

** The Bearish-not-so-goods include: accounts receivable are increasing; cash flow growth is not increasing as fast as sales growth; and the price to sales ratio gets the only red flag (danger).

### Bob just updated his spreadsheet and the latest version is No. 4.14, dated 5-22-10.

### You can get this super-duper, easy to use spreadsheet for free, along with an explanation of its many features, by going to my Favorite Links page: click here.

Armin

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Posted by arminfields

Filed in AAPL, EPS, Estimating EPS, Preferred Procedure ·Tags: AAPL, EPS, Estimating EPS, IAS, Preferred Procedure, SSG

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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 1^st 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 4^th
Debt to Equity, 2009 average: RIMM is much, much better than its industry average (-0- vs 134.2%) and is tied for 1^st
Pre-Tax Profit Margin, 5 year average: RIMM is much better than its industry average (27.8% vs 12.7%) and ranks 2^nd, 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 3^rd

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 2^ndand. 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]

Posted by arminfields

Filed in Estimating EPS, PTPM, ROE ·Tags: EPS, Estimating EPS, PTPM, RIMM, ROE, SSG

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.

– SYY recently paid $218M cash for three broadline foodservice operations (in Ireland, Los Angeles, Boston) and a produce distributor in Toronto [2009 10K, page 58, PDF page 78].

SSG Discussion

– The following table compares Shanna’s SSG with two of mine and with Take Stock. Both of my SSGs use the same judgments, but Armin-1 uses Morningstar-Hemscott data (as Shanna did) while Armin-2 uses S&P data.

– After the table, I briefly discuss two SSG issues and then focus on Sysco’s Pre-Tax Profit Margin and Return on Equity. I end with my assessment of whether SYY has too much debt.

Sysco Corp (SYY)	SSG by ShannaR	Armin-1	Armin-2	Take Stock
Date	3-5-10 data 3-12-10 price	4-1-10 data 4-7-10 price	Same Same	Same
Data	Hemscott-Morningstar	Same	S&P	Hemscott-Morningstar
Price	$28.64	$29.81	Same	Same
52 week High & Low Price	$29.58 & $20.63	$30.00 & $21.26	Same	Not Used
Last Quarter of Reported Data	Q2 ending 12-31-09	Same	Same	Same
Software Used	TK 6	Same	Same	TS Online

Project Growth From End of	Last Q	Same	Same	Last FY
Sales Growth	5.00%	6.50%	Same	*– 1.70%*
EPS Growth	5.00%	6.50%	Same	– *2.14%*
High PE	20.0	19.6 (from 2009)	19.8 (from 2009)	23.2
High EPS	$2.44	$2.62	$2.55	$1.59
High Price	$48.80 (8% > VL)	$51.40 (14% > VL)	$50.50 (12% > VL)	$36.90 (8% < VL)
Value Line Estimated High Price = $40-45 as of 1-29-10
Low PE	14.0	15.2 (from 2008)	14.7 (from 2008)	16.3
Low EPS	$1.77	$1.92 (ttm)	$1.86 (ttm)	$1.76
Low Price	$19.50 (recent severe low price)	$23.80 (80% of current price)	Same (Same)	*$29.81 (same as current price)*
Upside/Down	2.2	3.6	3.5	*Impossible to Calculate*
Total Return	13.7%	14.0%	13.50%	8.3%

SSG Buy Under	$26.79	$28.48	$27.83	$21.93
RV/PRV (outliers)	66.4/62.8 (no outs)	95.1/88.9 (05-07 out)	98.2/92.3 (Same)	Not Used
RV/PRV (no outiers)	66.4/62.8	77.2/72.3	79.6/74.9	Not Used
Quality	Mstar = 4 of 5 stars	TS = 1.60 unacceptable	S&P = A+	*TS = 1.60 unacceptable*

PTPM – 5 yr ave	4.70% Trend even	Same Same	Same Same	Same Trend N/A
ROE – 5 yr ave Ending Yr Equity	Not Used	30.6% Trend even	Same Same	Same Trend N/A
ROE – 5 yr ave Begin Yr Equity	32.9% Trend down	Same Same	30.5% Trend even	Not Used
Debt to Equity – 5 yr ave	53.2% Trend up	Same Same	64.7% Trend up	Not Used

Estimating Future Sales and EPS Growth for the Next 5 Years:

Shanna’s SSG:

– Presentation slide #42 shows that Shanna considered SYY’s historic growth for the last 10 years of 7.8% Sales and 10.4% EPS. She also found four long-term growth estimates: from Zacks, Sales at 4.85% and EPS at 15.0%; from S&P, EPS at 15%; from Morningstar, EPS at 10.5%; and from VL, Sales at 3.5% and EPS at 6.5%.

** VL’s 3.5% estimate was actually for sales per share, not sales.

– Shanna decided to estimate 5.0% Sales and 5.0% EPS growth primarily to be conservative.

Armin-1 and Armin-2:

– I always check seven different analyst estimates (not just seven websites) which were averaging 11.86% long-term EPS when I did my SSG. Three (S&P, Yahoo Finance & Zacks) were high at 15.00% while VL was low at 6.50%. The remaining three (Reuters.com, Morningstar, & CNNMoney) were each estimating 10.50%.

** Reuters 2 analysts estimated 15.00% high and 6.00% low. Reuters is now the only one of the seven that provides this extra detail as CNNMoney, which used to, has redesigned its website.

– I decided to use 6.50%, VL’s estimate and the lowest of the seven analysts.

– For how I estimate EPS for all my SSGs, see Estimating EPS: click here.

Take Stock:

– Take Stock estimated growth for the next 5 years at –1.70% Sales and -2.14% EPS (both are negative projections). To put these numbers in perspective, the very lowest estimate by any analyst was 6.00% EPS by one forecaster at Reuters.

Final SSG Results

– None of the four studies resulted in a SSG Buy which requires a minimum 3.0 Upside/Downside Ratio AND a 15.0% Total Return:

Shanna’s SSG got a 2.2 U/D and a 13.7% TR;
Armin-1 came closest with a 3.6 U/D and a 14.0% TR;
Armin-2 got a 3.5 U/D and a 13.5% TR; and
Take Stock doesn’t use any U/D and got only a 8.3% TR

Pre-Tax Profit Margin (PTPM) and Return on Equity (ROE)

– Sysco’s 5 year averages are a mixed bag: PTPM is trending even, ROE with ending year Equity is trending even while ROE with starting year Equity is trending down, both with S&P as well as Morningstar-Hemscott data.

– The industry data I use for comparisons only includes ROE with ending year equity.

Industry Comparisons using Morningstar-Hemscott Data:

– Sysco’s 5-year average PTPM is better than its industry average (4.7% vs 3.2%, Food Distribution Industry) and SYY ranks #3 out of 13 companies.

– Sysco’s 5-year average ROE with ending equity is much better than its industry average (30.6% vs 17.1%) and ranks #2. There is no industry data for ROE with starting equity.

– However, the ROE of two companies (DIT #1 at 35.7% and SYY #2 at 30.6%) seem like atypical outliers, especially when compared to the average of the five other companies with a positive ROE (10.76%).

Industry Comparisons using S&P Data:

– SYY’s PTPM is much better than its industry average (4.7% vs 2.7%, Food Distribution Industry). There is no company-by-company breakdown if the S&P industry data.

– SYY’s ROE with ending equity is also much better than its industry average (30.5% vs 16.7%). There is no industry data for ROE with starting equity.

Quality

– S&P gave Sysco an A+, its highest of 8 quality rankings. In contrast, Take Stock gave SYY a failing grade of 1.6 with a minimum 3.4 required to pass, 6.7 desired, and 10.0 the max.

– Morningstar makes no quality assessment and Shanna added its star rating to her SSG. The 4 out of 5 stars meant that SYY was a good buy, that it was then selling at a large discount to Mstar’s fair value estimate.

Does SYY Have Too Much Debt?

– As of 4-1-10, my SSG data from Hemscott-Morningstar (which Shanna used) shows that Sysco had $2.468 Billion in Long-Term Debt, a Debt to Equity Ratio of 70.9% in 2009, and a five-year average Debt to Equity Ratio of 53.2%. The company also had a Debt to Total Capital Ratio of 41.7%

** Moreover, SYY’s L-T Debt increased 25% last year, from $1.975 Billion in FY 2008 to $2.478 Billion in FY 2009.

– Does SYY have too much debt which is a more difficult question to answer than whether the company can safely manage its debt??

– Sysco’s 2009 10K Report to the SEC:

– Total Debt was $2.477B as of 6-27-09 and Sysco’s L-T Debt to Total Capital Ratio was 41.8% in 2009, up from 36.8% in 2008 [page 13, PDF page 19). SYY reported that it is required to maintain a L-T Debt to Total Capital Ratio below a specified level and states that it is “in compliance” with all such requirements [page 25, PDF page 31].

– No details were provided (unlike CHD which set forth its two required ratios and its compliance; click here). The 25% new debt was not explained nor was there any discussion, other than a simple list, that principal repayments on SYY’s debt would balloon from $9.16 M in 2010 to $204.390 M in 2012, $251.314 M in 2013, and $206.89M in 2014 [page 46, PDF page 66].

– I wrote Investor Relations which replied that SYY was required to have a L-T Debt to Total Capital Ratio below 70%; that last year’s 25% increase in debt was for unspecified, general corporate purposes; and that it could not discuss how Sysco planned to meet its 2012-2014 balloon payments, but believed the company had sufficient resources to repay those debts.

– Note the significant difference between SYY’s L-T Debt to Equity Ratio and its L-T Debt to Total Capitalization Ratio. The formula for the former is ($2.477B Debt / $3.450B Equity = 71.8%) while the latter is ($2.477B Debt / $3.450B Equity + $2.477B Debt = 41.8%). Sysco’s 70% limit pertains to its 41.8% L-T Debt to Total Cap Ratio, not to its 71.8% L-T Debt to Equity Ratio.

– Industry Averages:

** With Hemscott-Morningstar data, SYY’s 71.2% Debt to Equity Ratio for 2009 was way, way above its adjusted Industry Average (Food Wholesale, 13 companies) of 49.8% when one atypical company is removed (VPS @ 169.5%). Moreover, SYY was even well above its unadjusted Industry Average of 64.8%.

** With S&P data, SYY’s Debt to Capital Ratio was 41.8% for 2009 and averaged 36.9% for the last 5 years, both of which were above its Industry Average (Food Distribution, 16 companies) of 34.9%.

– The one-click Annual Report spreadsheet by Bob Adams:

** The Long Term Debt to Equity Ratio from the latest A.R. was 72% 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%;

** LT Debt increased by 25% in 2008 which gets a caution flag as Debt/Equity is already high;

** Total Interest Coverage [Pretax Profit + Total Interest Paid/Total Interest Paid] is 16.2% and is very good.

– Value Line:

** VL gave Sysco an A++, its highest grade, for Financial Strength;

** Total Debt was 42% of Capital and Total Interest Coverage was 17.5x as of 9-26-09;

** VL estimates that LT Debt will decrease from $2120.5M in 2009 to $1500M in the next 3-5 years, a 29% decline.

– Morningstar:

** The Morningstar narrative report said it was not concerned with the amount of SYY’s debt which, at the end of FY 2009, was 42% of Capital. Earnings Before Interest and Taxes covered interest expense 16.1 times which was also emphasized in the webinar.

– Conclusion:

** I learned that Sysco’s Interest Coverage is good, but that the amount of its L-T Debt and its L-T Debt/Equity Ratio are not considered good.

** I also learned, by writing Investor Relations, that SYY is required to maintain a L-T Debt to Total Capital Ratio under 70%, which doesn’t seem demanding to me since SYY’s LT-Debt to Equity Ratio is very high.

** I was dissatisfied with SYY’s 10K Report which was unnecessarily vague about its debt requirements, why it increased its already high debt by 25% in 2009, and that it offered no discussion whatsoever about its very large balloon principal repayments in 2012-2014.

– The answer to whether Sysco has too much debt is, I think, a personal one: after assessing all the pros and cons, would you recommend against buying SYY stock because of its debt? I know my answer, what’s yours??

Armin

please rate this post on the “mouse-over” star system below and/or leave a comment as your feedback is important to me. I’m especially interested in what you think about Sysco’s debt (and my discussion of it).

Posted by arminfields

Filed in Debt, EPS, Estimating EPS, PTPM, ROE ·Tags: Debt, EPS, Estimating EPS, PTPM, ROE, SSG, SYY

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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

Posted by arminfields

Filed in ARO, EPS, Estimating EPS, PTPM, ROE ·Tags: ARO, EPS, Estimating EPS, PTPM, ROE, SSG

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.

– The downtrends could be a worrisome sign of declining fundamentals or a signal that CSCO has unsustainably high fundamentals. Here’s what I found:

Industry Comparisons with Morningstar-Hemscott data:

– CSCO’s 5 year average PTPM is way better than its industry average (26.9% vs 12.1% Networking & Communication Device Industry). Moreover, Cisco ranks first out of 21 companies.

– CSCO’s 5 year average ROE is also way better than its industry average (21.6% vs 12.5% Industry) and ranks second. Moreover, after I remove Superclik (SPCK) as an outlier, the adjusted industry average drops to 8.3% and Cisco is way, way better.

Industry Comparisons with S&P data:

– CSCO’s 5 year average PTPM is better than its industry average (26.9% vs 20.5% Communication Equipment Industry).

– CSCO’s 5 year average ROE is also better than its industry average (24.0/21.4% vs 20.5% Industry). Although SPCK is not an outlier with S&P data, there is no company-by-company listing, a serious omission in my judgment, and I therefore cannot identify other possible outliers.

### To learn more about the investigating Industry Info, see: Investigating Industry Info; click here

Financial Condition

– Value Line gives CSCO an A++, its highest grade for Financial Strength, and reports $35.4 B in cash assets, $10.3 B in debt (all long term), and $350 M annual interest as of 10/24/09.

** VL also reported that CSCO is spending 12.9% of its sales on Research & Development which I see as an excellent investment in its continued financial strength.

– Morningstar says that CSCO’s balance sheet is “rock-solid” with much more cash than debt and with free cash flows that have averaged more than 20% of sales over the past several years.

** Cisco also covers its interest payments more than 20 times over with EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization).

– S&P’s Stock Report says that CSCO’s financial profile is one of the best in its industry (Communications Equipment), with $40 B in cash and investments as of January 23, 2010. Long-term debt stands at $15 B with total debt to capital at 46%.

** Cash flow from operations totaled approximately $10 B during FY 2009, close to a whopping $1 B per month. And, CSCO’s ROE is attractive, according to S&P standards, at close to 25% in FY 09 and above the industry average.

– The Bob Adams one-click Annual Report spreadsheet gave CSCO 57 out of 100 with 10 bullish results (good things) and 9 bearish (not-so-goods):

** The good things include: ROE (debt not included) is very good; Interest Coverage is very good and Pre-Tax Profit exceeds interest by 23.2x; the Quick Ratio and Current Ratio are both 3.2 and are very good; Accounts Receivable, Inventories, and Shares Outstanding are all decreasing.

** The not-so-goods include: Sales are decreasing while related costs are increasing; Long Term Debt is increasing; and Debt to Equity is high (27%, a caution flag).

Quality

– S&P gave CSCO a B+ for quality, fourth out of its eight grades. Take Stock, on the other hand, rates CSCO as almost totally unacceptable, a .50 out of 10, with a minimum of 3.4 required to pass muster and 6.7 desired.

– Other measures of CSCO’s quality:

#16 out of 100 on Fortune Magazine’s 2010 list of the Best Companies to Work For;
#20 out of 50 on Fortune’s 2010 list of the World’s Most Admired Companies (and #1 in the Networking and Other Communications Equipment segment);
#32 out of 50 on Business Week’s 2009 top 50 Most Innovative Companies.

Armin

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Posted by arminfields

Filed in CSCO, EPS, Estimating EPS, PTPM, ROE ·Tags: CSCO, EPS, Estimating EPS, PTPM, ROE, SSG

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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

Posted by arminfields

Filed in CHD, Debt, EPS, Estimating EPS, PTPM, ROE ·Tags: CHD, Debt, EPS, Estimating EPS, ROE, SSG

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Probing Paychex (PAYX): A Follow-Up

February 14, 2010

– Paychex (PAYX) provides comprehensive payroll, human resource and benefit outsourcing to small and medium-sized companies with 10 to 200 employees. It served about 554,000 clients as of May 31, 2009 (down 3% from 2008) according to its latest annual report.

– PAYX was the Online Stock Study for November 2009 at the Better Investing website that was led by Ron Bruyn, a Director of the BI Orange County (CA) Chapter. Study materials available for downloading include Ron’s SSG, the Presentation Slides, Value Line, and other handout material.

– After a three month delay, the recorded session is finally available at the BI website. A Consensus SSG was nearly, but not totally, completed and I waited for the recording in the hopes that it would explain why (it didn’t).

Company Background

– Morningstar considers that PAYX has a “wide economic moat” which constitutes a completive advantage. Switching to another company is costly, PAYX has a respected brand name, and clients are reluctant to entrust their payroll cash and other HR functions to an unknown or unproven competitor.

– In FY 2009, PAYX earned about 4% of its revenues by essentially doing nothing due to the “float”, cash that results from the lag between when PAYX receives and then pays payrolls. During the lag, Paycheck invests and earns interest on these funds.

** Interest from the float was way down last year, some 43%, from $131.8M in 2008 to $75.5M to 2009.

** Morningstar expects the float to earn 3.0% annually during the next 5 years.

– In its 2^nd Q ending November 30, 2009, PAYX’s total revenues were down 5.3% and EPS declined 10.3%.

– In addition to its core payroll business, PAYX has branched out to provide retirement/401(k) record-keeping services, workmen’s compensation insurance, and comprehensive HR outsourcing. Revenue from these services has grown to about 25% of the company’s total revenue.

** PAYX has recently entered the health and benefits services market which it believes offers significant room for revenue and profitability growth.

SSG Discussion

– The following table compares Ron’s SSG to mine. I also updated both SSGs with the current price and data, but left all judgments unchanged. After the table, I discuss several issues raised by the comparison.

Paychex (PAYX)	RonB-1 (initial)	Armin-1 (initial)	RonB-2 (updated)	Armin-2 (updated)
Date	9-28 (price) 11-02 (data)	11-6-09	2-12-10	Same
Data	S&P	Same	Same	Same
Price	$29.29	$30.37	$29.53	Same
52 week High & Low Price	$33.67 & $20.31	$32.88 & Same	$32.88 & $20.31	Same
Last Q of Reported Data	Q1 ending 8/31/09	Same	Q2 ending 11-30-09	Same
Software Used	TK 6	TK 5	Same	Same

Project Growth From End of	Last Q	Same	Same	Same
Sales Growth	6.00%	10.00%	6.00%	10.00%
EPS Growth	7.40% (from PP)	10.00%	7.40%	10.00%
High PE	24.0	Same (from 2008)	24.0	Same (from 2008)
High EPS	$2.01	$2.17	$1.96	$2.21
High Price	$48.20	$54.50	$47.00	$53.00
*Value Line Est High Price =* *$45-60 as of 8-21-09 and $45-55 as of 11-20-09*
Low PE	20.0 (Ron) 13.7 (Cons)	13.7 (from 2008)	20.0	13.7 (from 2008)
Low EPS	$1.48	$1.41 (ttm)	$1.48	$1.41 (ttm)
Low Price	$20.30 (Ron-recent severe low)	$19.30 (low EPS x low PE)	$20.30 (recent severe low)	$18.80 (low EPS x low PE)
Upside/Down	2.1	2.2	1.9	2.2
% Payout	63.9%	Same	63.9%	Same
Total Return	13.1%	15.1%	12.4%	15.1%

SSG Buy Under	N/A	$28.10		$27.73
RV/PRV	86.3/80.3 (2004 all out, 05 Hi PE out)	79.8/72.8 (no outs)	89.6/83.3(same outs as Ron-1)	80.3/72.8 (no outs)
RV/PRV (no outliers)	80.3/72.8	79.8/72.8	80.3/74.6	Same
Quality	A+	Same	Same	Same

PTPM – 5 yr ave	40.00% trend down	Same *Same*	Same Same	Same Same
ROE – 5 yr ave End Equity	N/A	33.87% trend up	Same Same	Same Same
ROE – 5 yr ave Start Equity	34.30% trend up	Same Same	Same Same	Same Same
Debt to Equity – 5 yr ave	-0- trend even	Same Same	Same Same	Same Same

The Current Price

– The Online Stock Study was held on November 4^th, but September 28^th was the (old) price date that Ron used for his presentation. Worse, his SSG shows that the data was updated November 2^nd, but inexplicably not its (even older) price.

** Good practice is to keep our SSGs updated with the current price and current data, especially when we share them.

Estimating Future Sales Growth

– Ron gave the online participants 5 options to estimate PAYX’s future sales growth for the next five years: 13.10%, its ten-year historical growth rate; 7.00%, Value Line’s estimate; 6.00%, Ron’s estimate; 5.50%, the one-year estimate from YahooFinance; and -6.30%, its sales growth in the most recent quarter.

** The recorded session reveals that Ron’s 6.00% estimate was based on Value Line’s dollar estimate for the next 3-5 years converted to a rate. It looks like a mistake was made to think VL offered two rates for the same thing.

– The Consensus chose 6.00% (Ron’s estimate from VL), but 7.00% (VL’s estimate) was very close in second place.

** VL’s 7.00% estimate was actually for sales per share growth and (sadly) Value Line does not make an estimate for sales growth.

** Zacks.com was estimating 10.13% sales growth for the next 5 years which Ron did not mention while Morningstar, which often makes a sales estimate in its narrative report, made none this time.

– The 13.10% and -6.30% choices were neither realistic nor meaningful options. PAYX’s sales growth has declined every year for the past 10 years from 13.10% in 1999 to 10.70% (5 years ago) to 7.70% (3 years ago) to 0.80% (last year).

Estimating Future EPS Growth

Ron’s SSG:

– Ron offered the participants 5 options: 6.00%, the same as their Sales growth choice; 13.10%, PAYX’s ten-year historical growth rate; 6.50%, VL’s estimate; 7.40%, Ron’s estimate based on the Preferred Procedure; and 13.30%, the five-year estimate from YahooFinance.

** The 13.30% estimate from Yahoo Finance might have indicated to Ron and the participants that a 7.40% estimate was too low.

– The Consensus chose 7.40%, Ron’s estimate.

Armin’s SSG:

– When I did Armin-1, Value Line had made a low-ball estimate of 6.50% compared to the other six analysts I checked. They were averaging 12.89% long-term EPS with YahooFinance high at 13.30% and Zacks.com low at 12.13%.

** The six estimates were close with only 1.17% separating the lowest from the highest.

– I chose to estimate 10.00% EPS which was the very lowest of the seven analysts at CNNMoney and the nine analysts at Reuters.com (with both groups ranging from 15.0% to 10.0%).

– When I did Armin-2, VL was even more a low-ball and had reduced its estimate to 5.50%. The other six analysts had slightly lowered their average a smidge to 12.58% (down from 12.89%) with Morningstar.com now high at 13.10% and Zacks.com still low at 12.28%.

– 10.00% was still the lowest estimate at CNNMoney and at Reuters.com.

** For how I estimate EPS for every SSG I do and for the names of the seven estimates I always check, see: Estimating EPS

Forecasting the High and Low PEs

Ron’s SSG:

– The group was given 5 choices to estimate the Forecast High PE: 28.1, the last five-year historical High PE average; 24.0, the most recent year High PE; 14.8, two times the estimated EPS growth rate or a PEG of 2.0; 10.6, one and one-half times or a PEG of 1.5; and 24.0, the average High PE for the last five years + the current PE / 2.

** The Consensus chose the most recent year High PE (39% of the votes), but Ron’s fifth option was close and in second place (35%). Apparently unnoticed, both were 24.0.

** I do not use the PEG because one number does not fit all stocks, there’s no agreement on what that number should be or even how it should be calculated.

– Of the five choices Ron offered to estimate the Forecast Low PE, one was “none of the above” and, as a result, was meaningless. The other four choices were: 20.0, the last five-year historical Low PE average; 13.7, the most recent year Low PE; 7.4, one times the estimated EPS growth rate or a PEG of 1.0; and 20.4, the average Low PE for the last five years + the current PE / 2.

– The Consensus (50% of the votes) chose 13.7, the most recent year Low PE, but Ron chose 20.0, the last five-year average (26% of the votes). The recorded session does not explain why the Consensus choice was disregarded. [Why bother having a vote?]

Armin’s SSG:

– High/Low PEs have fallen from 40.1/29.7 in 2004 to 24.0/13.7 in 2008. I used the lowest High PE in the last 5 years, from 2008.

Forecasting the Low Price

Ron’s SSG:

– Ron gave the group 5 choices: $29.60, the low PE x the low EPS option and the method most appropriate for growth companies; $28.20, the average low price during the last 5 years; $20.30, the recent severe low price; $20.30, the price PAYX’s dividend will support; and $23.40, 80% of the current price.

– The Presentation Slides show that the participants were not asked to vote. The recorded session does not explain why there was no voting.

– Ron’s SSG shows that he selected $20.30 as his Forecast Low Price, the recent severe low.

Armin’s SSG:

– I selected $19.30 as my Forecast Low Price, the low PE x the low EPS.

Pre-Tax Profit Margin (PTPM) and Return on Equity (ROE)

PTPM:

– The 5-year average PTPM is trending down which is usually a red-flag warning of deteriorating quality and, to me, a signal to check further. To others, it is often a sign to abandon their study. Ron, on the other hand, ignored the downtrend (Slide 34).

** With S&P data, PAYX is way better than its industry average (40.0% vs 15.4%, Data Processing & Outsourcing Industry.

** With Hemscott/Morningstar data, PAYX is placed in a different industry and is way-way better than its industry average (39.6% vs 6.9%, Staffing and Outsourcing Industry). Moreover, PAYX ranks first out of 35 companies.

** Therefore, I would not curtail any PAYX study because of this downtrend.

ROE:

– The 5-year average ROE trend is up which is a good sign.

** With S&P data, PAYX is again way better than its industry average (33.8% vs 18.1%) and way-way better with Hemscott data (33.5% vs 10.7%)

Financial Condition

– Value Line gives PAYX an A for Financial Strength, reports no debt, and $315 M in cash and short term securities as of 8-31 (down from $473 M as of 5-31).

– Morningstar says that PAYX is in “excellent financial health” with no debt and the ability to generate a strong cash flow.

– The one-click Annual report spreadsheet by Bob Adams gives PAYX a 48 out of 100 with 9 Bullish results (good things) and 7 Bearish results (not-so-goods):

** The Bullish things include: no debt, sales are increasing (up 1%) and growing faster than cash flow, and ROE is adequate.

** The Bearish not-so-goods include: cost of sales is growing faster than sales and free cash flow should be higher. Cash flow growth is down 5% and should increase, Bob notes, the same as or better than the company’s sales growth.

** 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.

What Does the PERT-A Show?

– The Toolkit software has a nifty feature called the PERT-A (in TK 5) and the Quarterly Trend Analysis (in TK 6). My favorite part is the last three columns of the Worksheet which show the per cent change by TTM quarter for the growth of EPS, Pre-Tax Profit, and Sales.

** For PAYX, the Worksheet shows 12 consecutive quarters of a decline in all three measures. This data shows me that PAYX’s performance has been dreadful with no sign of any improvement. The same awful record is also shown on the PERT-A graph, for those who prefer a visual analysis.

– If you are still interested in PAYX, check out my earlier post, Probing the Performance of Paychex (PAYX).

POLL (please leave your answers as a comment):

– How many consecutive “down” quarters will you tolerate before selling any stock?

– How many consecutive “up” quarters do you want before you’d consider buying PAYX?

-Armin

Posted by arminfields

Filed in EPS, Estimating EPS, PAYX, PTPM. ROE, SSG ·Tags: EPS, Estimating EPS, PAYX, PTPM, ROE, SSG

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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] ***

Posted by arminfields

Filed in EPS, Estimating EPS, MDT, PTPM, ROE, SSG ·Tags: EPS, Estimating EPS, MDT, PTPM, ROE, SSG

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Fundamental Investing Using the Stock Selection Guide (SSG) by armin fields

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