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| IN THIS ISSUE – July 9, 2010 | www.bullmarket.com |
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Feature Article By BullMarket.com: Family Dollar's Climb Hits a Speedbump By NextInning.com: Member Q&A - AMAT and the Solar Sector By BullMarket.com: Member Q&A: Broadwind By BullMarket.com: Mac Sales Strong in May
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Family Dollar's Climb Hits a Speedbump Family Dollar is a deep discounter that caters to lower-middle income customers, but it is not strictly a "dollar" store. It sells consumable items like household chemicals, paper products, candy, snacks and other food, health and beauty aids, along with hardware and automotive supplies, and pet foods and products. Its home good lines comprise domestics, housewares, giftware, and home decor. It also sells apparel and accessories along with seasonal items and electronics such as toys, stationery and school supplies, and personal electronics. The North Carolina-based company currently operates more than 6,700 stores in 44 states. It opened 125 stores in Q3 while closing 56. The company has been on a solid roll as recession-strapped consumers have been attracted to its bargain-basement prices, but Family Dollar is hardly the only player in this segment. Competitors include Dollar Tree (DLTR, $41.61, -1.32) and Dollar General (DG, $27.95, -0.05), not to mention Wal-Mart (WMT, $48.92, 0.35), which is once again focused on promoting its price "rollbacks." Once more of a mainstay in smaller, rural settings, Family Dollar has expanded into older urban markets to address a client base that may not have the mobility to visit larger stores operated in the suburbs. The company has also expanded its food offerings, which has helped to steal business away from competitors. The strategy of expanded locations, longer store hours and more product offerings has been working. The company's net income for its fiscal third quarter grew by nearly 20% to $104.4 million, or 77 cents per share, up from $87.7 million, or 62 cents per share, a year earlier. Total sales grew by 8% to nearly $2 billion, compared with $1.84 billion in F3Q2009. Sales on a same-store basis grew by 7%. Sales of consumables accelerated during the quarter, management said, while sales of discretionary categories were more volatile but increased overall. The Q3 results were a penny better than Wall Street analysts were forecasting, but the company's cautious outlook for the current quarter was a clear disappointment. "As we look to the fourth quarter, we expect that many of the trends we saw in the third quarter will continue. However, the environment remains challenging for consumers, and customers continue to buy close to need," Chairman and CEO Howard Levine said. "The fourth quarter is off to a good start, with sales in comparable stores increasing an estimated 5.5% in June." The Q3 growth in comparable-store sales was attributed to increased customer traffic, as the average transaction value for the quarter was flat with the prior year. The company said its sales were strongest in the seasonal, electronics, and consumables categories. Management forecast that same-store sales will increase 5% to 7% in Q4 and that EPS will fall between 46-51 cents, compared with 43 cents a year ago. It guided for full-year EPS to be in the $2.53 to $2.58 range, compared with $2.07 last year. Wall Street analysts, however, were projecting EPS of 53 cents for Q4 and $2.59 for the full year. Operationally, the company performed well. Gross margin as a percentage of sales improved by 40 basis points to 36.6% as the company took fewer markdowns and inventories shrank. SG&A expenses as a percentage of sales, meanwhile, declined by -60 basis points to 28.1%. The company said most of its costs were more than offset by the strong comparable-store sales increase and continued productivity improvements. Insurance and incentive compensation expenses were also lower. These improvements more than offset investments related to expanded store operating hours, increased advertising, and an expanded line of consumable items. The company has spent $136.4 million for CapEx through the first nine months, compared to $103.2 million in the prior-year period. It repurchased 6.6 million shares of its stock through the first nine months of the fiscal year and has $190.3 million of authorization remaining. It bought about 1.4 million shares in Q3 at a cost of roughly $56 million. Family Dollar generated $374 million in operating cash flow through the end of Q3, which was more than enough to cover its investing needs. Over the past two years, Family Dollar has worked to improve its supply chain, merchandising, and store operations. Now the focus is on driving top-line sales through longer store opening hours and a broader product assortment. "Food continues to be a significant driver of shopping trips, especially midweek grocery trips," Levine noted. "Reflecting this opportunity, this spring we added more than 100 new items in the food category, focusing primarily on grocery items, and to strengthen our quality perception, especially with new customers, most of these new items are nationally recognized brands." Family Dollar has also introduced its own private-label brands. "Basic needs are still the primary driver of recurring shopping trips, but we also understand that families want to celebrate and treat themselves in ways that are both fun and affordable. Private label, supported by our global sourcing capabilities, enables us to provide quality products at compelling price points," he told analysts. Levine summed up by saying that despite the company's success to date, he recognizes the competition is getting tougher. "Clearly, the operating environment continues to be challenging. The competitive landscape is heating up as retailers look for new ways to drive traffic and ticket. The global environment continues to evolve as governments respond to continued economic uncertainty and customer sentiment continues to shift," Levine said. "In recent quarters, we have seen increased interest in discretionary categories. And while we are encouraged by these trends, it is unclear when we will see consistent growth." BMR Take: Family Dollar has done an admirable job of positioning itself to profit from the recession and a renewed sense of thriftiness on the part of American consumers. Year to date the stock was up an impressive 43% prior to today's sell-off and traded as high as $42 in late May. The question is whether today's decline represents a buying opportunity? On a P/E basis the stock isn't overly expensive, but there are a lot of cheap stocks out there. It is trading at about 12x estimated 2011 profits, compared to approximately 14x for Recommended List selection Target (TGT, $50.43, 0.50) and also Wal-Mart (although these two companies should trade at a premium to most discount retailers given their real estate assets). We also don't find the company's guidance that disappointing; every retail executive continues to express caution over the strength of the recovery. Its sales outlook is still fairly robust though the comparisons will get more challenging in the second half of calendar 2010. Family Dollar is also in a highly competitive sector, bumping up against the bigger players noted above as well as the other deep discounters and drugstores, which are also beefing up their food offerings. Given the appreciation in the shares year to date, the volatility of the market, and what may be a bit of a decline in momentum, we think the stock is reasonably priced and more of a "hold" at present. If negative sentiment persists and pushes Family Dollar into the low $30s, then the shares would start to get more interesting.
Member Q&A - AMAT and the Solar Sector A) That's an interesting prediction - based on what I've been reading it would appear the news suggests just the opposite. While AMAT discussed a fairly bleak outlook for thin film solar and noted caution about the durability of demand for polysilicon solar during its May conference call, I've since read a number of news items that suggest demand for thin film is growing. However, even considering that, I'm not expecting it to produce a material upside. AMAT has exposure to both the polysilicon and thin film sides of the solar market; equipment from its traditional semiconductor orientated product line is used by the polysilicon fabricators and its more recently introduced equipment similar to what flat screen TV manufacturers use, serves the emerging thin-film solar panel producers. In the polysilicon markets, most of the growth recently has been in China where AMAT has stated it has good exposure. The major threat in these markets is an over-build of capacity, which if it occurs, would lead to a sharp reduction in demand production equipment like AMAT sells. In the thin film markets, two of the notable AMAT customers have run into financial trouble. AMAT was very clear in presenting these cautions during its last quarterly conference call. AMAT also stated that its lowered outlook for thin film has caused it to restructure its solar business unit. AMAT executives stated that this restructuring would be completed by mid June 2010 and that they expected the solar business to contribute profits in fiscal 2011 (ends October 2011). Interestingly, as opposed to Piper's view that demand has declined, I've read a number of news reports that suggest demand outlook for thin film solar may have improved since the May conference call. Setting aside the anecdotal news reports about growing demand for thin-film solutions in Asia and Australia, we all should be abundantly aware of the $2B loan guarantees signed by President Obama for major solar projects in Arizona, Colorado and Indiana. While I've not read the details about the Arizona or Indiana systems, it was announced that Abound Solar would get a loan guarantee of $400M for the Colorado job. Abound Solar uses a thin-film technology. I don't know if AMAT equipment will be used in the manufacturing of the Abound panels, but that's not the most important message here. The most important message is we're seeing thin-film technology develop traction and, with that, we'll see a need to increase aggregate manufacturing capacity; for AMAT, that might be a rising tide the company didn't have fully factored when it presented its quarterly results last May. From a valuation perspective, the earnings consensus for fiscal 2010 sits currently at $0.85. This is up a dime from where it was prior to the May conference call. The fiscal 2011 earnings consensus moved up $0.06 following that presentation to $1.18. This implies earnings growth of 39%. If we use a range of valuation multipliers running from 11 to 13 times the 2011 consensus of $1.18 plus AMAT's adjusted net current asset value of $3.97, the resulting estimated fair value range runs from $16.95 to $19.31. Please note the net current asset value has been adjusted upward to include $0.91 in long-term (non-current) investments and a deferred revenue liability of $0.73 per fully diluted share. The point here is the news about the situation in the solar sector has, if anything, improved since AMAT painted a fairly dismal picture of the market last May and capacity for leading edge semiconductor fabrication has remained tight. While I'm not expecting miracles from the solar sector, I think demand in AMAT's traditional business in the fabrication sector will drive earnings to at least match the consensus expectations and, in my view, those expectations warrant a notably higher stock price. Disclosure: At the time of this publication, out of the companies discussed herein, Paul McWilliams had a long position in AMAT.
Member Q&A: Broadwind A) Founded in 2006, Broadwind is an independent, horizontally integrated products and services provider to the U.S. wind industry. It produces such products as gearing systems for the wind industry and wind turbines. It also provides technical services and logistics to the industry. For 2009, 79% of revenue came from product sales, and 21% services. The company said it has about a 10% market share in gearing, and under 5% for wind towers, technical services and logistics. At $1.5 billion, the wind turbine market is Broadwind's largest addressable market, followed by technical services at $630 million, logistics at $450 million, and gearing at $400 million. The company provides products and/or services to all 10 of the largest wind turbine manufacturers currently selling into the U.S. Like many companies, 2009 was a rough year for Broadwind. Full-year revenue fell –9% to $197.3 million, while adjusted EBITDA plunged to $1.56 million from $4.33 million. The company also slashed jobs, ending 2009 with 690 employees versus 1,127 in 2008. The stock got a huge lift today after the company received an order from the U.S. subsidiary of Spanish turbine generator maker Gamesa Corporacion Tecnologica. Broadwind will supply structural wind towers for wind sites in the United States for installation in the second half of 2010. Terms of the deal were not disclosed. Broadwind reported Q1 results in May, posting a loss of -$14.1 million, or -14 cents per share, compared with a loss of -$7.2 million, or -7 cents per share, last year. Adjusted EBITDA was -$8.2 million versus $0.34 million a year ago. Revenue fell -58% to $22.1 million. The company attributed reduced purchases under key framework agreements, lower service revenues, and a reduction in non-wind related revenue for the drop. Despite the poor results, CEO Cameron Drecoll thought that Q1 was a low point. "During the quarter, we felt the lagged effect of the broad economic slowdown that began to impact our industry in late 2008," Drecoll said in a statement. "The hiatus in new wind developments did not subside until the late summer of 2009, when financing began to come available, thanks in part to Federal stimulus money. The effects of these new investment decisions will not have a positive impact on Broadwind’s business until the second half of this year. We entered the year with very low capacity utilization rates and back-end loaded purchase commitments from key customers. However, our volumes are building and we have called back or rehired an additional 25% of our workforce since January 1. We believe the first quarter represented a low point, and expect sequential growth in our quarterly sales as the year progresses. In view of the low revenue, we have continued to focus on managing down our fixed costs and streamlining our business processes." The company sold shares in January to raise $54 million. As a result, its balance sheet is in good shape with $26.3 million in cash and $19.1 million in debt. BMR Take: Based on next-year's EPS estimates, Broadwind is very cheap. But how accurate those estimates will prove to be, though, is a question, and the range from the four analysts that cover the stock is quite large (7 cents to 43 cents). While largely a pure-play on the U.S. wind industry, Broadwind nonetheless has a pretty small market share. This can mean it has room to grow or that it's not doing a very good job capturing market share. Given this and several quarters of poor results, we think this stock is best left to only very speculative investors.
Mac Sales Strong in May iPod unit sales, meanwhile, were down -13%, according to NPD, although the iPod data is considered to have a higher margin of error given the music players' larger international sales mix. Munster was expecting a sales decline of -9%. The data indicates that Apple will sell between 9-10 million iPods, which brackets the 9.5 million consensus. "We believe in the long run Mac cannibalization will exist, but will be minimal," Munster wrote. "Apple has successfully limited the iPad functionality to primarily content consumption vs. content creation on a Mac. And relative to the iPod, the physical size of an iPad provides a meaningfully different value proposition (portability vs. screen size)." BMR Take: Not surprisingly, it appears Q2 will be very strong for Apple, with iPad, iPhone, and Mac sales all looking robust. The iPod, meanwhile, has become an increasingly small part of the Apple story, but it's nonetheless pretty impressive that 9-10 million of the devices are sold each quarter. We continue to think Apple remains undervalued given its growth rate and huge cash position (roughly $46 a share), and believe the company's earnings will once again sail past estimates when it reports earnings later this month. We rate the stock a "Buy" with a target of $330.
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