Monday, November 30, 2009

Aflac (NYSE:AFL): Upgraded to Outperform at Credit Suisse; target raised to $60

Credit Suisse is out with an interestingly timed upgrade on Aflac (NYSE:AFL) raising their rating to Outperform from Neutral with a $60 price target (prev. $52).

Action: After sizing up potential losses and recent actions to restructure European banks’ capital positions, the firm upgrades Aflac to Outperform and raise their target price to $60. According to the firm their upgrade also considers the following: 1) Improved recent fundamental trends, including an up-tick in persistency and a wider gap between incurred claims and benefits paid, 2) reserve redundancy averaging over 20% (~$500m) per year, for which they believe may fully offset AFL’s prospective credit losses and (3) a potential RBC arbitrage (from selling or “derisking”) as a result of a continued rally in bank hybrid security prices relative to NAIC capital charges and 4) a manageable EPS impact if the company did in fact liquidate a large portion of its hybrid portfolio (less than a 5% EPS reduction).

Investment Case: With the assistance of CSFB's global credit research peers, the firm has composed a scenario analysis in regards to what they perceive to be AFL’s most at risk investments; totaling $12.7 billion dollars and representing the majority of AFL’s unrealized losses. Specifically, the analysis includes over 50 issuers, broken down into pools by risk assessment. Credit Suisse hase determined that AFL owns $1.8bn of securities that are at risk of coupon deferral, $2.3bn at heightened risk of some type of principal loss, $6.9bn they deem to be money good and $1.1bn which are more obscure instruments that are harder to analyze but they believe real losses will be well within current unrealized marks. In firm's base case analysis, they have concluded that AFL will be able to maintain an RBC ratio well in excess of 400% in the coming year, attributable to its industry leading cash flow generation (25% ROE) offset by manageable ratings migration and credit losses. Additionally, they note that AFL’s 20% debt to capital ratio could be further levered ($500 million / proforma 24% debt to cap / 2% EPS dilutive) in order to maintain a healthy capital cushion.

CSFB's analysis also considers 1) headwinds stemming from Moody’s wholesale ratings downgrades for which AFL has $8bn of securities exposure to, 2) the impact of potential interest rate “step-downs” on the perpetual portfolio in the coming years and 3) AFL’s susceptibility to a sustained lower interest rate environment.

Valuation: AFL currently trades at 8.3x CSFB's 2010 EPS estimate versus its peers at 7.1x. AFL has historically traded at 15-20x one-year forward earnings and generated year/year EPS growth of 15% (currency adjusted). They believe AFL can achieve its intermediate low-double-digit EPS growth target versus their low-to- mid single digit growth forecasts for its peers. AFL also has the least capitalintensive business among its peers. Firm bases their new $60 target price on 11x their 2010 EPS estimate of $5.25, to reflect their forecast of ROE's just north of 25% and steady earnings growth.

Conference Call: Credit Suisse will hold a call on Monday, Nov. 30th, at 11am ET to discuss their report in more detail. European credit research team will provide a brief overview on their assessment of the European debt market and will also be available during Q&A.

Notablecalls: I was surprised to see CSFB upgrade Aflac this morning following the fall-out in Dubai last week. Aflac has exposure to various hybrid securities (debt/equity) and the Dubai news sent some shivers around that space. There is no way to tell if the Dubai thing will remain a local problem or can be considered a precursor of things to come in larger scale.

Yet, here's the upgrade and I think people that were shorting Aflac on Friday based on Dubai news will get squeezed big time.

To add fuel to the fire, CSFB is holding a conf call to discuss the lengthy upgrade. I suspect that will ensure continuous buy interest in the name today.

So, all in all I think AFL will have a fair shot of trading towards the $45 level and possibly higher if the market continues to play ball. New highs are not that far off.

American International Group (NYSE:AIG): AIG Reserves Deficient - Sanford Bernstein

Sanford Bernstein is out with pretty negative comments on American International Group (NYSE:AIG) lowering their target to $12 from $20 after loss reserve analysis. Firm maintains their Undeperform rating on the stock.

Firm notes they conducted a segmented industry loss reserve analysis to see if it revealed any possible competitive issues that could emerge in the coming years. The main result is a letdown for the possibility of near-term pricing improvement. Every company subgroup—large publics, mutuals, reinsurance & international, and small privates—shows strong and relatively comparable loss reserve adequacy to the other segments. This means that no subgroup is more likely than another to outlast the soft market.

− In particular, average industry reserve adequacy of about 8 points of 2008 earned premium ($26bn dollar adequacy) ranged 4-14% across 4 industry subgroups they looked at. For the large US public companies in their coverage (excluding AIG), the average adequacy is about 11 points, concentrated in commercial lines and specialty businesses.

But they did reveal a very unexpected result that could have major ramifications in coming year. It appears that AIG's loss reserves are significantly deficient again, much sooner that they would have forecast 2 years ago.

− Sanford's estimate is about $11bn deficient, +/- a $4bn standard deviation and equal to about 24 points of total 2008 earned premium (35 points for US only). This equals about $10 per fully diluted share after-tax. The majority of the deficiency ($10bn) is concentrated in 3 long-tailed casualty lines: Work Comp ($1.8bn), General Liability ($5.6bn), and Professional Liability ($2.6bn).

− Because this result was so unexpected to them, they conducted numerous independent reasonableness checks on the AIG analysis. In each case, looking at paid/incurred ratios, implied real price adequacy, and empirical loss development factors, it appears at a minimum that AIG's results are worse than its other large peers, and directionally worse than its booked reserves.

− These results give some credence to long-held views that AIG simply has always been a more aggressive competitor. There is even some support to the idea that discipline was lost after former CEO "Hank" Greenberg left the company. But a more solid analytical reason that may explain the recent deterioration is that AIG's reinsurance usage has been cut nearly in half since the late 1990s, from 43% cessions in 1999 to 22% in 2008. This fact supports both the idea that AIG's underwriters never adjusted to the greater need for more "net line" underwriting, as well as the possibility that AIG's reserves will have a "thicker" tail without so much reinsurance usage.

Investment Conclusion
Sanford Bernstein cuts their AIG target price to $12 from $20 to reflect the reserve deficiency. There is now 64% potential downside to their target from AIG's most recent close. Firm continues to rate AIG Underperform. The results of this study were a big surprise to the firm. The original purpose of the analysis is rather anticlimatic, as current loss reserve adequacy seems rather evenly distributed by company subgroup, which suggests that the industry could continue competing with itself for quite some time. This lends support to our view that a balance sheet driven hard market, of the type seen in 1985 and 2001, is likely 2-3 years off. The potential implications of this result for AIG are quite significant. If their analysis is even directionally correct, it implies that AIG shareholders and the Federal Government face considerably more uncertainty than they may have anticipated. At a minimum, if these results are reasonable, AIG would likely have to take some kind of reserve charge before it could sell or IPO its Chartis unit, which would probably greatly increase the difficulty of implementing such a deal in the first place. There is also the possibility for even greater Government scrutiny and penalties, although they have no insight as to what this might be at this point.

But this may also lead to a result that was widely anticipated earlier this year but for the wrong reason, namely continued loss of AIG market share. It was viewed by many that AIG's weakened state would compel clients and brokers to want to move business. Sanford notes they were skeptical of this view because they felt that clients would instead stay put and wait for the uncertainty to pass before making a major decision. So far, their view is what appears to be playing out. But now, with this loss reserve result, they have a more analytical case to make that AIG may face client flight in the future, driven by fear over its potentially weakened claims-paying ability. That factor seems much more likely to matter to risk managers than what is happening in AIG's Financial Products unit. It is very difficult to determine if and when any reserving problems will be manifest in AIG's results, and so if and when competitors will be able to capitalize. But at this point, they now think it is more likely that companies like TRV, CB, ACE, and even CNA will eventually be able to capitalize on the likely uncertainty this will create in AIG's client base.

Notablecalls: AIG appears to be vulnerable here. I don't think people were ready for what Sanford Bernstein has to say this morning. If AIG's loss reserves are significantly deficient again, some odd $2 billion asset sales (as reported today by Financial Times) ain't going to help much.

This is negative for the whole financial system, I believe.

I expect AIG to trade down today. Could trade to $32 or possibly even lower.

Wednesday, November 25, 2009

Vistaprint (NASDAQ:VPRT): Upgraded to Buy from Hold at Citigroup - Short Squeeze Alert!

Citigroup is upgrading Vistaprint (NASDAQ:VPRT) to a Buy from Hold with a $62 price target (prev. $55).

Firm notes they are taking advantage of the recent 13% pullback in VPRT shares to upgrade what they have consistently viewed as a Core Internet Holding and one of the handful of ‘Net companies with a sustainable 20%+ 3-year EPS growth outlook. Their $62 PT is based on 22X our C2011 EPS estimate of $2.80. Three Upgrade Reasons:

1) Recent Market Reaction Overlooks Key Company Trends — On 11/16, a key Senate Committee published a highly negative report on Online Membership Programs, which listed VistaPrint as a beneficiary of these programs. This was the negative catalyst. Yet, Citi believes that the market reaction misses a) the Core Margin leverage in VPRT’s business model – they estimate organic Gross Margin (excl. the high-margin Membership Fees) has increased from 59% to 63% over the past year; and b) the increasing immateriality of these Fees to
VPRT – from 16% of profits in 2009 to an estimated 5% in 2010 to 0% in 2011.

Specifically, they estimate VPRT’s organic Gross Margin (excluding the high-margin Membership Fees) has increased from 59% to 63% over the past year.

What has caused VPRT’s Core Margins to expand? Citi believes the key factors have been scale, learning curve efficiencies, and the rollout of higher-margin Digital Subscription services, such as Website Design and eMail Marketing.

2) Citi Believes VPRT's New Product Rollouts & Investments Are Creating Long Growth Runways — Through the last three Recession quarters, VPRT maintained 32%-35% Y/Y Core organic revenue growth, highlighting the company’s secular growth opportunity – the online migration of Small Business marketing solutions. And they believe the recent rollout of high-margin products such as Website Design, eMail Marketing, and Online Search Placement – as well as new production facilities in Asia-Pac – are creating greater crosscategory/
cross-geography revenue opportunities.

3) Firm's Recent Factory Tour Gives Them Increased Confidence in VPRT's Growth & Efficiency Outlook — Per their 11/17 tour of the company’s key Windsor, Ontario, VPRT will be doubling the size of its production facility by mid/late 2010. Further, Citi's qualitative tour takeaway highlight the company’s efficiency steps/opportunities across Labor, Materials, Shipping & Overhead.

View Risk-Reward As Interesting Near- and Long-Term — Near-term, they view VPRT as one of the key Internet Market Share beneficiaries of the Recession. Long-term, VPRT continues to screen well against Citi's 4M Framework, including Management Team, Competitive Moats, Market Opportunity, and Business Model.

Notablecalls: I suspect this upgrade comes a bit of a surprise to many, especially the shorts. With the short interest close to 45% of float, the shorts had been feeling a lot of pain lately. They got a few breaks after Goldman Sachs downgraded the stock back in October and even talked Barron's to publishing a negative story on the co two weeks ago. That helped to knock the stock down from $55 to about $50. It looked like more downside was ahead.

Until this morning. With Citigroup upgrading the stock to a Buy, I think there will be more pain in store for the shorts. They may be right in thinking, but new 52 week highs are likely on the way regardless.

Taser (TASR) also went where it belonged EVENTUALLY but few folks who shorted that stock were alive to celebrate. Same probably goeth for VPRT.

The stock will trade to $52 today for sure with $52.50+ not out of the question if the market continues to play ball.

Let's see how it works out.

Tuesday, November 24, 2009

Amylin Pharmaceuticals (NASDAQ:AMLN): Upgraded to Overweight at Barclays, target raised to $22

Barclays is upgrading Amylin Pharmaceuticals (NASDAQ:AMLN) to Overweight from Equal-Weight with a $22 price target (prev. $16).

According to the firm, AMLN shares have been under pressure for several years, which they attribute to concerns regarding flattening Byetta trends, increasing competitive visibility, perceived regulatory risk for exenatide LAR, excess cash burn and limited pipeline visibility. Since reaching a peak share price of $51 on October 5, 2007 AMLN shares are off -76% as compared to the BTK that is up +3.2% over the same period of time. At current levels, with an enterprise value (EV) of $1.95B, AMLN shares are trading at 2x current year revenues and 4x AMLN share of revenues and appear to reflect limited sustainable growth for Byetta, low likelihood of exenatide LAR approval, heavily discounted earnings prospects and no value for its obesity assets.

Recently, however, AMLN has made significant progress towards addressing concerns with stabilization of Byetta trends, Byetta label expansion, operating expense reduction and global partnership for obesity assets. With focus on exenatide LAR as a primary value driver, however, uncertainty has persisted regarding approvability in the context of FDA concerns expressed regarding the long acting GLP-1 class. With FDA action on Novo Nordisks liraglutide as a potential nearer term proxy for FDA approach to the long acting GLP-1 class there has been an assumption that as goes liraglutide as will go AMLN.

- Barclays thinks exenatide LAR prospects may be better than expected irrespective of liraglutide action. In reviewing implications of Byetta label expansion, better than expected labeling for pancreatitis risk, differences in preclinical carcinogenicity profile, post-marketing experience with Byetta and efficacy data for Exenatide LAR the firm believes that a more constructive view regarding LAR approvability is appropriate.

- With over 1 million patients exposed to the exenatide molecule and with no major safety issues emerging Barclays believes that the Byetta safety database provides significant support for exenatide LAR approval in the event that FDA maintains a line extension designation for the product. With approval of the Byetta frontline monotherapy claim they believe that office of drug safety has had an opportunity to fully review the safety profile of the exenatide molecule and with better than expected Byetta labeling believe that a line extension designation would serve exenatide LAR well. In addition, with significant focus on cardiovascular risk for diabetes drugs they believe that the trend in favor of Byetta with hazard ratio (HR) of 0.70 could also serve to benefit exenatide LAR under a line extension designation.

- In assessing longer term value of AMLN obesity assets it may be tempting to consider market capitalizations for later stage obesity companies like Orexigen, Arena Pharmaceuticals and Vivus which range from $350-750M. They would note, however, that both Orexigen and Arena were valued in excess of $1B on phase II data and have lost considerable value on concerns regarding inferior weight loss to Vivus’s QNexa, potential for CNS adverse events, uncertainty on longer term intellectual property protection and in particular on the inability to secure a partnership. With 2 separate biologic products, efficacy on par with Vivus’s QNexa, a peripheral mechanism of action and a $1B collaboration with Takeda Barclays believes that AMLN obesity assets should command incremental value beyond current Vivus valuation and in excess of prior phase II value for other obesity targeting companies.

Firm is introducing long term estimates for AMLN from 2011-2020 which assume exenatide LAR approval and launch in the US by 3Q10 and by 3Q11 in Europe. In the US they estimate 2011-2020 exenatide molecule sales of $750M, $1.1B, $1.25B, $1.4B, $1.55B, $1.7B, $1.9B, $2.1B, $2.25B, $2.375B and $2.5B. EPS estimates for 2011-2020 are ($0.43), $0.91, $1.71, $2.24, $2.76, $3.34, $3.84, $4.20, $4.45 and $4.71, respectively.

Barclays arrives at their new $22 price target by applying a 25x multiple vs 16x multiple previously to 2014 EPS estimate of $2.24 as compared to prior 2012 EPS estimate of $1.70 and discounting at the same 25% discount rate. They believe that 2014 earnings are more representative of aggregate business opportunity for Byetta and exenatide LAR in the US and Europe and that the higher multiple is appropriate given the 35% EPS CAGR estimated for the period of 2012-2017.

Notablecalls: This is a fairly significant call for AMLN as Barclays is one of the first firms to come off their Neutral/Negative stance on the stock. Pull up a 2 year chart and you can see there has been very little reason to be positive on the stock. Yet now the stock is up 50% from its $8 low and that's usually the level where big players start to get interested again. The downtrend may be broken and catalyst lurk in the horizon. Also, if you look at Barclays' rec. history, they have down a pretty good job in AMLN, downgrading it to Underweigh in the mid-$40's and gradually turning more positive as the stock fell out of bed.

I was positively surprised to see the Byetta label expansion in light of the pancreatitis risk, which seems to indicate LAR is approvable. PDUFA date is set for March 2010.

When it comes to iraglutide, Novo continues to expect a formal update from the FDA before the end of 2009. This may create volatility in AMLN but the situation may end up as a win-win for AMLN as neg. iraglutide news means competition is pushed back and positive news will make a lot of people believe LAR is outright approvable.

So any way you slice it, it looks pretty positive.

Short interest still stands around 22%, which is significant enough to create a short squeeze on any positive developments.

Oh, and Barclays' $22 target is the new Street high.

All in all, I think AMLN will have legs today. The $13 level will break for sure with $13.50+ not out of the question.

Monday, November 23, 2009

Deere (NYSE:DE): Upgraded to Overweight at Morgan Stanley

Morgan Stanley is upgrading Deere (NYSE:DE) to Overweight from Equal-Weight with a $64 price target (prev. $48)

According to the firm demand for US farm equipment is growing as customers add acreage, a secular phenomenon that is widely underestimated. Cyclical factors are also more favorable than most believe, with corn likely higher into 2010 and the potential for recovery in Brazil. They see this as a rare opportunity where consensus is too conservative on both cyclical and secular factors, making DE risk reward highly favorable vs other machinery stocks.

Morgan Stanley's take on three core debates: 1) US farm equip sales rate is close to mid cycle, not above trend. Their proprietary analysis strongly suggests that the entire market for new equipment is a small group (~25,000) of very large farmers. These farmers doubled acreage over 10 years, taking 30mn acres from smaller farmers who don’t buy new equip. Those acres equate to 6,000 add’l annual tractors needed, vs 10 yr avg of 23,000 units.

2) Corn prices should strengthen into 2010. Demand should swing to up 4% from flat, on feed and ethanol. Lower demand from lower US livestock has already happened to a large extent.

MS commodity strategist Hussein Allidina argues for $4.50 corn in the ’09-’10 marketing year, on rising demand for US corn. Feed demand in the US will be soft again in 2010, but much of that downturn has already happened. EM demand for feed is still up.

3) Brazil has potential to offset a US drop if it occurs. A retracement of half the recent high hp market plunge in Brazil, plus 5 points of share, would offset a 10% US tractor fall. Deere gained 9 share pts. in ’09.

Brazilian offset could be bigger than realized. Brazil high horsepower volumes are down 50% in 2009, Deere has taken 900 bps of share on low volumes in Brazil. A rebound in Brazil that half retraced the fall, along with 5 pts of share, would offset a 10% US tractor drop.

Underpriced option in construction for ‘11/’12: Four years of volume declines, and two years of near zero volumes (’09 and ‘10e) will strain competitors’ dealers. Add in Tier 4 emissions turmoil and Deere (CAT too) should gain share as smaller competitors struggle.

Notablecalls: The Deere call reads pretty strong (and out-of-consensus). The stock is ready to break out and I think it will trade above the current 52-week high today. I'm guessing $53 level may break today with $53.50 not out of the question.

The Fertilizer stocks have been red-hot of late and Deere can be considered a sympathy play of a sort.

Something is going on in the Ag. space as big buyers have been lurking around for weeks now.

Friday, November 20, 2009

Dillard's (NYSE:DDS): Upgraded to Buy at Deutsche Bank, target raised to $28 - not your daughter's jeans!

Deutsche Bank is upgrading Dillard's (NYSE:DDS) to Buy from Hold with a $28 price target (prev. $13.50).

Based on Dillard’s merchandising and cost control initiatives, improved inventory management and recent operating trends, the firm believes the company is better positioned than nearly all investors would have anticipated to grow EPS significantly in both the near and long term. Management began implementing several initiatives in 2007 and 2008, which up until recently have been masked by the deteriorating economy. Deutsche believes that Q3:09 results area testament to inventory and cost containment initiatives that have been undertaken and are a glimpse into what is to come. Given the improved operating efficiencies they are significantly increasing their EPS estimates, their price target and upgrading DDS to a BUY rating, from HOLD.

Historically considered a laggard, now proving the skeptics wrong
While Dillard’s management was working behind the scenes on new merchandising initiatives and ways to right-size the business in 2007, the company got the reputation of a laggard versus some of their competitors as they experienced deterioration across many metrics including comps, operating margins, and return on invested capital, etc. Additionally, the company’s minimal communication with investors and the Dillard family’s significant economic ownership and control was perceived in a negative light. In late 2007 and early 2008, as the economy was beginning its vicious Great Recession downward spiral, the company began receiving letters from activist investors demanding initiatives be undertaken to improve the operations of the business.

These activists recommended initiatives including:

1) Reduce the company’s cost base – through sourcing, rationalizing SG&A expenses
and reducing capex

2) Improve inventory management – institute initiatives to moderate inventory levels as
the stores appeared over-inventoried

3) Refine merchandise assortment – aggressively re-merchandise with a new vendor
selection, exclusive brands, updated private label and in-house collections

4) Enhance brand marketing – add more image and lifestyle campaigns to
communicate a revitalized message

While Dillard’s did not to respond publicly to these suggestions, it is clear to Deutsche now that many of these suggestions were being implemented at the company.

Normalized EPS
Deutsche continues to believe that the cyclical recovery has not yet been priced into many of retailers’ shares. They expect the improving economy over 2010-2011 to drive strong sales, EBIT margins and EPS growth across most of their Broadline names, including Dillard’s. They expect Dillard’s to see significant EBIT margin expansion over the 2009 – 2011 period (+234bp), given the strong cost discipline, efficiency gains, and streamlined inventory levels. The analysis assumes Dillard’s can eventually return to their historic peak EBIT margin of 8.5%, which may seem like a lofty goal as it would likely take several years for the company to return to these levels. However, applying a normalized multiple (15x) to the implied EPS, implies a share price of $56, or nearly 300% upside.

How good can it get?
Next, the firm updated their “How Good Can it Get Analysis,” which increases their FY10 comp estimate (-2%) by 100bp to 500bp increments and our FY10 gross margin estimates (+91bp) by 10bp to 50bp, but maintains their SG&A dollar estimates. If Dillard’s saw an improvement in comp sales in FY10 to +1% and a GM increase of 120bp, they would report a year-over-year increase in FY10 EPS of about 180%, compared to Deutsche estimate of a +57% increase. If discretionary spending drove the FY10 comp to +3% and gross margins to +140bp, that would result in a year-over-year increase in EPS of about +270%. The company will clearly see significant upside if sales and margins see some improvement from current levels, further supporting their Buy thesis.

Revising Q4:09, FY09, FY10 and FY11 EPS Estimates
Based on Q3 results and the company’s line-item guidance provided, the firm has updated their Dillard’s model. For Q4:09, they now expect EPS to be $1.10 (vs. -$0.31 LY), up from their previous estimate of $0.17. For FY09, they are projecting EPS of $0.80 (vs. -$1.56 LY), up from their previous estimate of -$0.61. Deutsche is also revising their FY10 EPS estimate upward to $1.25 (+57% y/y), from $0.43 previously, and their FY11 EPS estimate is now $2.01 (+60.2% y/y), up from $1.30 previously.

Notablecalls: Certainly an interesting call from Deutsche's Retail team. While the new target of $28 is the new Street high target by a wide mile, Deutsche is saying that based on normalized earnings the stock could be worth $56, implying 300% upside.

This is bound to generate strong interest in the name today.

Dillard's has been paying down debt at a fairly fast rate and has significant real estate holdings that may actually be worth double the current share price (Deutsche est. $41 NAV). The Dillard family and other insiders own 25-30% of the co and control 2/3 of the board votes due to dual Class A/Class B share structure.

There's a 12% short interest in the name and the chart looks good for a breakout.

I think DDS can trade above the $15 level today with $15.50+ certainly not out of the question.

The main risk here seems to be the general market. Futures are in the red early going and I'm not quite sure we will see any meaningful bounces until the markets give back some more of the recent gains.

Thursday, November 19, 2009

Semiconductors: Cycle stalls; Downgrading sector view - Merrill Lynch/BAM


Merrill Lynch/BAM is out with a rather significant Semicondutor sector downgrade, downgrading 4 large players to Neutral and 4 to Underperform:

Firm notes they are downgrading their view on the sector given unfavorable indications from our cyclical framework suggesting a modest inventory correction, even in the face of improving electronic demand and a more constructive outlook for the global economies. They are also downgrading shares of INTC, TXN, MRVL, and LSI to Neutral, and MXIM, NSM, POWI and MCHP to Underperform. Merrill now rates a modest 5 stocks (BRCM, XLNX, ALTR, ADI and LLTC) as Buys within their coverage group (19 stocks in total).

In particular, Merrill's industry model suggests that following a normalization of semiconductor IC shipments to “true” consumption levels, inventories in the supply chain are approaching a level suggesting a modest overshoot vs. equilibrium levels, even after accounting for above consensus global GDP growth, and a smart recovery in global electronic systems sales into 2010. Thus, barring a sharp upturn in the global economy, their indicators point to the potential for an inventory correction, thus rendering the risk-reward associated with ownership of chip stocks unattractive.

In some ways, the firm thinks the current backdrop reflects a striking contrast to the conditions that prevailed at the time of Merrill's upgrade. Specifically, at the time, supply chain inventories were at abnormally depressed levels, economic forecasts were poised to improve but as yet depressed, and indications of an inflection in electronic demand had just started to manifest themselves. Fast forward two quarters, and the picture looks completely different. To wit economic growth forecasts have trended higher, as have expectations of electronic demand growth, and supply chain inventories are perking above what they’d consider to be a normal equilibrium level. Last but not the least, sentiment around growth prospects for the group has also seen a marked improvement. Simply put, the ideal mixture of investor skepticism coupled with the potential for sharp upward revisions – which served as potent fuel for the semiconductor rally – no longer prevails. This then begs the question: What is the incentive to own chip stocks, esp. on the heels of a spectacular move up (SOX +83%) over the last 12 months?

For those looking for real world confirmation of the potential inventory adjustment being forecasted by Merrill's industry model, the firm would point to indications from the Asia PC supply chain suggesting a material downward bias to desktop forecasts in the near-term. In particular they note that their Taiwan Hardware analyst Tony Tseng is now projecting ~flat Q/Q growth in PCs (desktop motherboards and notebooks included) into Q4. Merrill notes that it represents a sharp downward revision (esp. on the motherboard front) vs. just a month ago, in turn suggestive of slowing momentum in the PC space – the lynchpin for semiconductor industry growth. Serving as further corroboration of waning momentum are resale trends out of Asia distribution suggesting recent monthly sales trends that have been solidly below seasonal. Importantly, they’d note that above seasonal trends in the distribution data in late 2008/early 2009 had served as a harbinger of the cyclical upturn, thus, in Merrill's view, underscoring the importance of the data.

Last but not the least, for those looking for a smoking gun, Merrill has one: namely, foundry utilization. Using TSMC utilization as a loose proxy for trends in overall foundry utilization rates, they’d note that a sale of the SOX every time TSMC’s utilization rates hit 100% would have put you on the right side of the trade in short order. As counterintuitive as this might sound (after all isn’t tighter capacity great for chip ASPs etc.?), the fact is that there is such a thing as too much of a good thing. When it comes to foundry utilizations, 100% seems to be the magic number, simply because “sold out capacity” – esp. in the face of an improving perception around the economy and by extension end demand – is often a catalyst for double/excess ordering in the supply chain. After all who wants to be caught short on semiconductor parts, which average a paltry $1.00-1.50 in ASPs, when demand is improving?


Will it be different this time, and will the backdrop allow for an extended period of rationality in the supply chain despite tight supply? Perhaps. Then again recent history suggests that this has ultimately never been a bet that worked out in favor of the chip investor.

Notablecalls: So, Merril Lynch/BAM is joining the Anti-Semi group today (call was out last night) after Morgan Stanley downgraded the Semi Equipment sector last week.

The call makes perfect sense and is backed by FBR Capital this morning. According to FBR, recent checks into 4Q PC builds with the top five notebook ODMs and top four desktop motherboard makers are worse than their month-ago checks. Overall, the firm forecasts 4Q PC builds to decline –1.5% QOQ, worse than their month-ago forecast of +5% growth QOQ.

It's kind of surprising to see this kind of action ahead of Q4 numbers but I guess this can be explained by recent rumours of double and triple ordering that has been occuring over the past months. The Intel's and Dell's of the world have enough components to work with and are paring back their future orders.

Good thing no real production capacity was added, which makes the upcoming decline somewhat easier to handle.
How to play it?

I'm not a big fan of shorting INTC here down 3-4% in the pre mkt. Too much of a battle, given how WDC/STX performed following the Merrill downgrade yesterday.

The Merrill call is good for context but not for actual trading, I think.

Wednesday, November 18, 2009

Smith International (NYSE:SII): Upgraded to Buy at Citigroup, RBC buys the deal

Smith International (NYSE:SII) is getting some interesting comments following yesterday's sell-off on the announced secondary:

- Citigroup is upgrading SII to a Buy from Hold while raising their price target to $35 (prev. $29).

Smith shares plunged nearly 13% as the company tried to place a 28 million common share offering that no one expected and that seemed to be poorly timed. Citi notes they have lowered their EPS estimates slightly to reflect the dilution from the share offering. Their EPS estimate for 2010 is revised to $1.05 from $1.10 and their EPS estimate for 2011 is revised to $1.60 from $1.65. They believe that Smith is a company with high quality products and services and a premier brand name in oilfield services. That Smith is the one of the poorest performers among the major oil service stocks in 2009 makes this stock worth of a second look (especially following the stock’s brutal sell-off).


Smith Pays a Price to Remain Investment Grade While Pursuing Growth
Smith surprised analysts and investors by announcing a 28 million share stock offering, with proceeds to be used for debt repayment and to fund potential acquisitions and new growth initiatives. The company (which is determined to preserve its investment grade credit rating) realized that issuing new debt for acquisitions or growth would have resulted in a ratings downgrade.

Citi Believes SII Shares Are Oversold and Could Bounce in 2010
They have raised their rating on Smith to Buy from Hold. While Smith has been one of the worst performing oil service stocks in 2009, its poor operating results and its need for new equity capital are reflected in its current share price. Citigroup believes the stock has upside to around $35 in 2010.

They Believe Smith is a High Value M&A Target
Two M&A deals in oilfield services in 2009 have apparently kicked off another round of industry consolidation. While Smith’s stock offering clearly signals its desire to move forward on its own in the next phase of the business cycle, we see Smith as an ideal M&A target based on its longstanding global leadership in drilling fluids and bits.

Citi believes that Smith is a logical fit for several companies that have clearly signaled to the market that they want to make acquisitions. The most likely buyer of Smith, in firm's view, would be National Oilwell Varco (NOV.N; US$46.13; 1H). Clearly the operations and technological strengths of the two companies are well aligned. Other candidates to acquire Smith could be Schlumberger (SLB.N; US$67.09; 1M) and Weatherford (WFT.N; US$18.56; 1H)(in that order of probability).

If Smith Stumbles Next Year, Pressures to Merge Could Build Quickly
In 2010 Smith will face continuing challenges in the form of start-up costs in new international markets and pricing pressures in domestic markets. Smith’s PathFinder suite of drilling services is trailing expectations with respect to its pace of international expansion. If the company were to stumble amid these challenges, pressures to merge with a larger competitor could intensify quickly.


- RBC Capital is out with a call titled "Buy the Deal". Firm is reiterating their Outperform rating and $35 price target (unch).

They would buy the deal. Here's why:

1. Deal will help accelerate the expansion of SII's Directional Drilling product line and the growth of its international footprint.

2. SII remains the most consumable (razor blade) intensive company.

3. SII is the only pure play service specific company for mid cap ($2-10bn)
investors.

Highlights from chat with company last night:
1. Company has ~30 deals in various stage of discussions, and they typically close 10%. The M&A pipeline has heated up recently, as such, we would expect some deal flow within the next 3-6 months.

2. The sizes range between $6mn-$200mn. This indicates to us that most, if not all, potential deals will be private.

3. Company noted that any acquisition won't be pressure pumping and this equity deal is not related to SLB's put option on the M-I joint venture with SII.

Clients are still questioning execution.
RBC notes they would be concerned about execution if it coincided with status quo. This is not however the case. John Yearwood has been CEO since Jan 1, 2009. He has recently hired a new CFO and established an IR effort, SII's first ever. The CFO is an upgrade, in RBC's opinion, and the IR role shows a commitment to improving its communication effort with both investors and the sell-side.

From an operational standpoint, they have expanded the Pathfinder product line into 6 new countries in 2H09 and are targeting 1-2 new Eastern Hemisphere countries per qtr through 2010.

In RBC's view, the investment decision on SII is simple:
You either buy into John Yearwood, a successful geographic expansion, roll-out of the Pathfinder product line into new countries, successful execution on M&A and an improvement in investor communication or you don't.

Notablecalls: So, there you have it. Two firms are telling you buy SII down 4pts from the $31 level. The thing priced $26.50 last night.

Could trade towards $28 level if the market plays ball.

Tuesday, November 17, 2009

Assured Guaranty (NYSE:AGO): 100% price target from J.P. Morgan - MAJOR CALL ALERT

J.P. Morgan is out with another major call on Assured Guaranty (NYSE:AGO) raising their price target to $42 from $28 following earnings announcement out last night.

AGO reported op EPS in line with the pre-announced $0.45 per share. Included in its Q was a premium amortization schedule that was well above what JPM had previously modeled. In short, they were not properly accounting for the way FSA's premium revenue is recognized going forward as AGO purchased the company at a large discount to book. As such they are raising their estimates substantially and pushing their price target up to $42, using the same 7x multiple to their new 2011 estimate. With shares trading at half firm's target, they would be aggressive buyers.

Premium discount amortization significantly higher than modeled.
When AGO acquired FSA it booked ~ $1.6B of premium discount. A majority of the discount was applied to RMBS exposures that have a shorter duration than the overall portfolio. As a result, the discount amortization built into future premium earnings will run at a significantly higher rate than we had expected. AGO disclosed in its Q that deferred premium revenue earned will be ~ $1.1B over the next four quarters and gradually decrease ~15-20% annually over the next 3 years. This increased revenue does not change the economics of AGO’s business but will bolster regulatory capital dramatically.

RMBS loss mitigation efforts pay off.
AGO has been negotiating with mortgage originators to recover losses from improperly underwritten mortgages based on existing warranty covenants. In its 3Q earnings release AGO announced that they have reached an agreement to have $146M of mortgage loans repurchased by the originator and expect to put back an additional $804M of RMBS loans for a $527M total net benefit.

Additional capital to be raised by year-end.
As previously announced, AGO has initiated a capital plan in order to have its Aa3 rating affirmed by Moody’s. The plan includes external reinsurance, inter-company capital support, and $300M of new capital. The external reinsurance has already been negotiated, and the $300M of capital is expected to be raised by year-end. This capital may be a mix of common and preferred or convert/hybrid equity.

Significant earnings power increase.
JPM is raising their 2010 and 2011 earnings estimate to $5.00 and $6.00 per share from $3.00 and $4.00, respectively, to reflect significantly higher earned premiums and loss mitigation efforts.

Trading at just 3.5x JPM's normalized earnings estimate of $6, compared to the doubledigit multiple on normal earnings we had seen in the past, the stock is cheap in firm's opinion. Moreover, even if they penalize the stock for its ratings uncertainty, the lion’s share of the future earnings will come from amortization of back book of business; therefore, they believe there is little downside to the stock and reiterate their Overweight rating. JPM's new Dec 2010 price target of $42 is based on a historically low 7x multiple to their new 2011 estimate.

Notablecalls: So, today is 'Make Wilbur Ross Happy' day. The legendary distressed business investor owns around 16 million shares of AGO with an average price of ~$15-20 per share. He started buying AGO in February 2008 and has steadily increased his take since then.

I suspect AGO will fly high today following the results and the HUGE call from J.P. Morgan:

- I'm sure many of you saw how AGO reacted to the less ominous Moody's cut and J.P. Morgan comments last Friday. The stock shot up 4 pts from open and didn't give back much during the day. There was some serious buying going on.

- J.P Morgan has been and continues to be the Axe in the name. Their $28 price target was the Street high and the $42 target just mops the floor with other analyst covering the name.

- The reasoning behind the $42 target isn't based on some quirky DCF-based analysis. The people at JPM realized they were being too conservative and are upping their 2011/2012 EPS estimates by a friggin mile.

This stuff is bound to get attention. How many stocks are there with 100% price targets and a blessing from the Axe?

So how high will AGO trade today?

I suspect we may see another 10%+ move in the name today. If you look at the chart the stock has broken out to a new 52wk high and there is really nothing stopping it (except maybe some of momo buyers from Friday taking profits).

This will put the $23 level in play with $23.50-$24.00 levels definitely not out of the question.

Let's see how it goes.

UPDATE: Based on pre-market action, I now think this one can trade $25+.

Monday, November 16, 2009

Sprint (NYSE:S): Upgraded to Outperform at Credit Suisse, Added to Focus List with a $6 target

Credit Suisse Telecommunication team is making a major call on Sprint (NYSE:S) upgrading the shares to Outperform from Neutral with a $6 price target (prev. $4) and adding it to their Focus List.


Investment Thesis: CSFB notes that while they rarely add turnaround stories to the Focus List and fully recognize the degree of risk and volatility involved in this case, the Credit Suisse Investment Policy Committee (IPC) believes that Sprint is one of the few stocks in their coverage universe with a legitimate chance of doubling over the next 18 months (their optimistic scenario yields even greater upside with a fair value of $9). More importantly, based on extensive valuation and credit work, they believe the stock has limited downside risk with a floor value in the $2 range, particularly as consensus 2010 EBITDA estimates have recently moved down to very achievable levels.

CSFB believes the business is at an inflection point with revenue and EBITDA starting to grow over the course of the next two quarters. They are forecasting flat retail subscribers in 4Q09 for the first time since 2Q07 and expect growth to accelerate in 2010 and 2011. The return to growth will be driven by steadily moderating losses in postpaid, coupled with continued robust net adds in prepaid.

CSFB forecasts call for 4Q09 to be break-even for retail subscribers (first time since 2Q07). They see subscribers growing by more than 300k in the core for 2010, and they see Virgin Mobile adding an additional 1.2MM adds. Sub growth, coupled with considerable operating leverage and cost cuts should drive EBITDA and FCF growth, as well as multiple expansion.

Growth potential: Including the Virgin brand, the firm thinks net adds will increase 1.5M for 2010, driving 1% revenue growth in 2010 and 2% in 2011, after three years of declines. EBITDA should stabilize in 1Q10 and grow thereafter (they estimate 4% growth in 2011 while consensus is calling for EBITDA declines throughout 2010 and 2011).

Catalysts: 1) CSFB expects Sprint to launch a compellingly priced prepaid unlimited offer under the Virgin brand (on its robust CDMA network) soon after they complete the acquisition of Virgin Mobile (shareholder vote scheduled for 11/24/09). While expectations are low for this launch, the firm expects it to be successful (similar to Boost) and 2) S will report Q4 results in mid February.

Balance Sheet/Liquidity: The company’s CDS has tightened to 475bps from 1200+ back in March, indicating the fixed income market is becoming far more confident in the company’s prospects. This view is also shared by Credit Suisse's S credit analyst who believes the company has ample liquidity for 2010 and 2011 (S should end 2009 with a manageable Net Debt/EBITDA ratio of 2.8x).

Tying It All Together: Estimates Have to Come UP
CSFB is are forecasting EBITDA of $5.8BN for Sprint's exiting business, in line with the "sensible consensus" estimate.2 When they add Virgin, they arrive at EBITDA of $6.1BN. Firm expects revenue growth in 2011 of 3.1% which, when coupled with the operating leverage discussed above, should translate into EBITDA growth of 9%. CSFB's 2011 EBITDA estimate of $6.1BN excluding the contribution from Virgin Mobile is 5% above the consensus estimate of $5.8BN. Perhaps more importantly, their expectation of 4% EBITDA growth (again excluding VM) probably results in a higher multiple than the consensus expectation of EBITDA declines.


Valuation: S currently trades at 4.7x EV/EBITDA, in line with peers but with a much steeper EBITDA growth trajectory from current depressed levels. The stock also offers a 20%+ FCF yield. Finally, firm's conservative asset break up value is $2.

Notablecalls: CSFB Telco analyst Jonathan Chaplin sure is making a name for himself here. If you look at analyst sentiment, there are only two Buy-rated firms covering S (out of 10). So the call is certainly an out-of-consensus one.

What caught my eye is the huge move S made on November 9, following the Clearwire news. The stock has retraced about half of the gains and now we have a major upgrade from a tier-1 firm. To me, this indicates the stock may be gearing up for another move higher, possibly surpassing the bounce high made on November 9. Not sure it will happen today but that would be my bet for the next couple of weeks.

Btw, when was the last time in recent history when quarterly results acted as a catalyst for Sprint? Cant remember? Me neither. But there it is, CSFB is calling for break-even for retail subs. That would be pretty big.

With a $6 target (and possible upside to $9) this one is going to generate some serious buying pressure today.

I see the stock trading to $3.40 for sure with possible upside to $3.50+ today.

Sunday, November 15, 2009

Notable Calls Network (NCN): Genzyme (NASDAQ:GENZ)

I think anyone who has been in the game agrees that trading has been extremely tough over the past several weeks. The indices have held up fairly well but the underlying action in single stocks has been very choppy. Most calls or news have very little if any follow-through, so one has had to be very quick to book even the slightest gains.

I know it's tough out there when people who have been trading for 20+ years are complaining. And they certainly have been complaining.

Still, there have been some really bright spots in overall action. For example the Notable Calls Network (NCN) caught a nice move in Genzyme (NASDAQ:GENZ) on Friday November the 13th.

- Right after 11:30 AM ET the shares of Genzyme (GENZ) started plunging with very high volume. I (and I think everyone else as well) knew the plunge had to have something to do with the much-publicized problems at the Allston manufacturing facility but given there was no confirmation there was very little we could do.

So we sat and watched as the stock kept plunging.

- Around 11:45 AM ET, just 15 minutes later I started hearing trading desk chatter of another possible contamination accident at Allston, this time involving several product lines. That sounded pretty bad, given many had hoped the problems with Cerezyme were close to conclusion.

Some minutes later we got confirmation that the FDA has issued a warning letter about the potential for foreign particle contamination of several products manufactured by Genzyme Corporation that are used to treat rare, serious, and life-threatening diseases.

By that time the stock was already down 4 pts so shorting it felt like gamble. The stock however did fall another 1.5 pts to about $48+ level over the next 10 minutes. The selling pressure was that immense, with 300,000-400,000 shares crossing the tape every minute.

- Around 11:53 AM ET a top Notable Calls Network (NCN) member pinged me with the following:

'... From Sanford Bernstein : FDA comments on GENZ: we think over reaction. These drugs are NOT being pulled from the market. Just letting docs know about past issues...'

So there it was, Sanford Bernstein saying the almost 6 pt plunge was based on old & insignificant news. I knew this was the kind of defense that could be bought with size.

Around 11:54 AM ET to 11:55 AM ET I distributed the following to all Notable Call Network (NCN) members:

GENZ - SANFORD BERNSTEIN DEFENDING - we think over reaction. These drugs are NOT being pulled from the market. Just letting docs know about past issues! - (not sure if it's confirmed - fyi)

I added the 'fyi' comment because I had not seen the actual note nor had the NCN member that sent it to me seen it. This usually happens with sales calls as the analyst realizes she does not have the time to write up a full note. So, the sales people are instructed to send out these short messages from the analyst.

I had no reason to doubt the sincerity of the sender as I have been trading alongside this high profile trader for several years.

- As you can see from the chart this represented the low in GENZ stock on Friday. Some 5 minutes later J.P. Morgan came out with a defense, followed by Deutsche Bank about 30 minutes into the bounce.

Depending on one's entry and exit up to 3-3.5 pts worth of gains were to be had from the Sanford Bernstein defend til the stock ran out of gas again after hitting the 51.75 level.

The best thing about it was that this call enabled people to take size! You could have literally bought 100's of thousands of shares and flip them for a tidy intraday profit.

Later we had Goldman Sachs out negative on GENZ (they still have Conviction Sell rating on the stock) and Merrill Lynch downgrading GENZ to Underperform from Buy around 2:10 PM ET. The latter was worth a shot yielding a quick ~0.5 pt profit.

But the main play was definitely the Sanford Bernstein defend at 11:53 AM ET. The risk/reward was there and size was to be had.

This is how Notable Calls Network (NCN) works - sharing the flow. We catch them every day.

Want to be part of NCN?

It's easy. Just shoot me a brief email that includes a short description of yourself and your AOL nickname.

Please do note that contacts via IM are limited to people with:

- 3+ years of trading experience

- Access to quality research/analyst commentary

- Ability to generate and share (intraday) trading calls

I will not accept contacts from purely technically oriented traders, penny stock fans or people who have less than 3 years of experience in the field.

Friday, November 13, 2009

Goodyear Tire (NYSE:GT): Upgraded to Buy at Goldman Sachs

Goldman Sachs is making an interesting call on Goodyear Tire (NYSE:GT) upgrading it to a Buy from Neutral with a 6-month target of $19 (prev. $17).

Goodyear shares have declined 20% (vs. an average increase of 12% for Goldman covered suppliers) since they reported 3Q09 results on Oct 28th based on weak 4Q09 guidance. While they were also surprised by the 4Q outlook, the shortfall was largely driven by the transitory accounting impact of production cuts (specifically the resulting unabsorbed fixed costs flowing through the P&L on a lagged basis), which does not impact firm's longer term outlook. Goldman sees the selloff, which put shares back to their July 21st levels, as an opportunity to build positions in the shares.

Increasing their GT estimates on better pricing outlook
Goldman is raising their 2010/2011/2012 ests to $1.05, $1.88 and $2.49, for GT from $0.95, $1.77 and $2.38, respectively, on better pricing. They expect a much more favorable supply/demand balance in 2010 to be supported by the safeguard tariffs which increase the costs of tires at lower end of the market. Firm sees Goodyear’s announced price increase of up to 6% in the US and recent price increases by Pirelli and Toyo as evidence of this.

Pricing looking like more of an opportunity than a risk
Pricing has remained a positive surprise for the industry during the past year. Following the broad based increases of 2007 and 2008, pricing remained stable in the face of falling raw material costs and extremely low levels of capacity utilization, two conditions which they thought were likely to lead to more competitive actions than actually took place. Now having exited what they would consider to be the highest risk environment Goldman thinks the pricing landscape looks good for several reasons. Most basic is that following an estimated 60mn units in Goodyear production cuts we think supply is much tighter than it has been over the last 2 years, and they believe it will be even more so as we head into 2010 where they forecast a 4% increase in tire demand versus the -27% peak to trough decline experienced over the last 4 years (using their 2009 volume estimate). Goldman also sees pricing benefiting from the safeguard tariffs levied on imports of Chinese tires. While Goodyear has largely exited the private label products that compete with these imports, by raising prices at the lower end it does establish a higher floor which is healthy for the more expensive branded products. As such they are encouraged by the price increases recently announced by or planned by Toyo, Sumitomo, Bridgestone, Pirelli and now Goodyear to offset the cost of safeguards and/or the increased cost of raw materials.

See 38% upside in Goodyear shares
Goldman expects GT to see a sizable earnings improvement post 4Q09 driven by: increased consumer tire demand, benefits from improved fixed cost absorption, and continued cost reduction from better manufacturing flexibility afforded by the new USW contract. This underpins their new 6-month PT of $19 (from $17) with 38% potential upside.

Notablecalls: First of all, this is a dual call as Goldman is concurrently downgrading Federal-Mogul (NASDAQ:FDML) to a Neutral from Buy.

GT got whacked two weeks ago following a messy quarterly report and hasn't really recovered since. It's down 3 pts and I think the Goldman blessing will help it to retrace at least 1-1.5 pts of it, putting $15 level in play today.

The car-parts sector continues to be red-hot.

Let's see how it works out.

Thursday, November 12, 2009

Apollo Group (NASDAQ:APOL): APOL Management Meeting and Campus Visit Reassure Us - ALERT - J.P. Morgan

J.P. Morgan is out defending Apollo Group (NASDAQ:APOL) following management meeting and campus visit.

Firm notes they met Apollo Group’s co-CEO Greg Cappelli and visited the company’s campus in Jersey City. Overall, they came away reassured about APOL’s approach to accounting, student retention, and 90/10.

Management’s tone around compliance and accounting was comforting to JPM.
While co-CEO Cappelli did not give any updates to the timeframe or the scope of the SEC inquiry, he sounded credible and engaged in the business. Mr. Cappelli reiterated his confidence with APOL’s accounting policies, particularly related to revenue recognition, and operational controls in various parts of the firm. He reminded JPM that members of the current senior management team (including President/COO D’Amico) had first worked with APOL in a consulting capacity tasked with (along with forensic accountants) scrubbing its financial statements. Since then, management made numerous operational enhancements, including finance and HR functions. Furthermore, senior management and the company's auditors signed off on the FY2009 10K. To the best of JPM's knowledge, there does not seem to be a direct link between the ongoing Education Department actions (focused program review of APOL and neg-reg) and the SEC inquiry, which reduces the probability of the cash flow being affected.

90/10 looks manageable when including relief.
Firm notes they were reminded that APOL's 90/10 ratio of 86% for FY2009 (Aug) was reported before the preferred treatment of the $2,000 in unsubsidized Stafford loans (approved in 2008). Including the impact, APOL's 90/10 ratio will be somewhat lower.

Quality of student experience is a top focus.
JPM believes the topic of student experience is "top-of-mind" for management. Clearly, better student experience results in higher retention and enhanced student outcomes. APOL would be willing to sacrifice some start growth to obtain more committed students. Importantly, APOL has been collecting vast amounts of data related to student behavior, and now (after about two years) is trying to put analytics around it. In addition, APOL's new free orientation pilot program is designed to help new students to self-select out of college (without debt burden), if they see college as too demanding. They also appreciate the need for such tool, particularly at Axia which enrolls students with more risk factors. Finally, the firm thought that APOL’s student-to-teacher ratio (of mid-teens) was much lower than most of its peers and traditional institutions.

Campus visit highlighted the need for continuous enhancements of the student experience.
JPM attended an entry-level class in APOL’s Jersey City campus. The demographic of the students in the class (13 students in total) was representative of inner cities with a mix of working adult students and a couple of traditional-age students. The firm thought the quality of the material was appropriate, and the instructor did a fine job of engaging students in the learning process. They also think the new Student Resource Centers provide a reinvestment in the local campuses and community activities which will bear fruit.

Maintains Overweight on APOL.

Notablecalls: While the stock is down 20pts following the SEC investigation news and overall bad publicity over the past couple of weeks, I'm not making a bounce call here following the JPM note. I would not be surprised to see a bounce in APOL but the JPM call is just a tad too superficial to inject the much needed conviction to buy the education name down here.

I would put APOL on the bounce radar and if/when the market starts ripping again an opportunity may present itself.

So, just a heads up on the call.

Wednesday, November 11, 2009

Palm (NASDAQ:PALM): Encouraging management meeting; Reiterate Buy - Merrill Lynch/BAM

Merrill Lynch/BAM is out very positive on Palm (NASDAQ:PALM) this morning following meeting with management. Firm reiterates their Buy rating and $20 price target ahead of multiple catalysts.

Management meeting reinforces Merrill's positive views
Firm notes they had an encouraging meeting with Palm CEO Jon Rubinstein, CFO Doug Jeffries and IR head Teri Klein. Their key takeaway: despite increasing smartphone competition Palm can maintain differentiation and remains well positioned to launch its products with multiple new Tier-1 carriers in early 2010 by which time it should have a robust apps catalog. While they expect the stock to remain volatile, the recent selloff creates an interesting buying opportunity, in Merrill's opinion, for a company with an attractive platform, selling into a high growth market, and at a compelling valuation. (<1x CY10E EV/S, <11x PE on $1/sh in EPS power). Next catalyst is next week’s (15-Nov) launch of Palm's Pixi smartphone at Sprint.

Substantial channel expansion in 2010
The current pressure on Palm stock is due to limited distribution of its products at just 5 carriers led by relatively weak Sprint. However they expect this situation to change substantially in early 2010 as several new tier 1 carriers (including VZ) launch Palm's smartphones. This channel expansion supports their expectations for nearly 80% HoH ramp in 2HFY10 sales that management still seems comfortable with, in Merrill's view. They note that in the past Palm has sold products via 100 carriers.

All about the ecosystem
While Palm has a breakthrough operating system, its ~350 apps catalog pales in comparison to multiple thousand apps of RIM, Android and Apple. However Palm is adding 50-100 new apps to its catalog (still in beta) every week, and they expect new e-commerce features and mid-December formal opening of the apps store to all developers. Merrill highlights here a new capability that Palm is building that will enable customers to download apps by just clicking on a web URL (as opposed to going to an app store). They believe this will dramatically improve discovery of apps and attract attention from developers. They also note new tools that will let developers integrate apps with other device functions such as the calendar. Palm also recently hired few people from Mozilla to further its apps effort.

Merrill likes Palm's new Pixi
The firm had a chance to play with Palm's new Pixi smartphone that Sprint will launch this weekend (for $99 retail) along with new advertising campaign. Pixi retains all the cool features of Palm's webOS and user interface but in a smaller, cheaper and lighter package. Despite the small size the keyboard was surprisingly easy to use. They expect the product to target a younger demographic compared to the power powerful and fully featured Pre product.

Strong balance sheet for investing in marketing campaigns
With its recent secondary offering Palm now has over $570mn to co-invest with carriers in marketing programs and accelerate R&D of new products and applications. While cash burn could persist for another 1-2 quarters they believe the company has the required resources to execute on its current business plan.

Notablecalls: First of all, I have and continue to be skeptical of PALM on the long-term (see the archives).

Yet, with the stock down 40% from its recent highs in just over a month, it may be due for a bounce. Here's why:

- As Merrill highlights, PALM is going to add several new tier-1 carriers like Verizon over the coming months. This will help sales.

- Palm is set to launch their new Pixi smartphone this weekend at Sprint. Reduced features at a reduced price seems one for the kids. With a new ad campaign it will likely help sales & feed the hype.

- PALM's short interest stands at over 30%.

- The secondary overhang is gone. Palm is flush with cash (to burn) and will likely stay off the market for at least couple of years.

- Finally, there's the ever present chance of a takeover.

So, a beaten down stock, with catalysts and hefty short interest.

I think you can catch a nice 50c-1pt bounce in PALM as soon as today, putting the $11.50-12.00 range in play.

Monday, November 09, 2009

Abercrombie & Fitch (NYSE:ANF): Upgraded to Conviction Buy at Goldman, Outperform at Credit Suisse

Abercrombie & Fitch (NYSE:ANF) is getting two upgrades this morning:

- Goldman Sachs upgrades ANF to Conviction Buy List from Neutral with a 6-month price target of $45.

According to the analyst they view the story as increasingly attractive within the context of their investment framework, given a combination of: 1) Significant longer-term growth drivers: Accelerating international store openings have the potential to almost double EPS in 2010 due to the much higher productivity and profitability of these stores; Goldman sees ample room for more international openings in 2011 and beyond; and 2) Company specific drivers for improving sales trends in existing stores, including a more vocal value message (which is starting to help traffic) and returning tourist visitation to the US.

Catalyst
ANF shares are 58% off their two year high vs. an average of only 25% for Goldman's apparel retail coverage. While the international profit opportunity has been part of the bull case for some time, they see it as a bigger catalyst for shares in the coming quarters as the pace of openings is accelerating notably vs. last 12 months and domestic profit erosion should be much less of an offset thanks to drivers noted above. Goldman expects ANF’s stock to react favorably to improving sales trends in coming months and upside to EPS in 4Q and beyond. Assuming higher sales, they raise their new 2009/2010/2011 EPS forecasts to $1.11/2.02/2.67 from $0.99/$1.91/$2.49; new estimates average 22% above consensus.

ANF’s more vocal value message is now starting to close the gap on traffic
Goldman's analysis of ANF’s transaction trends vs. peers highlights the severe relative traffic loss ANF experienced over the past four quarters as peers promoted aggressively. It also shows the relative improvement in transactions ANF has seen in recent months as they have become more vocal on value.


- Credit Suisse is upgrading ANF to Outperform from Neutral with a $49 price target (prev. $30) after increasing their F09E from $1.11 to $1.30 and their F10E from $2.00 to $2.17 based on higher than anticipated flagship and international Hollister stores’ revenue/margin contribution. ANF reported an in-line October comp of (15)% on Thursday, but new space productivity came in higher than expected, driven by international Hollister stores, the Milan flagship opening and e-commerce. This gives the firm greater confidence that the company can beat earnings expectations in 3Q09, 4Q09 and F10.

There are three key points to CSFB's upgrade: 1) While they have always thought the market underappreciated the near term international impact, the increasing spread between total sales growth and comps indicates international Hollister locations and the SoHo and Milan flagships are driving even higher revenues than we previously estimated, and the Tokyo flagship is not even open yet, 2) CSFB believes the combination of Ruehl closing and incremental revenues from F09/F10 flagship and international Hollister openings will drive $1.14 in incremental EPS in F10, and 3) Their estimates do not assume any turnaround in the U.S. business, although recent months give them more comfort that stabilization in F10 is likely.

Catalysts: CSFB believes ANF will beat 3Q09 EPS, to be reported this Friday (they are at $0.22 vs. cons. of $0.20), and upside to 4Q09 will become more clear (they are at $1.34 vs. cons of $1.01), driven by international strength.

Notablecalls: The shorts (15% short interest in the name) must be sweating bullets here.

Not only is CSFB out with a new Street high target on the name but Goldman Sachs is blessing the stock with their Conviction Buy rating. It can't get much worse from here for the shorts.

Note that CSFB is calling for a better-than-expected quarter this Friday, which will serve as a catalyst for the shares.

Barron's was out negative on ANF last Friday. Think that sucked in some more shorts.

So, the ingredients of major short squeeze seem to be in place. I'm guessing ANF will trade toward the $37-37.50 range today.

Friday, November 06, 2009

Peet's Coffee (NASDAQ:PEET): Janney initiates with a Buy, sees $62-$87/sh fair value

Janney Capital Markets is out with an interesting call initiating Peet's Coffee (NASDAQ:PEET) with a Buy rating...and get this...$62-$87 fair value valuation range (official target stands at $62/sh).

With the pending acquisition of Diedrich Coffee (DDRX-$25.99; NR), PEET now has access to the fast-growing single cup segment of the specialty coffee category and is participating in this trend with the market leader, Keurig. Prior to the acquisition, PEET had been increasing EPS at a 25%+ rate despite a slowdown in the core PEET retail stores, driven by a rapid increase (20%+) in Peet’s branded coffee sales in the grocery channel. The one hole in PEET’s portfolio was the lack of participation in the rapidly growing single cup coffee trend, and this is now solved through the Diedrich acquisition. Prior to the acquisition, Janney forecast PEET has a three-year sales and EPS CAGR of 9% and 20%, respectively. With Diedrich, they forecast a three-year sales and EPS CAGR of 19% and 47%, respectively. At $37/sh, PEET is trading at 35.0x their 2009 EPS estimate of $1.06. While 2010 EPS will see the dilutive impact from the acquisition primarily in the form of non-cash goodwill amortization (~$0.50/sh), they expect EPS to more than double from the estimated 2009 level of $1.06 to $2.49 (ex-goodwill amortization) in 2011. Janney's current DCF-derived fair value of PEET excluding Diedrich is $40/share. Applying a forward P/E range of 25.0x to 35.0x (31.7x historical average) to their 2011 cash EPS estimate (including Diedrich) of $2.49 yields a twelve-month fair value target range of $62/sh to$87/share.

PEET’s leadership in specialty coffee is now enhanced with the ability to participate in the rapidly growing single cup coffee segment. Prior to the acquisition of Diedrich, PEET did not have a single cup offering. With the acquisition, PEET will now participate in the segment with the market-leading Keurig system (owned by Green Mountain Coffee Roasters (GMCR-$68.04; BUY).

PEET’s solid top line growth has been driven by grocery expansion (20%+ YTD). Growth in the channel has been the result of expanded geographic distribution into the Eastern U.S. At the end of 2Q09, PEET had added approximately 1,200 new grocery store accounts over the past twelve months for a total of 8,400 doors in the grocery channel. The addition of Godiva coffee to the PEET’s distribution system will provide incremental growth over the next 12 months.

PEET’s grocery distribution strength is an accelerator for Diedrich K-Cups penetration: PEET’s unique direct store distribution (DSD) system for specialty coffee has helped PEET gain meaningful share in a relatively short period of time in the grocery channel. Janney believes PEET’s grocery strength will accelerate Diedrich K-Cup sales through the grocery channel (currently very small).

Significant incremental earnings growth from Diedrich: Though management’s 2010 guidance range of $0.80/sh to $0.90/sh (compared to previous 2010 EPS guidance range of $1.24 to $1.30) implies roughly $0.35/sh to $0.50/sh of dilution related to the Diedrich acquisition in year one, Janney expects the acquisition to be on a cash basis ($1.45/sh cash vs. $0.92/sh GAAP). Management’s revised 2010 net revenuev guidance ($440 to $460 million) implies ~50% growth in Diedrich sales.

Single cup coffee a trend – not passing fad: Janney believes single cup coffee has clearly elevated itself from fad to trend. Led by industry leader Keurig (85% share of single cup brewer sales), they believe single cup brewing remains in the early innings of household penetration. Keurig brewers have been growing at a rate in excess of 100% over the last two years, and they believe this rapid growth will continue for the foreseeable future. Firm expects that the installed based of Keurig brewers will end 2009 in approximately 3.7 million homes and 375,000 offices. Based on approximately 90 million households with coffee brewers, Keurig’s share remains in the 4% range; they ultimately believe single cup brewing could reach 20% of all U.S. brewers - and Keurig is the far and away leader.

Impact of Peet’s branded K-cup: Janney estimates Diedrich has a current 14% share of systemwide K-cups through its Diedrich, Gloria Jeans, and Coffee People brands. According to Diedrich management, the Coffee People Donut Shop coffee is the number one selling K-Cup in the Keurig system, and their Gloria Jean’s Hazelnut coffee is the number one flavored coffee in the system. Given PEET’s loyal customer base on the west coast (and growing nationally), they believe PEET should help accelerate Keurig brewer growth and provide incremental K-Cup growth with the Peet’s brand.

Another way to look at Diedrich: Based on their estimate of systemwide K-Cup volume of 6.5 billion in 2012 and a 10% market share for Diedrich K-Cups (ex-Peet’s K-Cups), Janney estimate Diedrich would have volume of 650 million K-Cups. Assuming Diedrich’s gross profit is $0.10/K-Cup, Diedrich K-Cup gross profit would be $65 million in 2012. Assuming $10 million in selling expenses (could be less due to PEET infrastructure leverage); pre-tax earnings would be $55 million and on an after-tax basis on higher share count, would represent an incremental $2.15/sh to earnings in 2012.

Notablecalls: Wow - $62-87/sh fair value range for PEET sounds pretty amazing. Now, take look at the charts of GMCR, DDRX & CBOU - The coffee group.

The Coffee group are movers.

And now Janney comes out and blesses PEET, another coffee name with a huge, just HUGE price target.

I discussed the call with a fellow trader and this is what he had to say:

'... I would not be surprised to see PEET pushed to $39 today. I'm not even going to rule out higher levels. This stock has potential to go nuts...'

NC: I agree. I'm tempted to call this one Actionable Long.

Amazon.com (NASDAQ:AMZN): Upgraded to Outperform at Sanford Bernstein; $160 target - New Street High

Sanford Bernstein is making a major call on Amazon.com (NASDAQ:AMZN) upgrading their rating to Outperform from Market Perform with a $160 target (prev. $125).

Firm notes they believe that current valuations give Amazon insufficient credit in three areas. First, they think consensus revenue growth estimates of 32% YoY for 4Q:09 and 25%YoY for 2010 are too low. They think Amazon's revenues will re-accelerate to 41% YoY in the seasonally high 4Q:09 and average at least 35% in FY2010 (versus 28% for FY 2009) driven by a) the higher spending power of Amazon customers, which they think has been underestimated; and b) the company’s 30 new product category introductions in 2009.

Second, Sanford thinks consensus GAAP operating margins of 4.6% in 4Q:09 and 5.1% in 2010 have also been underestimated. They expect GAAP operating margins to reach 5.3% in 4Q:09 and 5.4% in 2010 driven by: a) the company's improved ordering and safety stock algorithms and b) a growing share of apparel in the mix.

Third, although they see some risks from increased capital expenditures, they think the market is underestimating the strength of Amazon's free cash flow in 4Q:09 and in 2010 in particular the benefit of negative working capital, which they think will boost free cash flow by just over $1 billion in 2010. Accordingly the firm is increasing their 4Q:09 (GAAP) earnings estimate to $2.04 and their FY 2010 (GAAP) estimate to $3.07. Firm forecasts that 52% earnings growth will enable Amazon to maintain a 46x GAAP P/E multiple on 2010 earnings ex-cash (or 52x 2010 total earnings) giving them new price target of $160, which is also supported by firm's DCF model.

- Sanford expects revenue re-acceleration to continue through 2010: They think 4Q:09 revenues will come in at just under $9.5 billion or 41% YoY in 4Q:09 and slightly exceed $33 billion or growth of 35% YoY in 2010 thanks to: a) faster than expected revenue growth – especially the N. American media business: b) continued expansion into new high growth categories; c) strong overseas growth boosted by a currency tailwind in 2010; and d) higher than average discretionary spending from the company's superior consumer demographics.

- Sanford expects sustainable improvements to both gross and operating margins. Although the one-time costs of $35 million associated with the Zappos acquisition will impact 4Q:09 GAAP operating margins, they think the recent underlying 100bps improvement in U.S. margins is sustainable and expect operating margins to reach 5.4% (GAAP) or 6.9% (pro-forma) in 2010 thanks to: a) a shift in product mix to higher margin apparel, which they think will offset the deceleration in book sales; b) continued buying power and scale leverage; and c) superior logistics management, especially shortening of wholesaler delivery times which was a major factor in the 3Q:09 margin improvement and is eminently sustainable.

- Although they see some risks from increased capital expenditures and possible further acquisitions, they think the market is underestimating the continuing strength of Amazon's free cash flow. Specifically, they believe the following: a) Amazon's large cash flow boost from negative working capital is sustainable and will increase in 2010; b) much of the increased capital expenditure needed for distribution center expansion was incurred in 2008, greatly benefiting cash flow in 2009 and 2010; c) although the company plans to expand overseas it can currently serve almost all international regions from its existing distribution network – Sanford thinks it is unlikely to tackle new geographies before 2011.

Notablecalls: Sanford Bernstein analyst Jeffrey Lindsay is surely making a name for himself here with the new Street High target of $160 (previous high was J.P. Morgan with their $150 target).

The call itself doesn't highlight anything new but given the trading dynamics, it may prove to be a significant one. The thing is that a lot of people have been using AMZN as the vehicle of choice to lean short the general market. It's up a lot, carries a hefty valuation and is hated for its accounting.

Yet, it started perking up again yesterday. That should create some nervousness among the shorts. There is little doubt about Q4 being very strong and that could yield a $130-$135 stock. Nobody on the short side wants to be 10-15 pts in the hole even from current levels.

One thing to remember about AMZN is that despite its size the stock is a stealthy mover. It can sit quietly for hours in the pre market just to explode again after the open. Given it's Sanford Bernstein (and not a tier-1 firm) upgrading the stock that looks to be a likely scenario.

With the little help from the market I think AMZN can trade to $124 (or higher) today.


PS: We have non-farm payroll data out 8:30 AM ET today so that's a variable one must consider here as well.