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Market Data from Around the World
Monday, December 5, 2011
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Index
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Close |
Change |
Day% |
YTD% |
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UNITED STATES - |
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- |
- |
- |
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Dow Jones |
12,098 |
78 |
0.7% |
4.5% |
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S&P 500 |
1,257 |
13 |
1.0% |
-0.1% |
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Nasdaq |
2,656 |
29 |
1.1% |
0.1% |
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Russell 2000 |
747 |
12 |
1.6% |
-4.7% |
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S&P Midcap 400 |
893 |
12 |
1.3% |
-1.5% |
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Advance/Decline & Volume |
Click Here for Data |
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TREASURY BONDS |
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- |
- |
- |
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10 Year |
2.04% |
up 1 basis points |
-124bp |
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30 Year |
3.02% |
down 1 basis points |
-131bp |
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OTHER KEY DATA POINTS |
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Gold |
Down $16.80 to $1734.50/oz |
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Silver |
Down $0.31 to $32.37/oz |
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Oil |
Up $0.03 to $100.99/bbl |
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Natural Gas |
Down $0.205 to $3.59/mmbtu. |
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EUR-USD |
Rose 0.0784% to $1.3400. |
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USD-JPY |
Fell 0.3046% to 77.7475 yen. |
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EUROPE |
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- |
- |
- |
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UK FT-SE 100 |
5,568 |
16 |
0.3% |
-5.6% |
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France CAC 40 |
3,201 |
36 |
1.1% |
-15.9% |
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Germany DAX |
6,106 |
25 |
0.4% |
-11.7% |
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ASIA |
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- |
- |
- |
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Japan Nikkei 225 |
8,696 |
52 |
0.6% |
-15.0% |
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Hong Kong Hang Seng |
19,180 |
139 |
0.7% |
-16.7% |
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Shanghai Composite |
2,333 |
-27 |
-1.2% |
-16.9% |
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India BSE 30 |
16,805 |
-42 |
-0.2% |
-18.1% |
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AMERICAS |
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- |
- |
- |
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Brazil Bovespa |
58,910 |
1025 |
1.8% |
-15.0% |
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Canada TSX Composite |
12,119 |
44 |
0.4% |
-9.8% |
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Mexico Bolsa |
37,103 |
347 |
0.9% |
-3.7% |
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Stocks rose on the day, with the Dow up 78 points to 12,098. The S&P advanced 13 points to 1,257, while the Nasdaq jumped 29 points to 2,656. Oil edged up 3 cents to $100.99 a barrel, while gold fell -$16.80 to $1,734.50 an ounce.
In economic news, the Institute for Supply Management said its non-manufacturing index fell to 52.0% in November from a reading of 52.9% in October. Economists had expected a November reading of 54.0%. Elsewhere, the Commerce Department said factory orders fell -0.4% in October, in line with estimates, and the September reading was revised down to a -0.1% drop from an initial reading that showed a 0.3% gain.
In earnings news, discount retailer Dollar General (DG, $40.58, 0.64, Spy) said its fiscal third-quarter profit climbed 34% to $171.2 million, or 50 cents per share, from $128.1 million, or 37 cents per share, a year earlier. Revenue rose 12% to $3.6 billion, as same-store sales increased 6.3%. Analysts had expected a profit of 47 cents on sales of $3.57 billion. Dollar General forecast an adjusted 2011 profit of $2.29-$2.32 a share up from previous guidance of $2.20-$2.30 a share. The company forecast revenue growth of 13% and same-store sales growth of 5.6-5.8% up from prior guidance of 3-5%. Shares of Dollar General rose 1.6%. Eighteen pros held Dollar General in their portfolios at the end of Q3 and nearly 100 tickerspy members own the stock in their portfolios.
Grocery store chain Ingles Markets (IMKTA, $15.00, 0.00, Spy) said its fiscal fourth-quarter profit rose 33% to $11 million, or 45 cents per class A share, up from $8.2 million, or 34 cents per class A share, a year earlier. Revenue increased 6% to $905.8 million, while same-store grocery revenue, excluding gasoline, rose 2.2%. Shares of Ingles Markets were flat.
Yum Brands (YUM, $57.09, 0.84, Spy), parent company of the KFC, Pizza Hut and Taco Bell chains, upped its 2011 profit forecast and said it expects earnings per share to grow at least 10% in 2012. The company said it expects to earn at least $2.85 a share on an adjusted basis in 2011, implying growth of 13%. That compares with an original estimate of 12% profit growth. The company said it expects to open 600 new restaurants in China next year. Shares of Yum rose 1.5%. Nearly 60 pros held Yum in their portfolios at the end of Q3 and nearly 800 tickerspy members own the stock in their portfolios.
Shares of SuccessFactors (SFSF, $39.75, 13.50, Spy) soared 51.4% after the company received a $3.4 billion takeover offer from German software giant SAP AG (SAP, $58.38, -1.16, Spy) that it promptly accepted. SAP announced on Saturday that offered $40 a share in cash for SuccessFactors, a 52% premium to where the stock closed on Friday.
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| While off their highs, stocks closed with solid gains on the news that Germany and France were in "complete agreement" over a EU debt plan that would restrict future deficits. However, a report from London's Financial Times that S&P could put several EU countries on "creditwatch negative" reduced some of the day's earlier bullishness. The economic news back home, meanwhile, was relatively lackluster, breaking the recent pattern of solid data. We continue to remain cautiously bullish heading into the New Year, although a slowdown in China is our biggest worry, not headlines from Europe. In the end, though, everything is interconnected, as what happens in Europe can impact China, which can in turn influnce the U.S. as well. |
Bullishly best,
Bull Market's Research Team
editor@bullmarket.com
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++ Visit the Recommended List for Bull Market's latest portfolio thoughts, analysis,
and ideas ++ |
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None |
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Top Gainers:
+ OpenTable (OPEN, $39.10, up 2.86, 7.9%)
+ Titanium Metals (TIE, $16.21, up 1.02, 6.7%)
+ Walgreen (WAG, $34.37, up 1.25, 3.8%)
+ DigitalGlobe (DGI, $15.99, up 0.59, 3.8%)
Top Losers:
+ Shutterfly (SFLY, $28.17, down -0.92, -3.2%)
+ Navistar International (NAV, $39.12, down -1.11, -2.8%)
+ Liberty Global (LBTYA, $39.75, down -0.63, -1.6%)
+ Visa (V, $96.06, down -1.14, -1.2%)
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I. Barron's Bearish on Shutterfly
Over the weekend, Barron's published a bearish piece on recent Recommended List selection Shutterfly (SFLY, $28.17, -0.92, Spy), predicting that the shares could fall to $20.
The article cited the heavy discounting that caused the shares to drop the day we decided to step up and add the stock to the Recommended List. It also talked about fellow Recommended List selection Apple (AAPL, $393.01, 3.31, Spy) introducing a $2.99 greeting-card app in October that let iPhone and iPad users design and send greeting cards.
In addition to competition, author Christopher C. Williams cited valuation, commenting that the stock trades at 31x P/E based on the 2012 consensus of 94 cents, or 29x times after excluding its $2 a share in cash. The author also noted that profit margins fell last quarter due to an increase in expenses.
The article quoted Robert W. Baird analyst Colin Sebastian, who said, "We are incrementally cautious due to ongoing price discounting [earlier citing a Buy-One-Get-Two-Free deal on photo books from Snapfish]. There seems to be risk to the [fourth] quarter." Sebastian has an "overweight" rating and $66 price target on the stock.
Finally, Williams discussed insider selling to frame his bearish argument, writing: "With pricing pressure intensifying, however, investors might be wise to take a cue from Shutterfly insiders, who have sold some $12 million of stock in the past six months. That's not too pretty, either."
BMR Take: We usually consider Barron's to be a pretty decent publication, but this article is a bit of a hack job that seems to purposely ignore a few key points. To begin with, the valuation argument is pretty amateurish. While earnings can be a good valuation metric, longtime Bull Market readers know that earnings metrics aren't the be all and end all of how to value a stock. And, when it comes to a company like Shutterfly whose free cash flow is more than double its earnings, it's much more important to look at this metric (remember cash flow is the actual money a company brings in, not earnings), where the stock is trading at a very attractive 11x multiple excluding its net cash based on the $2.28 FCF per share consensus. Its EV/FCF yield, meanwhile, is an attractive 9%.
As for the insider selling, what the article fails to mention is that most of the selling was in the form of 105b trading plans, where insiders were exercising options and then selling the stock. This is very common and an extremely low-level investment signal, and most of the ex-sales were in the upper $50s and lower $60s. The only notable sale was an executive from Tiny Prints cashing out after Shutterfly bought the company. This is also pretty common after an acquisition and another low-level signal. The article also skips over the recent $1 million insider buy last week by a director, and Shutterfly's CEO shelling out more than $380,000 to buy 10,000 shares last month at an average price of $38.25. These two buy transactions were the last insider trades.
The competitive pricing issue is real, but also very common around the holiday season. However, this hasn't always impacted Shutterfly greatly in the past, as the company just has a much greater assortment of designs and options that draw in customers when it comes to cards and photobooks. As for the increased expenses, the article failed again to mention that this is due to investments in the business. We never begrudge a fast-growing company with strong free cash flow investing in its business, even if it depresses near-term profits.
Finally, Barron's is known for having a lot of analyst and money manager quotes when it discusses a stock. We find it kind of amusing that the only analyst it could find in making its bearish argument was one that has an "overweight" rating on Shutterfly and expects the stock to more than double at his current $66 target price.
As for us, we rate the stock a "Buy" with a $46 target.
II. November Same-Store Sales Edge Up at Walgreen
Recommended List selection and drug store operator Walgreen (WAG, $34.37, 1.25, Spy) reported that its same-store sales rose 1.8% in November, less than the 2.7% increase in comparable-store sales that analysts were expecting. A calendar shift negatively impacted results by -0.3%. Total sales climbed 4.2% to $5.84 billion.
Same-store pharmacy sales rose 1.2% for the month. The introduction of generic drugs negatively impacted results by -2.2%, while the calendar shift had a negative impact of -0.4%; and a lower incidence of coughs, colds and flu hurt results by -1.3%. Overall, pharmacy sales rose 3.4% and accounted for 64.7% of total sales for the month.
The number of prescriptions filled at same-store pharmacies advanced 0.6%, hurt -0.8% by fewer incidences of flu; -0.4% by the calendar shift; and -1.1% due to transfers and other trend analysis of prescriptions managed by Express Scripts (ESRX, $46.19, -0.42, Spy).
Year-to-date, Walgreen has administered nearly 5.0 million flu shots versus approximately 5.4 million last year.
Front-end, or general merchandise sales, meanwhile, rose 2.7% on a comparable-store basis. Total front-end sales rose 4.0%. Same-store customer traffic decreased -0.3%, while basket size rose 3.0%.
Walgreen opened 31 new stores in November, including seven relocations and one acquired store. It now operates 8,261 locations, including 7,811 drugstores, in 50 states, the District of Columbia, Puerto Rico, and Guam.
BMR Take: Walgreen's November came in a bit weaker than expected as some early Express Script transfer negatively impacted its results for the month, as did a slower start to this year's flu season. Moving forward, Walgreen has several catalysts (the next generic drug cycle; less store openings, which can lead to increased cash flows, profits, and dividends; and an improved format that has been driving sales) offset by one giant overhang: namely, the expiration of its deal with Express Scripts at year-end.
If the deal expires without the two sides reaching an agreement, we would expect the stock to tumble, but if a deal were reached we'd anticipate a big rally. At this point in time, we have our position protected via the purchase of January 2012 $32 puts. We also have a position in CVS Caremark (CVS, $38.33, 0.04, Spy), which would likely be the biggest beneficiary if no agreement is reached between Walgreen and Express Scripts. If no contract is reached, our plan is to close our Walgreen position before the put expires.
III. Member Q&A: Golar LNG
Q) What are your thoughts on Golar LNG (GLNG, $43.96, 0.30, Spy)? How does it compare to Recommended List selection Teekay LNG (TGP, $33.31, 0.11, Spy)?
A) As a reminder, Golar LNG is a liquified natural gas shipper that directly owns 12 vessels. It owns a fleet of eight LNG vessels (four of which are modern) and four floating storage and regasification (FSRU) vessels. It also owns a 65% interest in Golar LNG Partners (GMLP, $29.01, -0.38, Spy), which owns four LNG vessels that are on long-term contracts.
The company reported its Q3 results last month, recording net income attributable to shareholders of $13.7 million, or 17 cents, compared to a loss of -0.6 million, or breakeven per share, in Q2. Operating income more than doubled sequentially to $45.5 million from $21.3 million last quarter.
Revenue rose 5% sequentially to $77.8 million from $74.0 million. The increase in revenue was due to the reactivation of one vessel and no drydocks during the quarter.
Third quarter average daily time charter equivalents (TCEs) was $91,614 versus $91,666 in Q2. Utilization was 99%, up from 97% in Q2.
"Spot rates, as we said, sitting at about $110,000 a day, one-to-two-year rates, probably in excess of that and with a good outlook there are lots of new supplies coming on as we head further into the decade," CEO Doug Arnell said on the conference call.
"A lot of this is being driven by very, very good LNG and natural gas fundamentals put against some nuclear uncertainty in Japan and stagnating crude oil growth across the market. The other factor that we see is that the extreme regional disparity in different natural gas markets, North America to Europe to Asia, is certainly supporting the development of lots of projects, which will require mid-stream infrastructure, FSRUs and carriers.
"Another big factor that we see coming along that could be – create a paradigm shift again for the LNG shipping market is the realization of U.S. LNG export projects. We have certainly seen some positive announcements in the last weeks with commercial agreements being reached on specific projects, which is good news. They aren't at the finish line yet, but I would say the outlook is positive. We believe in the fundamental story of U.S. exports, and again with some of those projects going ahead, it changes the outlook again in terms of shipping demand."
After the quarter, Golar LNG dropped down the Golar Freeze to its MLP, Golar LNG Partners, for $330 million. It also signed a three-year charter for the Golar Grand to a major oil company for an annualized EBITDA of approximately $39 million per year.
The company is currently having built seven 160,000 LNG carriers and two FSRU, with delivery expected to begin in 2013 and extend into 2014.
"Golar LNG Limited is our growth vehicle," Arnell said. "It is where we conduct our business development activities for new FSRU deals. It is where we hold assets that are usually carriers, that are in short-term or spot service, and it is where we house our newbuilding program.
"The other company Golar LNG Partners is a company that owns long-term contracted assets with stable cash flows, it's a yield orientated company, lower risk vehicle.
"The synergy between those two companies, we believe, is very strong. The sell down of assets into Golar LNG Partners is a very effective way for us to raise capital and fuel growth at the Golar LNG Limited level. I think it's fair to say we've demonstrated that in recent months with the drop-down of Golar Freeze. The Freeze drop-down produced $330 million of proceeds, which increased MLP dividends by 11%, but crucially for Golar LNG Limited, those proceeds will be brought back up into the company to finance in part upcoming commitments on our newbuild program.
"So we're very happy with the way our corporate structure is operating and we intend to do the same again next year in the first quarter and with other assets in the future."
BMR Take: While much of shipping has been in a bad slump, the LNG shipping market has been extremely strong, with spot rates about quadrupling since bottoming out around May 2010. With three of its four newer vessels operating on short-term contracts that end in 2012 and one of its older vessels reactivated to participate in the market, Golar's stock has been enjoying the strong LNG shipping market, as it has soared along with spot prices. (Golar's exposure to the spot market is what really differentiates it the most from Recommended List selection Teekay LNG, whose vessels are all on long-term contracts. Golar's MLP, Golar LNG Partners, is more similar to Teekay LNG.)
As Golar's vessels get re-chartered with the next year, other older vessels get reactivated, and its newbuilds start to come online beginning in 2013, the shipper should perform very well operationally the next few years.
That said, rates can't go up indefinitely, as soon it becomes more advantageous for charterers to just order ships for themselves, which should help put a bit of a ceiling on spot rates in the near term. As such, Golar's stock appears to largely be pricing in much of the strong fundamentals of the current LNG shipping market. However, it is a stock to consider on a dip, as the long-term fundamentals of the LNG shipping market remain positive, with demand expected to continue to exceed supply.
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1. Buffet Stock Dollar General Delivers Solid Quarter
Dollart store operator Dollar General (DG, $40.58, 0.64, Spy) reported its quarterly results this morning. We thought it was the best option in the dollar-store space when we looked at the sector in September, and not just because it is also in Warren Buffett’s portfolio at Berkshire Hathaway (BRK.B, $78.11, 0.67, Spy). It was attractive because it was among the least expensive of its peer group at the time. It also offered a good runway for growth in what has been a solid slice of the retail sector the last couple of years.
The Goodlettsville, Tennessee-based based deep-discounter reported better-than-expected results this morning for its fiscal third quarter ended October 28th. Dollar General also increased its guidance for the year above the analyst consensus. Finally, the company announced a $500 million stock repurchase program. All of those factors attracted investors to the name today.
"Dollar General delivered another great quarter, and we expect to continue to build upon our strong track record of delivering excellent results for our shareholders" said Rick Dreiling, chairman and chief executive officer. "Our same-store sales increased 6.3% in the third quarter, representing our third-consecutive quarter of accelerating same-store sales growth and demonstrating our ability to balance the challenges of pricing and rising input costs. Based on these results, we are raising our full-year adjusted earnings per share guidance to the range of $2.29 to $2.32," Chairman and CEO Richard Dreiling said in a statement.
Dollar General’s earlier guidance was for profit in the $2.22 to $2.30 per share range. Analysts had coalesced around $2.29 per share in profit on $14.71 billion in sales. The improved guidance reflects the solid Q3 performance and anticipated comparative-store sales growth of 5.6%-5.8% in the current quarter. Management had previously estimated comp sales would grow in the 4-6% range in Q4, The improved guidance also reflects $185 million of prior share repurchases and management’s ongoing effort to keep its costs under control.
For the most-recent quarter, Dollar General reported net income of $171 million, or 50 cents per share, which was 3 cents per share better than the analyst consensus estimate. In the year-earlier period, it reported net income of $128 million, or 37 cents per share. In addition to the growth in comparative store sales, Dollar General benefited from a lower tax rate and reduced interest expense.
"For the holiday season and into 2012, we expect our customers to remain very interested in value and in ways to make their dollars go further. November sales were strong. Our Thanksgiving week and Black Friday sales suggest that we are well positioned to meet our customers’ expectations," Dreiling added.
Dollar General’s total sales for Q3 grew by 11.5% to $3.6 billion, which was in line with the analyst consensus.
Looking at some operating metrics, Dollar General’s operating profit was $311 million, an increase of $37 million, or 13%, over last year. The operating margin rate was 8.6%, an increase of 14 basis points over the 2010 third quarter.
"Once again, we had a very balanced approach to managing our financial performance. Gross margin decreased by -31 basis points but was offset by 45 basis points of SG&A leverage," Dreiling said.
SG&A expense as a percentage of sales was 22.4% in Q3, a decrease of -45 basis points from a year ago and was largely due to the impact of increased sales and improved utilization of retail store labor, which management attributed primarily to new workforce management initiatives.
Consumable sales continue to increase at a faster pace than the non-consumables, with the strongest growth in the food and snack categories. Salty snacks, carbonated beverages, coffee and milk were the largest contributors, the company said. Pet Supplies and health care also performed well, and the company said it increased its share of the consumables market.
"Our most recent Nielsen data shows that we have continued to increase our market share in units and dollars on a four-week, 12-week, 24-week and 52-week basis. Several areas within our non-consumable categories showed good success in the quarter as well, for example, automotive, hardware, stationary, sundries and domestic. We were pleased with our Halloween sales and back to school was strong. We are seeing signs of strength in several areas in our home category that had been weak for some time, such as core bath towels, window treatments and bedding, and we are optimistic that this trend will continue," Dreiling said on the earnings conference call.
Dreiling said he was disappointed with the company’s performance in apparel. During the Q2 conference, he said Dollar General had begun to show traction in "selective" apparel categories, such as men’s and boy’s, infant and toddler accessories, and shoes.
"We believe that repositioning of our merchandise with greater space allocation to infants and toddlers and men’s and boy’s is the right move for the longer term, where we have seen more pronounced softness is in our non-core and hanging apparel, especially in ladies, and while we believe we can improve our execution in this area, the economy has also been a factor," he said, citing continue high levels of unemployment and "underemployment," higher gas prices year over year, and tight credit requirements, along with the still largely moribund housing market, all of which are impacting the discretionary spending of Dollar General’s customers.
Part of Dollar General’s strategy is to increase the number of private-label products it sells because those products generally deliver bigger margins for retailers than national brands. The company added more than 175 private-label products during the quarter, which brought its total number of private-branded consumables to nearly 1,900 products.
Private label sales grew by 14% in Q3, compared with a 13% increase for its national and other brands. Those sales represented 23.9% of Dollar General’s total Q3 sales, which was a 30 basis point improvement year over year.
Cash flow from operating activities year to date totaled $604 million, a 15% increase over the prior-year period. The company has spent $363 million so far this year in CapEx while also reducing long-term debt by -$566 million to $2.7 billion.
Looking ahead to 2012, the company said it plans to open approximately 625 new stores and to remodel or relocate another 550. Square footage is expected to increase by approximately 7%. The company said 80 of the new stores were targeted to open in new markets, including California, Nevada, Connecticut, Massachusetts and New Hampshire. Dollar General said it also plans to lease a distribution center in California to support its stores in the western states and expects to complete the construction of its new Alabama distribution center in early 2012.
The company said it would also buy back $185 million in stock held by its controlling shareholder, Buck Holdings, as part of the $500 million repurchase plan. Buck is owned by Kolbergh Kravis Roberts (KKR, $13.52, 0.42, Spy) and Goldman Sachs (GS, $99.82, 2.57, Spy), which took the company private in a leveraged buyout in 2007. It was spun back out to the public in 2009.
The purchase of Buck’s interest is in conjunction with another planned secondary offering by the ownership group. KKR and Goldman still own about 69% of the outstanding stock and can be expected to continue to cash out of their interest through periodic secondary stock sales. While that could put some temporary pressure on the stock it shouldn’t have a material long-term effect and is part of the normal process of backers cashing out.
BMR Take: Dollar General turned in a sold quarter and offered encouraging guidance, which investors responded to. The company has a good runway for growth as the typical Dollar General store requires an investment, including owned inventory, of less than $250,000. While the dollar store industry may target lower income consumers, a broader swath of the consuming public finds their small size and numerous locations a convenient place to run in and pick up a few items.
As we pointed out in our initial profile of Dollar General, its good growth prospects, sound management, and strong cash flows are the kind of attributes Buffett looks for when selecting a company to invest in. Trading at about 15x the current consensus estimate for 2012, the stock has gotten a bit more expensive than our last look, but it is still significantly cheaper than the nearly 18x valuation investors have assigned to Dollar Tree (DLTR, $83.48, 1.73, Spy) and a bit more than the 14x forward P/E of Family Dollar (FDO, $59.20, 0.50, Spy). Family Dollar is in hedge fund manager William Ackman’s portfolio.
We said in September that while we liked the stock, we would have preferred to pick up shares at less than $35. It was $37-plus at the time. The opportunity never arose as the stock bucked the broader bearish trend of the market in October and November. Dollar General traded to a 52-week high of $41.05 on December 1st. We still like the stock, but at current levels will stay on the sidelines.
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 Frontier's Fat Yield Reflects Concern Over Declining Revenue
In our annual high-yield special report, published last week, we focused on income-generating stocks that we feel also offer solid, sustainable business models. As such the yields offered by the stocks we selected for the 9 Must-Own Income Stocks for 2012 are for the most part in the 4.0% plus range.
There are, of course, stocks that offer much fatter yields, but the question for investors is how sustainable are the businesses? Can they continue to cover their payouts? In short, the yields they offer are fat in many cases because the market has assigned a higher risk premium to owning them. The old-line telecom firms that provide landline and broadband services, especially in rural markets, are among the high-yielders in that group. We will give an update on a few this week.
One of the fattest yields is offered by Frontier Communications (FTR, $5.77, 0.22, Spy), which is now the largest rural local exchange carrier (RLEC) in the U.S. Its 75 –cent annual dividend is currently yielding over 13% and management has said it is committed to the payout. Of course, the yield is that rich because the stock price has steadily declined in 2011. It peaked at $9.84 on January 3rd; it closed on Friday at $5.64. Its low for the year of $5.22 came on November 22nd.
We last took a look at the Stanford, Connecticut-based company in early March. Frontier acquired 4.0 million access from Verizon (VZ, $38.05, 0.20, Spy) in July 2010. It tripled in size and became the largest pure rural communications provider and the nation’s fifth-largest incumbent local exchange carrier (ILEC) operating in 27 states.
The company currently has a little over 5 million access lines; it generated about $5 billion in revenue last year and produced about $2.5 billion in EBITDA. The Verizon deal effectively tripled the size of Frontier, but while transformational for the company, it comes with considerable integration work to mash together a host of disparate systems.
To make the deal work, Frontier has had to carve out costs. Going into it, management believed it could ultimately achieve $500 million in annual synergy savings. As it got deeper into the business it bought from Verizon, it quickly found it would be possible to push those savings into the $600 million range.
"We literally have a synergies project list that is as long as my arm that has project after project and opportunity after opportunity where we can take cost out. It's directly attributable to the Verizon transaction. And as we get a clear line of sight that those are going to hit the bottom line, they get moved from the tentative schedule to the actual schedule and that schedule today, we're now at a $600 million target. And we certainly have a mandate from our board and CEO to continue to try to get that number up. But as we stand today, $600 million is the number we feel good about," Senior VP and Treasurer David Whitehouse explained at a recent investor conference.
"On a run-rate basis, through the third quarter of 2011, we're already at almost $500 million run rate. And a good amount of that delta, between the $496 million and the $600 million, can be alleviated once we completed some of the system conversion work," he added.
Its latest effort to grow revenue is a deal to re-sell AT&T’s (T, $29.15, 0.19, Spy) wireless services starting in 2012. Frontier will be able to brand the wireless offering under its own name. It is essentially renting space on AT&T’s network; the deal is similar to one its competitor CenturyLink (CTL, $36.02, 0.54, Spy) has with Verizon Wireless. The company will be able to re-sell AT&T smartphones, but not the iPhone initially. The company said it hoped to work out an agreement with Apple (AAPL, $393.01, 3.31, Spy) to offer the popular device.
The need to generate additional revenue from new products is clear as Frontier’s sales have slipped sequentially throughout 2011. Revenue in Q3 slipped by -2.4% sequentially and by -8.0% year over year to $1.291 billion. Wall Street analysts were looking for $1.302 billion. The reported revenue compared to $1.322 billion in Q2 and $1.403 billion in Q3 2010. Roughly 64% of the company’s revenue comes from broadband and business customers; the remainder is from residential lines and other sources.
The company attributed the revenue decreases to the number of residential and business customers, switched access, video and directory revenue. After excluding $67.4 million for acquisition and integration costs, $3.6 million for severance and early retirement costs and $14.0 million for the reversal of uncertain tax positions, net income attributable to common shareholders would have been $50.2 million, or 5 cents per share. Wall Street had estimated 6 cents in profit ex items.
"Frontier’s third quarter showed the strongest level of broadband growth since we closed on our acquisition last year," said Maggie Wilderotter, chairman & CEO of Frontier Communications. "In total, we’ve brought broadband to 592,000 new homes while removing $496 million of annualized costs. We also recently completed our largest successful conversion of the acquired property operating systems onto Frontier’s legacy platform, which will further enhance our marketing, streamline our operations, and increase our cost saving opportunities. Frontier is committed to profitable expansion of broadband to our mostly rural communities, and we’re focused on enhancing revenues to protect our stable dividend."
Adjusted operating cash totaled $609.2 million, for an operating cash flow margin of 47.2%. Adjusted EBITDA came in at $603.2 million, below the $614.75 million consensus. The EBIDTA margin was 47.0%.
The company has paid a total of $559.8 million in dividends for the first nine months of the year, equating to a hefty payout ratio of 75% of free cash flow. Management’s goal is to get the payout ratio back down to around 50% of free cash flow or less.
Frontier had about 3.2 million residential customers at quarter-end and a little less than 320,000 business customers. It added 16,200 high speed Internet customers to bring its total to 1.76 million. It claimed 2,300 net new video customers for a total of 555,600, and 2,300 wireless data customers.
"This growth reflected the effectiveness of our local engagement model as well as organic demand for broadband in both legacy and acquired properties. We have also largely completed our efforts to migrate middle-mile congestion," Wilderotter said.
Frontier, like a lot of telecoms, carries a hefty debt load. Its net debt was just under $8 billion on September 30th, but management says it has deleveraged the balance sheet from 4.04x to 3.17x in the past year. It had over $1 billion in liquidity, including $750 million available on its revolver at the end of the third quarter. Interest expense was $165.8 million in Q3, compared to $166.6 million a year ago. The debt repayment schedule is reasonably well balanced with negligible debt due in 2012 and about $600 million coming due in 2013 and 2014. The current unused revolver also expires in 2014.
Wall Street’s view of the stock is mixed. Seven analysts are recommending the stock to clients, but nine others are neutral and two remain negative.
BMR Take: When we looked at Frontier back in March, we said we would be mildly bullish on the name if the company could post some steadily improving results in 2011, but that hasn't been the case with results largely mixed. Positives for Frontier include doing a good job of integrating the assets it acquired from Verizon and carving out costs; investors have little to complain about on that front. The growth in high-speed Internet users has also been solid all year, but obviously not enough to offset the loss of residential telephone lines and other business.
The sequential decline in revenue is obviously a concern as is the high dividend payout ratio. The deal with AT&T gives the company another product line to sell and CEO Wilderotter is emphasizing marketing new products to the company’s customer base. With a forward EV/EBIDTA multiple of 5.6x the 2012 EBIDTA consensus, the stock isn’t expensive, but it's also not cheap for a business in gradual decline.
For now, given the company has negligible debt coming due in 2012, we think the company’s cash flow is sufficient to maintain the payout. Clearly, however, if revenue continues to slide a dividend cut is always on the table. For the record, Frontier’s quarterly ex-dividend date is December 7th.
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