Friday, October 29, 2010

Vivus (NASDAQ:VVUS): Upgraded to Overweight at JPM

Vivus (NASDAQ:VVUS) is going to hurt the shorts today after receiving a CRL in Qnexa, its weight loss drug.

- J.P. Morgan is upgrading VVUS to Overweight from Neutral with a $13 target (prev. $6) saying all things considered they believe this is a relatively benign CRL, although perhaps not as good as it could have been. The letter’s language around cardiovascular (CV) risk is the one component in particular that gives us some pause and will likely be what the bears try to hang their hats on. Nevertheless, their interpretation of the letter is that it provides a manageable path to approval in 2011, which should be enough to drive meaningful appreciation in VVUS shares over the next several quarters. As such, they are upgrading VVUS to OW and raising our 2011 PT to $13. Importantly, with the worst case scenario (significant new pre-approval trials) off the table—at least temporarily—we suspect downside could potentially be limited from current levels.

CRL overview: 5 issues in focus. According to the company’s press release, the CRL touches on five issues, including 1) clinical, 2) labeling, 3) REMS, 4) a safety update, and 5) drug scheduling. In our view, the clinical component—focusing on teratogenic (birth defect) and CV (heart rate) risk—is the only one that matters as far as getting Qnexa over the goal line. While the FDA apparently left the letter somewhat vague and open-ended (at least that’s how the PR reads), firm is encouraged that no new clinical trials are required at this time and that Vivus believes it can submit its response in ~6 wks. They await more detail on Friday morning’s call, but in the meantime, they work through the key issues below.

CV risk is still a hurdle, but JPM thinks Qnexa can clear it. As indicated, their most significant concern in the CRL is the language around the implications of increased heart rate and the need for evidence that it “does not increase the risk of major adverse CV events. Vivus intends to provide several new analyses exonerating Qnexa. JPM suspects these have to do with the recent disclosure that across the entire 4,323 pt development program for Qnexa (incl 2-year SEQUEL data), serious CV and neurovascular AE rates in pts taking the drug were similar to placebo with a relative risk of 0.59 (95% CI: 0.33-1.06). That’s a 41% relative risk reduction in favor of Qnexa. Moreover, firm's comfort with Qnexa’s CV profile is reinforced by the product’s demonstrated favorable effects across a range of key cardiometabolic risk factors including waist circumference, systolic and diastolic blood pressure, total cholesterol, LDL, HDL, triglycerides, HbA1c, fasting plasma glucose, and fasting insulin. These benefits are also accompanied by statistically significant improvements in inflammatory biomarkers such as CRP, adiponectin, and fibrinogen.

- Canaccord reits Buy rating on VVUs and raises its target to $15 (from $10). Firm views the letter as benign; it asks for more data and analyses but no new studies. They believe that VVUS’ resubmission in about six weeks will pave the way for approval around mid-year 2011.

Investment highlights
The CRL asks for more information on birth defect risk, cardiovascular effects, and the full data from the two-year SEQUEL study. There will also be more discussion about labeling and REMS.

Firm thinks FDA is showing that it listened to the July ad com’s concerns and providing a path to approval for VVUS.

VVUS believes that it can assemble the necessary preclinical and clinical data (including a final study report of SEQUEL) to enable resubmission in approximately six weeks. Assuming a Class 2 designation, this should set up approval in mid-2011.

They will be listening for more color from VVUS’ 8:30 am EDT conference call.

Notablecalls: My only question is - this' going to $8.00 today? or higher?

- Arena (ARNA) didn't go down on way more negative CRL. Also, ARNA's news came out ahead of Vivus', which probably lowered the expectations even more.

- VVUS has a 20% short interest & a tight float.

- Vivus believes they can submit their responds in 6 weeks, which is a surprise. Given this ultra-short time frame it seems (seems!) they have the CV/birth defect data to assuage FDA.

Again, only question is - this' going to $8.00 today? or higher?

Thursday, October 28, 2010

Savient Pharmaceuticals (NASDAQ:SVNT): The Price Is Right, upgrade to Outperform - Cowen

Cowen is upgrading Savient Pharmaceuticals (NASDAQ:SVNT) to Outperform from Neutral saying they think Krystexxa could generate WW sales in refractory gout of $600MM and believe the asset is worth $19/share on an NPV basis. Although timing and/or price may have dissuaded potential acquirers from making a bid for Savient, Cowen believes that Krystexxa’s unparalleled efficacy (enabling premium pricing), longevity (biologic), likely high profit margins (specialty market) will continue to make it an attractive strategic asset.

What Just Happened? Savient shares are down >40% following the company’s failed attempt to sell itself. Discussions with management indicate Savient is now focused on building shareholder value via a successful U.S. launch of Krystexxa. While the company will likely need time and additional capital to prepare for a launch, Cowen's view on Krystexxa’s ultimate commercial opportunity is unchanged as 1) they had viewed Savient as fully valued at the time of M&A discussions and 2) they see no reason to question their market assumptions based upon recent events.

Cowen's View On The Key Issues. Following the company’s decision to launch Krystexxa on its own, bulls and bears are now debating multiple issues. They believe there is much unmet medical need in refractory gout and view Krystexxa’s efficacy as unique. As such they expect Savient to obtain pricing in the $50K/year range. Based upon conservative assumptions for the size of the refractory gout population (50-60K patients), penetration (12% in 2015), and duration of therapy (3 or 12 months depending on patient’s response), they estimate U.S. sales of $300MM.

Where Could They Be Wrong? Refractory gout is a virgin market. As such, estimates for the size of the treatable population are wide ranging and uncertain. It will take time before Krystexxa is reimbursed, and the drug’s launch is likely to be slower than consensus expectations.

Notablecalls: I must say I was kind of surprised to see the stock get crushed (-40-50%) on Monday after the co said it would go it alone. Felt like a mis-pricing on the market's part.

Let's not forget big pharma is still out there, desperately looking for (revenue) acquisition candidates. Savient still fits the bill. Management was probably too arrogant following the approval but time & chance happen to us all, eventually. Expectations were reset and the co is still in play.

Bubbleheads at JMP Securities downgraded the stock yesterday morning, which resulted in a big squeeze. I didn't even bother to read the note. I mean guys, really?!

All in all, I think SVNT will work its way back towards the $14 level, possibly as soon as today. I feel large buyers at at work here. Don't chase it pre-market. Let it come to you after open.

Wednesday, October 27, 2010

Equinix (NASDAQ:EQIX): Colour on quarter - Bounce?

Equinix (NASDAQ:EQIX), the latest nail on my coffin, is enjoying some hot analyst lovin' this morning after the co issued above consensus guidance for 2011.

- Cowen reits Outperform noting quarterly revenue and EBITDA results were slightly above reduced guidance Equinix issued on October 5, however they were more encouraged with initial 2011 revenue and EBITDA guidance of >$1.500B (Street: $1.491B) and >$675MM (Street: $660MM). The company also expects a meaningful reduction in capex next year suggesting it will be FCF positive an important milestone that investors have been looking for. While heightened churn in Europe negatively impacted results in that market the company showed solid results in both North America and Asia including better than expected cabinet adds and revenue per cabinet. Overall, results further confirm Cowen's view that its recent pre-announcement was not indicative of deteriorating fundaments and believe the recent sell-off provides a significant buying opportunity.

Fundamentals intact.
*Issues at Switch and Data already improving.
*Reduced capex means company will start generating FCF.
*Equinix will host its Analyst Day in New York on November 11.

Valuation. EQIX trades at 7.2x 2011E EBITDA versus the comp group at 10.6x. Cowen believes EQIX should trade at a premium based on its industry leading growth and margin and its ability to generate significant cash flow in outer years. Using a 9.0x exit multiple and a 10.9% WACC, firm's DCF valuation suggests EQIX can outperform the market by 30% over the next 12 months.

- Deutsche reits Buy and $100 target saying their overall takeaway from full 3Q results is that this should help investors begin to get more comfortable that the 3Q miss was company specific and fixable. The company did a good job on the call providing further clarity into the issues (churn, pricing) and provided 2011 guidance that was ahead of expectations. As a result, they are raising their forecasts and reiterate their Buy and $100 target. Firm likes the stock at current levels and thinks it slowly works its way higher as it rebuilds investor confidence.

At $80, the stock trades at 7.4x 2011 EV/EBITDA, near the bottom of its historical range of 7x – 17x. The analyst day on November 11th could prove a positive catalyst and they think the stock can work its way back over time to where it was pre-3Q miss.

- Morgan Stanley is a bit more cautious on the name saying that despite better than expected MRR / cabinet results, they see risks to 2011 EBITDA guidance on higher churn (set to average 2.7% in 2H) and expense pressures. While management’s plan to address SDXC was encouraging, they believe that efforts may be in their early stages, with a turnaround unlikely until mid-2011. Firm sees significant risks for higher capex in 2011 than in current guidance, although they now forecast FCF breakeven results. In their view, EQIX remains a show me story, despite the near historical trough valuation (ex the credit crisis) at 7.6x 2011E EBITDA.

- Piper reits OW & $110 target noting Equinix is beginning to make the transition from a high growth company to one focused on balanced growth and free cash flow generation. They believe management is now focused on free cash flow generation with growth layered on top. As the firm noted in their October 21 note ("What Is Equinix Worth?...), they estimate that valuing the free cash flow generation could yield to a 2012 valuation of $108. Piper realizes that the stock is not likely to recover to these levels until investors have confidence that supply/demand/pricing trends are positive; however, they think the current stock price represents a good buying opportunity for investors with a 12-month horizon.

Notablecalls: So there you have it, it looks like EQIX can indeed overcome the brief speed bump that caused its stock price to crash 35 pts on Oct 6.

Given my awful (just awful!) track with EQIX, I'm not going to make an outright call here. I think its going higher from the $80 today and in the n-t. But my guess is worth squat here.

Just don't chase it, let it come to you.

Tuesday, October 26, 2010

Veeco Instruments (NASDAQ:VECO): Colour on quarter - Bounce?

Everyone looooves Veeco Instruments (NASDAQ:VECO). Ok, not everyone. Shorts hate it. But the MOCVD equipment maker's hot love affair with the analyst community continues even after the co posted in-line results and slightly worse than expected order guidance last night.

- J.P. Morgan reits their Overweight rating and $75 target noting exceptional margins, large backlog, and strong demand from China offsetting modest weakness in Korea.

- UBS's Stephen Chin reits Buy and $54 price target saying Veeco reported all-time record high margins and EPS and guided higher again in 4Q10 despite disruptive Korean customer shipment rescheduling from 4Q10 into 1Q11 and zero new Korean LED tool orders in 3Q10 and 4Q10.

Veeco guided 2011 sales to be higher than $1B, which suggests 2011 EPS should be higher than $4.74, compared to consensus at $4.67.

Chin estimates Veeco’s net cash balance will be about $600M, which is $14/share, at the end of the Dec-10 quarter, assuming Veeco does not spend any of its net cash on the remaining $168M in its stock buyback program.

- Citigroup reits Buy and $52 target noting that following their Asia trip, they haven’t been overly excited about the near-term set-up here given what is now a transitional phase of order/backlog choppiness. Indeed, with a slightly disappointing order number, the stock is apt to trade off and remain range-bound in the near term especially if they are right about orders being down another ~20% Q/Q in CQ1. More broadly, however, even if China only took ~325 tools in 2011 versus what appears now to be ~550-575 (acknowledging the speculative nature of a portion of shipments into China), Citi estimates VECO still earns ~$4.30 in C2011. This is just slightly lower than Street $4.70.

Combined with ongoing share gains (AIXG continues to struggle w/its new G5) and ~$12/share net cash in CQ4 and ~$15 cash YE2011, this means VECO trades <6x downside C2011 EPS in an industry with excellent longer-term growth prospects. So, while CQ1 should keep the stock range-bound as it looks now, there is more than ample room for multiple expansion given improving visibility into general lighting and better sentiment around the TV market. Adjusting estimates as high margins offset revenue pushout: C2010 EPS from $4.28 to $4.64, C2011 EPS from $5.14 to $5.72.

Positives — 1) Big cash flow provides added flexibility; and 2) share gains should continue given AIXG struggles to ramp G5 (some custs switching back to G4).

Negatives — 1) MOCVD orders look down ~20% Q/Q in CQ1:11; 2) Citi estimates at least 75-80% of tool shipment in CQ4 will be to China which fuels bears’ skepticism; and 3) TV-related orders unlikely to come back much for a few Qs

Notablecalls: Could see a bounce. Order momentum is slowing but the thing has 14 bucks per share in cash & and short interest still stands at 30%+.

Look at what CREE did after posting similar results.

Not exactly a high conviction call but I thought I'd share. Feedback appreciated.

In a beauty contest its not who you think has the finest ass it's who the judges think does. The judges seem to love VECO.

Monday, October 25, 2010

Citigroup (NYSE:C): Added to Goldman Conviction Buy List with $5.50 target

Goldman Sachs adds Citigroup (NYSE:C) to their Conviction Buy list today with a $5.50 price target (prev. $4.60) as:

1) the current valuation discounts a significantly lower ROA/ROE than the 120 bp/16% they estimate post the run-off of Citi Holdings;

For Citigroup Goldman expects steady-state earnings of about US$20 bn (equivalent to about $0.70 per share) based on 117 bp ROA and ‘core’ assets of US$1.7 trillion. Given their base case for a 3-4 year projected run-off of Citi Holdings, the firm believes that Citicorp can potentially reach this level by 2014 and along the way asset run-off in Citi Holdings should continue to generate significant capital.

2) its private label MBS exposure is small relative to peers, limiting put-back risk;

3) disposal of the 10% government stake should be completed by early in 2Q11, eliminating the stock overhang;

On the former issue, the government is currently working on its fourth selling program (1.5 bn shares), and once this is complete we anticipate just over 2 bn shares remaining heading into 2011. To put the 2 bn shares into perspective, that is less than 4 days of average daily trading volume for Citigroup, or said otherwise, only 45 trading days would be needed to sell the remaining stake assuming shares are sold at 8% of average daily volume.

4) Goldman estimates C's core earnings power ($20 bn pa) and excess capital from the run-off of Citi Holdings supports their $5.50 12-m price target (35% upside).

Notablecalls: I'm somewhat surprised to see Citi added to the List at Goldman, so I think it sees some buying interest into $4.30.

Tuesday, October 19, 2010

Apple (NASDAQ:AAPL): Colour on quarter..

Apple (NASDAQ:AAPL) is getting a lot of supportive commentary from the analyst community this morning after posting strong headline results on somewhat weaker gross margins which led the stock down around 6% in after hours trading.

I'll highlight only the more interesting ones:

- J.P. Morgan notes that shares of Overweight-rated Apple may come under near-term pressure, but it should be a phenomenon they expect to pass quickly. Gross margins of 36.9% were below Street consensus expectations of 38%. Meanwhile, iPad units came in below elevated investor expectations. Despite these bumps, Apple's meteoric revenue and profit growth and 14.1 million iPhone units should be enough for the bulls to keeping running. Market momentum stands to continue in each of the company’s three main products, and the absolute numbers should keep getting bigger. At 17.2x JPM revised C2011 EPS estimate, versus the peer group average of 14.2x, they believe Apple is trading like a value stock and not as the high-growth story in large cap equities.

Gross margins are a set-back, but absolute numbers should keep climbing. Gross margins came in better than company guidance of 35% but below the Street consensus estimate of 38%. Firm thinks investors will re-adjust for the gross margin setback and guidance, taking all in stride given the total revenue and profit growth profiles continue to rise. Competitive pricing by Apple in both the iPhone 4 and iPad weighed on gross margins, and costs related to a richer iPhone 4 feature set (i.e., Retina Display and Accelerometer) also were drags. During the earnings call, the company’s commentary indicated these factors would not dissipate.

Investors may have a mixed reaction to CEO's participation on the call. CEO Steve Jobs made a special appearance on last night’s quarterly conference call. Mr. Jobs passionately discussed the competitive environments related to the iPhone and iPad and answered analysts’ questions. JPM thinks that investors may have more questions than answers as to why Mr. Jobs participated on the call.

In firm's view, investors could speculate his appearance was a “smoke screen” to deflect attention from the gross margin weakness or lighter than expected iPad unit shipments. Alternatively, on a more positive note, they think that Mr. Jobs may have been on the call to trumpet the company’s break-out revenue performance, eclipsing the $20 billion revenue threshold on a quarterly basis, which is a major milestone. Lastly, Mr. Jobs may have been on the call to downplay the media hype related to the pending onslaught of competitive responses to the iPad.

On this last point, they believe that Apple’s iPad market leadership could be retained longer than Bears may fear. JPM notes they are skeptical of competitive tablets exhibiting any sort of similar adoption curve as the iPad’s. In JPM's view, the key factor driving the separation from other tablet vendors stands to be Apple’s access to content. With tablets, they think that offering a trove of applications, as is industry practice in smartphones, will not be enough. The ability of the user to access content, such as movies and TV shows, is more important for tablet users, and this is where Apple has fought hard to secure access to content.

- Bernstein notes Apple's FQ410 top-line and bottom-line results were very strong, handily beating consensus revenue and EPS. As a result they are raising estimates for FY11 to $20.49. iPhone sales of 14.1M units were significantly above expectations and led to the revenue beat ($20.34B vs. consensus at $18.8B). EPS benefited an estimated $0.23 from a lower than expected tax rate; ex- this adjustment, Apple still beat EPS (4.41 vs. 4.08) expectations by 8%. The company guided for above consensus revenue for only the fourth time in 11 quarters, reaffirming Bernstein's belief that Q1 should be a very strong quarter.

The big question is what happened to Apple's gross margins, which declined sequentially despite a huge mix shift to high-margin iPhone. Bernstein's analysis suggests that iPhone gross margins may have been 700-900 bp lower in FQ4 vs. FQ3 due to a sequential increase in iPhone 4 BOM of $40 - $50 vs. the iPhone 3GS. Given that Apple's guidance for Q4 appeared to have only forecast a decline in iPhone GMs of about 500 bps, the firm wonders if Apple was somehow blindsided by higher COGS, potentially as a result of extraordinary demand for the device. If true, then some of the GM pressure experience in the quarter could reverse going forward.

Bernstein's analysis suggests that iPhone GMs declined 700-900 bps sequentially, however they don't believe the margin decline can be attributed to either competitive pressures or pricing pressure from carriers (stand-alone handset ASP actually improved sequentially from $595 to $610); rather they believe this was due to an increase in BOM on the iPhone 4. The question remains whether Apple should have been more prescriptive/explicit in its guidance for gross margins in FQ4, or whether Apple was blind-sided by higher than expected COGS during the quarter, potentially because of extraordinary iPhone demand. Ultimately, Bernstein thinks it may have been a bit of both.

While Apple's stock was down over -6% in after hours trading and there will likely be strong debate among investors regarding gross margins, the net result is that Berntein has increased their FY 11 revenue and EPS estimates by 9% and 5% respectively, and believe that even if the iPhone 4 does have sustainably lower margins than its predecessor, its increased functionality has led to a step up in demand that is meaningfully accretive to overall earnings. Ultimately they believe Apple made a bet that significantly increased functionality on the refreshed iPhone would drive a step-function increase in demand, and that is exactly what has transpired. Whether Apple should have guided gross margins more carefully last quarter, or whether unprecedented iPhone demand blind-sided Apple and hurt margins are interesting questions, but the end result is that iPhone revenues and gross margin dollars were higher than the most ardent bulls had expected for Q4. Additionally, surging iPhone sales volumes are also strategically important in helping Apple secure its first-mover advantage vs. other device manufacturers

Investment Conclusion
Firm rates Apple outperform with a price target of $375. They believe that the stock is attractively valued (trading at an EV/FCF on FY 2011 results of less than 12x, in line to below the market) and consider it the most secularly attractive name in their coverage universe.

Notablecalls: The 1st line of JPM's comment is about as cautious as the analyst community goes on AAPL this morning. Everyone else is still very positive on the name. The stock traded as low as $294 after the halt last night and is now back above the $300 level this morning. While I don't have a strong view on the stock today, please consider the following:

- Over the past years Apple has been in the business of building a better mousetrap. The Mac, the iPod, the iPhone were all better mousetraps.

- And then cometh the iPad. The Pad's not a better mousetrap. It's a completely new one. Building something completely new is way more expensive than building something that is just merely better than the predecessor. This is what lies ahead for Apple - higher costs.

Again, I have no view on AAPL this morning. My brain (deductive logic) tells me to go ahead and buy the low $300's but my gut tells me to stay away as the bounce may not last long...

Monday, October 18, 2010

Synaptics (NASDAQ:SYNA): Touched Down: Upgrading to Overweight - JPM

J.P. Morgan is making a big out-of-consensus call on Synaptics (NASDAQ:SYNA) upgrading the name to Overweight from Neutral with a $40 price target.

Firm believes SYNA will hold share in the PC/laptop market, garner share of the nascent 'slate' computing market, and grow with the high-end smartphone market. In this context, even with ongoing price pressure from Cypress, Atmel and others, they believe that consensus estimates are too low, and that the multiple can expand from these trough levels with solid execution. The market is opaque, competitive rivalry is acute, so it’s difficult to muster up high conviction, nonetheless, coming off a third consecutive double-digit growth quarter, they believe risk-reward is favorable at this price levels and are therefore upgrading to Overweight

Growing with the market. JPM believes SYNA continues to dominate the PC/laptop market, with the overall PC market tracking 7.6% y/y growth in 3CQ10 (source: IDC). SYNA has signaled its expectations that design wins in the nascent slate market will lead to material segment revenue in CY11, not least with a 2-chip Clearpad 7200 solution buoying ASPs. In handsets, despite continued competitive pressure from Cypress and Atmel, in particular, SYNA is achieving record revenues, design-win activity points to future growth, and they believe the firm can grow with the market. J.P. Morgan's Telecom analyst, Rod Hall, is looking for 50% y/y smartphone unit growth in 2010, 49% in 2011, accelerating to 58% in 2012 as the international market accelerates.

JPM is raising estimates slightly with this note, increasing the handsetrelated growth rate to align more closely to J.P. Morgan’s forecasts, offset by slower growth for the PC/laptop segment. They believe the adjustment also better reflects mix-shift revealed by the company achieving record handsetrelated revenues in F1Q as revealed in the 10/11 preannouncement. Firm projects FY11 PF EPS of $2.64, which is ahead of consensus (Street $2.38). They look for the company to report $0.69 PF EPS in F1Q11 on revenue of $153mm. SYNA reports F1Q11 results on October 21. The conference call is at 5pm ET; dial-in 877-941-8416

There is hair on this story. JPM believes much of the risk is already priced into the stock; the market has been debating the module-to-chip and the market-share loss in handsets for nearly 2 years. There are, however, new risks to consider, including the possibility that the slate market stifles growth of the PC/laptop market, shifting the market away from SYNA’s relative strength. In addition, the unexpected resignation of the CEO on 10/11.

SYNA is currently trading at 9.3 times CY11E PF EPS, which is a 52% discount to the firm’s 5-year mean trading multiple, and a 50% discount to the mean of JPM coverage, notwithstanding anticipated 2-year revenue growth of ~15%. JPM's December 2011 price target remains $40.00.

Notablecalls: As I said, this is surely an out-of-consensus call from JPM's Paul Coster and his team. A quick look at analyst consensus reveals that there are a lot of firms rating SYNA as a Sell. The reason being competition. It seems that Asian players like Alps Electric are eating SYNA's lunch in touchpads with CY, ATML, TXN etc. pushing into SYNA's territory in mobile touchscreens.

The co has lost several key people over the past year, including the head of handheld systems and more recently, the CEO.

The thing that happened with SYNA was that they were always the technology leader in touch-based interfaces...right until the technology went into masses. So getting a new CEO may not be the worst thing.

Now, there is some hope in form of Tablets or slates as JPM describes the iPad-like devices. As many of you know, these devices have touch-only interfaces which should be quite positive for SYNA. It also looks like the Tablets are becoming increasingly popular. So, there may be some unexpected upside to current consensus estimates for SYNA.

Couple this with a huge 45% short interest and you'll likely have a winner. Note how the stock absolutely refused to go down following the CEO resignation last week?

I would not be surprised to see SYNA trade above $27 level today & closer to $27.50 if the general tape plays ball.

Friday, October 15, 2010

Apple (NASDAQ:AAPL): Expect In-Line Quarter Despite Headwind Of iPhone & iPad Supply Shortages - Piper

Apple ALERT! - Piper's Munster is not so high on Apple's qtr.

We expect September quarter results in line with the Street; but note results would have been better if not for iPhone and iPad supply shortages world wide that we have monitored throughout the quarter. We believe the printed numbers for iPhone and iPad are less relevant than usual given the lack of supply and we expect the company to address these supply shortages on the earnings conference call.

Bottom line: we believe over the next three months, investors will become increasingly more optimistic that the Street revenue growth in FY11 of 26% y/y is conservative given the size of Apple's addressable markets combined with the company's relatively small market share. Assuming Apple guides December quarter consistent with past guides implies $22.76b and $4.41 EPS (Street $22.1b and $5.01 EPS).

- Don't expect typical EPS upside due to iPad. The Street is looking for EPS of $4.05. Assuming a typical beat over the past 17 quarters, Apple would report $4.80. To get to $4.80 on $18.8b in revenue would require gross margin of 43%, well ahead of 39.1% in June, the Street's 38% September estimate and guidance of 35%. The bottom line is the mix shift and revenue upside driven by the lower margin iPad (about 30% gross margin) significantly tempers EPS upside potential. Over time, we expect iPad margins will trend higher, and give Apple the opportunity to post upside consistent with historical trends.

- iPhone: (37% of sales) Supply Shortages Persist, Limit Upside. Ultimately we remain comfortable with our 11.0m iPhone estimate which is in-line with consensus, but recognize that supply constraints may limit upside.

- iPad: (16% of sales) Strong International Demand Could Be Muted By Production Limitations. The Street is looking for 4.7m iPads in September, compared to our 4.5m estimate. We are slightly below the Street because of uncertainty in the supply levels internationally. See details on page 2.

- Mac: (25% of sales) NPD Tracking In-Line To Slightly Ahead Of Street Consensus For Sept.

- iPod: (9% of sales) NPD Data Suggests Units Of 10.0m-10.5m (Street ~10m) For Sept. Qtr.

Notablecalls: This is going to hurt Apple. Hudson chose a bad day to hype themselves (see below).

Apple (NASDAQ:AAPL): $500 target from Hudson Square!

Daniel Ernst from Hudson Square Research is making a name for himself with a $500 price target (prev. $300) for Apple (NASDAQ:AAPL) this morning.

- Driven by a comprehensive deep dive into Apple’s expanding addressable market, we are increasing our target price from $300 to $500.

- With the launch of the iPhone, the App Store, the iPad, and the relaunch of Apple TV, we estimate Apple’s total addressable market for hardware, content, and services expanded from roughly $400B to $1.5T

- We note over the last five years, Apple’s revenues have grown by a factor of 4.5x and earnings have risen nearly 10x.

- We expect Apple to report a very strong FY4Q10 after the market close on October 18. We expect upside to our bellow consensus estimates for revenue of $18.2B, up 49% Y/Y and EPS of $3.82 up 38% Y/Y.

- Our DCF driven $500 price target equates to 24.2x our revised FY11 EPS estimate, plus a projected FY11 cash balance of $71.6 per share.

BLUE SKY OPPORTUNITY With the launch of the iPhone, the App Store, the iPad, and the re-launch of Apple TV, we estimate Apple’s total addressable market for hardware, content, and services expanded from roughly $400B to $1.5T. Apple’s Mac share has doubled over the last five years and we believe could double again. In a little over 3 years Apple has captured less than 3% of the mobile phone market by units, but by revenue Apple holds a ~14% share. The iPad is off to a strong start, and the product greatly expands Apple’s addressable market for content distribution. While the new Apple TV and iAD are still in the very early stages, we believe the opportunity is very strong.

EXPECT STRONG QUARTER We expect upside to our bellow consensus estimates for revenue of $18.2B, up 49% Y/Y and EPS of $3.82 up 38% Y/Y. Our channel checks throughout the quarter, particularly in our summer iPad survey (8.23.10) and back to school surveys (9.13.10) showed very strong demand for Apple products. We forecast Mac sales rose 28% Y/Y to 3.9M and iPod sales down 2% Y/Y to 10M units, offset by a lift in ASPs. We see likely upside to our 9.5M up 29% Y/Y iPod forecast, and our 4.5M unit iPad forecasts. Given the late start we see little contribution from Apple TV.

RAISING ESTIMATES While we expect upside to our forecasts in the quarter we are leaving our estimates unchanged and await results on Monday. That said, driven by our bottoms up opportunity assessment, we are increasing our FY11 revenue estimate from $71.9B to $77.3B, and our EPS forecast from $16.67 to $17.67. VALUATION Our DCF driven $500 price target equates to 24.2x our revised FY11 EPS estimate, plus a projected FY11 cash balance of $71.6 per share. While direct peers trade at 13x, we note the broader consumer tech spaces trades at 25x. Key risks include the uncertainty of demand for consumer discretionary products, competition, pricing pressure and a potential management transition.

Notablecalls: Needless to say, $500 is the new Street High target for Apple. Rocket fuel.

Would not be surprised to see $310 or higher today.

Wednesday, October 13, 2010

Western Refining (NYSE:WNR): Deleveraging, Restructuring Drive Upside; Overweight - Morgan Stanley

Morgan Stanley is making a big call in Western Refining (NYSE:WNR) upgrading the refiner to Overweight from Equal-Weight with a $9 price target (prev. $6).

MSCO believes WNR is in the early stages of a strategic restructuring that will significantly deleverage its balance sheet, remove restrictive debt covenants, refocus its portfolio to more attractive markets, and unlock shareholder value. In the next twelve months they believe WNR will: 1) monetize ~$560MM of assets, 2) repay its high cost and covenant heavy term loan; 3) reduce its debt to cap by 23% from 65% in 2Q10 to 42% by 2011YE; and 4) emerge as a pure-play mid-con refiner (with ~15% of EBITDA generated by retail marketing). MSCO believes both deleveraging (similar to TSO in 2002) and strategic repositioning as a mid-con refiner (favorable markets) will drive a re-rating of the stock. Into the seasonal refining trade (late November-May), they expect WNR’s stock to converge on their $9.00 target price as it executes on this plan. Firm assumes limited commodity driven upside in their call with only 1% improvement in Gulf Coast indicative margins, risk the asset sale execution at 25%, and assume a target multiple at ~15% discount to mid-con peers.

Asset monetization to drive deleveraging: two prong driver for future performance.

De-levering balance sheet provides a path to improved valuation. MSCO believes WNR will be able to pay down the covenant-heavy term loan of ~$348MM and ~$210MM of $256MM Floating Senior Secured Notes in 2011 with asset sales. The company has reportedly commenced discussions to restructure its revolver that would remove restrictive maintenance covenants and may be completed by mid-November. Firm believes deleveraging alone will drive a multiple expansion, similar to FTO and TSO in 2002-2004. Their $9.00 price target assumes a 25% discount for execution risk associated with asset sales. Firm's bull case target of $12.50/sh removes the execution risk factor yet assumes no margin lift y-o-y.

Restructured refining is in niche and profitable markets and should be re-rated. WNR’s Southwest refining consists of two strong cash generating assets: El Paso and Gallup (2 consolidated assets) and associated marketing. For the last 3 years, these two refineries have averaged net refining margins of $5.42/bbl and $7.53/bbl versus Yorktown of $0.09/bbl. Both assets are niche, mid-con markets sheltered from imports and benefiting from growing local crude production (Permian) providing advantaged crude pricing. The removal of Yorktown in 2010, pro-forma, would improve WNR’s 2010E EBITDA by $58MM. Assuming no y-o-y improvement in cracks, MSCO believes WNR’s total company 2011 EBITDA will be $268MM,
pro forma for asset sales, reducing ~$35MM of EBITDA related to asset sales.

Background: how we got here? WNR became public in the golden age of refining in 2006 at $17/sh and traded as high as $65/sh in July of 2007. In May 2007, the month US cracks reached multi-decade highs, WNR completed the acquisition of Giant Industries in a largely debt financed transaction. WNR financed the Giant acquisition with $1.5Bn of debt comprised of $1.25Bn Senior Secured Term Loan and $275MM Senior Secured Revolving facility. Giant owned several refineries including the 70mbpd Yorktown refinery, an asset that had historical operating issues (formerly a BP asset divested in 2002) and is exposed to competitive East Coast markets (Yorktown, Va.). The combination of the high leverage, high interest expense, poor operations at Yorktown (Marlim discount also closed), and the cyclical downturn in refining triggered covenant violations and raised concerns regarding WNR’s solvency in 2008/2009.

In June/July of 2009, WNR recapitalized and repaid $927MM of Term Credit facility issuing 1) 20MM shares of equity, 2) $600MM senior notes (10.25-11.25%), and 3) $215MM convertible debt. These transactions increased the implied interest rate, yet provided covenant relief. The legacy Western refinery in El Paso (128mbpd) and the New Mexico refinery acquired from Giant (23mbpd (Gallup) have remained profitable as niche refineries.

MSCO notes that when they initiated on WNR with a Neutral rating in October 2009 (WNR at $6.20), they were concerned about: 1) a potential covenant breach in 2010, and 2) Yorktown’s operational and competitive position. In firm's view, management has solved the Yorktown issue by shuttering the loss-generating refining, avoiding future capex and allowing for monetization of unvalued storage assets. They believe management is committed and will solve the leverage issues in 2011 with asset sales. The restructured company would become a mid-con pure play with sustainable leverage by 2012. They think WNR is a turn-around, deleveraging, and re-rating story.

Notablecalls: So what do we have here?

- A forgotten mo-mo stock that has been crushed over the past 3-4 years.

- Tier-1 firm upgrading it with a Street high target saying it can only get better from here. Firm says they see positive 4:1 risk reward between their base and bear cases: bull case offers additional upside to $12.50.

- Short interest stands at 25%.

- $500M market cap.

Not bad. Expect a large move up today. Goes above $6, possibly $6.25 or up 10%. Would not rule out $6.30-.40. if general tape plays ball.

Tuesday, October 12, 2010

Officemax (NYSE:OMX): Buyout Math Supports a Much Higher Value for OMX - JPM

J.P. Morgan is out with some interesting comments on Officemax (NYSE:OMX) saying the company is a takeover/LBO candidate with potential upside to $28 per share (implying ~100% upside).

- It’s cheap on trough earnings…OMX is trading at 4.3x on an EV/EBITDA basis for 2010 – the lowest in JPM coverage universe and compared to their group average of 7.2x. If one includes OMX’s ~200MM of underfunded pension liability, the multiple would still only be 4.9x. Sales and EBIT rates remain depressed, with their 2010 forecasts 21% and 60% below 2007 levels, respectively. Predicated on mid-single-digit revenue growth in its five-year plan, OMX expects to reach its historical peak EBIT of 3.8% (and OMX has since taken out ~$400MM/550 bps of costs). At this level, EBITDA has the potential to leap from $180MM in 2009 to ~$450MM.

- Ability to restructure. JPM believes that there remains an opportunity to continue to restructure the business – a key selling point to private investors. CEO Sam Duncan’s successful turnaround strategy emerged in 2005 and the current five-year plan builds upon this foundation. Certainly there are questions as to the differences in the underlying assets, but there is a significant gap between OMX and SPLS/ODP in store productivity (OMX 30% and 13% lower, respectively) and to SPLS in margin (1.9%E EBIT in 2010 vs. SPLS 7.1%E).

- Real estate provides real options. With 60% of leases expiring through 2014, OMX has an ample opportunity to 1) right-size the average store size, 2) relocate into higher traffic locations, and/or 3) close a swath of stores (JPM believes that ~10-15% may not be four-wall profitable).

- Multiple exit strategies. JPM sees three potential exit strategies on the back end with a potential public offering or a full/partial sale to SPLS and/or ODP. There has always been a strong appetite for consolidation in the space going back to the FTC’s successful block of SPLS’ attempted acquisition of ODP in the late 1990s. Moreover, with OMX well below its potential earnings, a recovery in sales and margins takes the pressure off the exit multiple. The current sub-5x 2010 valuation compares to historical mid-cycle levels closer to 7x.

- The silly math. If JPM were to assume, let’s say, a 20-25% premium to the current market value, the potential IRRs would be in the 70% to 90% range. While they believe this would likely be moot considering the Board would be unwilling to consider an offer that does not bake in the potential for an economic recovery, it certainly provides a compelling argument for PE investors to look at OMX.

- 20-25% IRR equates to a $28 takeout. If they use the “rule of thumb” private equity return threshold of 20-25%, under the assumption of a sales acceleration from flat in 2010 to a 3% average growth from 2011-2015 with a 20% average incremental margin, OMX could be bought for $28 (roughly double current levels).

- SPLS and ODP could take a fresh look. If OMX were to begin to garner private interest, SPLS and ODP could be compelled to take a fresh look as well. The synergies are potentially dramatic as OMX’s domestic supply chain costs could essentially be eliminated (perhaps 5-7% of sales), plus there could be overhead reductions of 1-2% and buying synergies of up to 1%.

- Would OMX sell? Among the big issues, this is one of the key questions. Industry players such as ODP CEO Steve Odland have acknowledged the need for long-term consolidation given the potential synergies and fragmented nature of the industry. Indeed, JPM views this as an economies-of-scale business that grew through acquisition and now has a need to right-fit the industry store base. The blocked 1997 SPLS-ODP deal is still brought up in investment circles. It is difficult to know if any minds within OMX have changed (the company has not publicly commented on exploring a possible sale) but the challenges of the recession, uncertainty on the employment outlook, the retirement of Sam Duncan in February 2011, and the right price could be a powerful combination for either a financial or strategic transaction.

Notablecalls: With the recent GYMB deal and Ackman & Vornado going after JCP, JPM's call is going to put OMX in the spotlight today.

I would not rule out a 5-7% move here, barring a market crash.

Friday, October 08, 2010

Alcoa (NYSE:AA): Appetite for hard assets and healthy demand should keep aluminum prices elevated; Upgrade to OW - J.P. Morgan

J.P. Morgan is upgrading Alcoa (NYSE:AA) to Overweight from Neutral with a $20 price target (prev. $16). The move comes after the co reporter its quarterly results last night.

According to the firm, the upgrade comes to reflect the impact on their 2011 estimates from the new aluminum price forecasts of JPM metal strategist, Michael Jansen. Mr. Jansen raised his 2011E aluminum price forecast to $1.06/lb from $0.98/lb and 4Q10E to $1.07/lb from $0.95/lb, vs. today’s price of $1.04/lb, which is the primary driver for their raising their 2011E EPS for AA to $1.38 from $1.02 and 4Q10E EPS to $0.14 from $0.10. The increases are to reflect an expanding appetite from investors to hold hard assets given their unease about the prospects for further easing along with stronger than anticipated demand for metals from real consumers. While the aluminum balance is still expected to be in surplus over the next several years, Mr. Jansen believes that zero interest rates, unfettered storage capacity, and investor involvement in the space should allow the industry to carry surplus inventories and allow for prices to trade higher than otherwise expected.

- Alumina should benefit from de-linking and low-cost production. While higher aluminum prices are the main reason for JPM's increased earnings expectations for 2011, they also think the company has the potential to expand its profitability over the next several years in its Alumina business. As spot alumina prices have generally traded above LME-linked alumina prices, they think AA’s Alumina segment should benefit as the company moves away from LME-linked price contracts over the next several years, while increased lowcost production should aid margins as well.

- Solid 3Q beat. AA reported 3Q10 EPS of $0.09 (excluding one-time net charges of $0.03) vs. JPM estimate of $0.01. The beat vs. their numbers was primarily due to better than expected profitability in AA’s Primary Aluminum segment.

- Raising PT to $20. JPM is raising their Dec 2011 price target to $20 from $16 to reflect their higher earnings estimates. Firm's new target is based on a 2011E EV/EBITDA multiple of 6.9x vs. AA’s average forward multiple of 7.8x since 2002. They think a discount is warranted until the company can demonstrate a higher degree of earnings leverage to rising aluminum prices than it has over the past several years. AA currently trades at 5.2x their 2011E EBITDA.

Notablecalls: This is the Street high target among tier-1 firms. Not a bad call. JPM is very respected.

Tupperware (NYSE:TUP): Upgrade to Buy; shares ready to party on bigger dividend payout - Goldman

Goldman Sachs is upgrading Tupperware (NYSE:TUP) to Buy from Neutral with a $60 price target (prev. $48), implying 30% upside.

They see three key reasons to buy TUP shares today.

1. Potential for 180% increase in dividend in 2012 – They expect net debt/capital to drop below 0.2X over the course of 2011. Tupperware is unlikely to use its healthy cashflows for acquisitions or aggressive buybacks. Instead, the firm forecasts a sizeable increase in the dividend in 2012 towards $2.80 per share.

2. Emerging markets drive 19% EPS growth in FY2011 – Tupperware sales growth should outpace the HHPC peer set with acceleration to 6-7% organic sales growth in 2011. The company’s geographic footprint is attractive with 50%-55% of global sales from emerging markets versus a 20%-30% HHPC peer average.

3. Valuation is undemanding – They see more than 30% upside to their 12-month. P/E- and DCF-based price target of $60. Current valuation is undemanding at 10X-11X our 2011 EPS estimate. Goldman views this as attractive for a company that has exhibited consistent organic sales growth. In addition, TUP has lowest PEG in the HHPC sector at under 0.9X FY2011E.

Improved capital allocation could drive multiple expansion

Goldman expects net debt/capital will drop below management’s 0.2X target during 2011, at which point TUP will have substantial cash-flow flexibility.

- See big dividend hike as debt levels move to near-zero – Tupperware is poised to see debt/capital fall below its target 0.2X by mid-2011. With this significant cash flow flexibility, they are forecasting an increase in the dividend from the current $1.00 per share to $2.80 in 2012 (60% payout ratio).

- Expect TUP to return to historic payout levels – The company’s payout ratio was 55% or higher from 1999-2005 until the company acquired Sara Lee’s direct selling subsidiary. The current dividend of $1.00 per share only suggests a 28% dividend payout ratio, the lowest ratio in the company’s history for the past 10 years and below the peer group average.

- Other uses of cash seem unlikely – Goldman sees acquisitions or big buybacks as unlikely based on management commentary. Tupperware appears settled in its brand portfolio with ample room for organic growth. The company is also reluctant to make major share repurchases due to the relatively low liquidity in the stock. They would note that they do expect moderate buybacks of $60 mn-$70 mn per year with the remaining cash flow after dividends.

- Goldman believes improved capital allocation could increase the quality and visibility of earnings and drive P/E expansion. Investors have historically been wary of the direct selling business model due to the limited visibility into the business and higher volatility of results relative to other Consumer Staples companies. This said, a 2-3 fold increase in the dividend could give investors more comfort in the quality and visibility of earnings, and they believe could result in P/E expansion. Firm's forecast for a 60% payout ratio would be significantly above its HHPC peer average of 30%-40%.

Notablecalls: Given the Equinix (NASDAQ:EQIX) blunder, I'm barring myself from sharing

any opinions for the time being.

Wednesday, October 06, 2010

Equinix (NASDAQ:EQIX): Bounce?

Equinix (NASDAQ:EQIX) is getting lots of commentary this morning after the company preannounced a revenue miss, but operating cash flow beat last night.

We have several relatively good defenses and so far 3 ill-timed downgrades.

- Piper Jaffray seems to have the most knowledgeable analyst on board (Chris Larsen). PJCO is lowering their tgt to $110 from $124 but keeping the stock Overweight rated. This is what they have to say:

Let's first put this in perspective. The company announced a 2.2% revenue shortfall for the third quarter. Sequentially, revenues are still going to grow an estimated 4.4%. Margins are ahead of plan, and have the potential to be higher longer term. Yet the stock is down as much as 25% in after market trading.

The concerns that investors have are creditability and pricing. We don't think investors are overly concerned with slower growth at recently acquired Switch and Data. However, in a highly recurring revenue business like datacenters, such a miss from a company that is well respected is somewhat disturbing.

As far as credibility, it seems the guidance issue was one of process and not systems. Assuming management has already made this correction (to processes), investors will only be able to confirm this following a handful of consistently accurate guidance ranges. This could take us into 2Q of 2011 before investors have/pay for the previous level of high confidence in management.

As for pricing, we believe price discounts, such as the ones given in 3Q, are fairly normal in the industry, especially for large anchor tenant customers. Frankly, had the discount not been given retroactively, this would merely have translated into a very slight miss and lower guidance, and investors may not have been as troubled. Management indicated that gross bookings were on track or ahead of plan in the quarter and at good price points.

All of the independent data we have picked up regarding pricing indicates that the industry is seeing very stable prices. However, by calling out 25% of its space as being used by non-interconnect oriented customers, investors will likely be concerned that that space is at risk for a price concession, too. Again, it's likely that only time will heal the concerns around pricing.

We applaud Equinix management for being price disciplined during the quarter, as it would have been easy to pick up incremental sales by discounting a slug of business in order to get it billing for the quarter. However, the company is managing for the long-term profitability of the business.


Why now?
One question we've gotten from a number of investors is, why is Equinix announcing this now. During the quarter, it was probably trending as a small miss, one that could be updated on a quarterly earnings call. However, Equinix could be a potential bidder for the privately held European data center company, Interxion. If this was the case, and Equinix was using its stock as currency, it may have felt compelled to ensure that all relevant information was priced into its shares during the bidding process.

- Deutsche Bank reits Buy on EQIX but lowers their tgt to $100 from $120.

We believe most of these issues are specific to Equinix and fixable. At $78 and 7.6x EV/EBITDA, we think risk-reward is attractive, but recognize this company is in the penalty box and is likely range bound until investor's gain higher confidence in the future growth profile.

- Merrill Lynch remains very optimistic. They reit Buy & 130 tgt noting sellers attacked on the announcement, taking EQIX shares down over 20% in the thin after-market trading, and taking most other related data center and REIT stocks down as well. Touching as it did on issues of price and churn, EQIX handed the bear thesis a gift, which hinges on, instead of evidence of oversupply in the data center market, signs that oversupply may be creeping in, such as higher churn and lower prices. Merrill rejects this interpretation and view the announcement as highly specific to EQIX, correctable, and at the end of the day not entirely meaningful to the demand story to which it is among the best exposed.

- Wells Fargo downgrades to MP from Outperfirm lowering their valuation range to $89 - $103/share (from $120 - 135)

- Citigroup downgrades EQIX to Hold from Buy with a $94 price target (prev. $121).

The downgrade comes in the absence of a meaningful acceleration in revenue growth during 2H/10, our outlook for slower PF revenue growth during ‘11 of 14-15%, & the uncertainty for Equinix to slow the rate of capital reinvestment in the domestic segment to increasingly focus on cash flow generation. While gross revenue bookings were cited as favorable across the heritage & Int’l operations, we view results as an early sign-post that revenue growth for its core U.S. target segment may be slowing sooner than we anticipated.

- Oppenheimer downgrades EQIx to Perform from Outperform.

Although the reduction in revenue guidance was not materially large, we found the qualitative commentary regarding pricing/competitive issues more concerning. It appears that EQIX is beginning to see increased pricing pressure for larger customer accounts, particularly from wholesale providers, as incremental capacity becomes available in some markets. Higher churn/slower SDXC revenue growth also raise concerns, though we expect management to fix these issues. While the stock reaction after hours appears to be discounting some of these concerns, we do not see any near-term catalysts and hence downgrade the shares to Perform from Outperform. We also lower our 2010-11 estimates.

Notablecalls: EQIX is one of the true growth names out there & the leader of the data center business. I think the stock can recover some of the losses in the n-t

Here's why:

- The revenue miss does not seem demand related. It's partly attributable to Switch and Data integration, to chief of sales leaving and to revenue recognition error. Most of it seems fixable.

- The timing of the preannouncement seems to be tied to the European takeover Equinix may be planning, as highlighted by Piper Jaffray. A little known tid-bit that could make all the difference here.

- The shorts have been in trouble with this one for a while. Short interest stands at 20%+ & I suspect many of them will be cashing in their chips just to be safe.

I would not be surprised to see EQIX trade back above the $80 level as soon as today, and probably closer to the $82-85 level if the squeeze really sets in.

PS: I know I must sound nuts going against numerous downgrades. If you want to have minimal risk, try buying it 76-77 range. I'm not sure it will get there today but if it does, buying there with a 1pt stop sounds like a plan. But again, that's the minimal risk plan.

Monday, October 04, 2010

Ford Motor (NYSE:F): Dearborn Revolution, Initiate Overweight & $20 target - Morgan Stanley

Morgan Stanley's Autos & Auto-Related team is making a huge call on Ford Motor (NYSE:F) initiating the US automaker with an Overweigh rating and $20 price target.

Ford didn’t just avoid bankruptcy in 2009, it took advantage of exceptional economic and political circumstances to slash capacity, renegotiate healthcare, divest non-core brands, cut debt, preserve valuable tax assets and reduce its breakeven point. While the improvement to Ford’s cost structure has not gone unnoticed by investors – in Morgan Stanley's view, the revenue opportunity is significantly underestimated.

Morgan Stanley EPS estimates are nearly 40% above consensus for 2011 and 11% above for 2012. On their calculations, Ford should be well on its way to achieving an investment grade credit rating as it turns $5.4bn of net auto debt as of 2Q10 into $1bn net cash by the end of 2011 and $9bn net cash by 2013. Key assumptions that drive firm's above-consensus forecasts include:

1. Ford N. America. V-shaped US market recovery to 14m units in 2011 and 15m in 2012 as improving credit availability unleashes pent-up demand.

2. Ford Credit. Strong credit quality metrics (loan loss, delinquencies, severity) suggest finance company profits to remain higher for longer.

3. Ford Europe. European profits to beat low expectations on stable pricing and CO2/FX
headwinds to Asian rivals.

The Ford of 2010 is hardly recognizable vs. the Ford of just a few years ago. The company’s cost structure has shrunk in so many ways vs. 2006 including: a 26% reduction in plants globally, a 38% cut in global headcount (leading to a 26% improvement in sales per worker). The company has cut the number of nameplates by 67%, platforms by 44%, and dealers by 19%. Legacy liabilities have also been reduced significantly, including a 77% cut to its health care liability and a 32% cut to its non-US pension plan (as of December 2009). Ford has announced plans to close 3 Ford plants and 1 Automotive Components Holding plant in 2010-2011. Jaguar, Land Rover, Aston Martin and Volvo have been sold, while the Mercury brand is being eliminated.

The changes mean Ford is structurally stronger than it has been in decades, but some soft spots remain. Despite the capacity reduction, Wards still calculates Ford’s N. American capacity utilization at just 66% YTD. Longer-term, the company is still too dependent on N. America revenue and profit, with much less EM exposure vs. other global players such as Toyota, Nissan and VW. The company is still highly dependent on SUVs and pickup trucks for sales and profitability. To achieve the changes, Ford suffered a deteriorating financial position to $5.4bn of net debt at the end of 2Q10 vs. $2.6bn net cash at the end of 2006 and # of shares outstanding has nearly doubled – all sacrifices well worth making, in Morgan Stanley's opinion.

Firm believes Ford can achieve a 5% Auto division EBIT margin through the cycle, with normalized group earnings power of $1.60 per share. They note they can pay just over $19 for Ford on their 5-year LBO model run at a full 35% tax rate. To this they add $0.74/share NPV of deferred tax NOLs to derive their $20 price target.

Bottom line: Consensus expectations for Ford are just too low. At this stage, Morgan Stanley sees Ford as a revenue story much more than a cost story, with optionality far outside the scope of US GDP or US SAAR. At 3.4x 2011 EBITDA and 7.2x normalized PE (ex NOLs), they believe the shares do not properly discount a top-line set to grow 42% by 2015, while generating cash equal to 60% of its market cap. >60% upside makes Ford their top pick in N.A. autos and a Morgan Stanley Best Idea.

Notablecalls: This is big. I sure didn't expect Morgan Stanley to come out on Ford with such positive comments and Street high target in the near-term. Neither did anyone else, I suspect.

I suggest you take a look at how the stock acted on a Barclays upgrade about a month ago. It acted rather well, ending up 6-7% on the day (see archives). The call from Morgan Stanley is bigger, in my opinion.

Ford is headed toward $13 share level, possibly as soon as today. Barring a market crash, of course.

I suggest you don't pay up too much for it in the pre-market. Good things come to those who wait. At least sometimes.

Sunday, October 03, 2010

Two Days Down to Finish a Quarter

It's a bit unusual to see the market decline the last 2 days of a quarter. Below is a study that looks at other times this has happened.

In the past the market has frequently seen a rally following a weak finish to a quarter.

Notablecalls: This probably means d*ck but good to know what the other side is thinking.