Barron's 2012 Roundtable Part 1
Barron's 2012 Roundtable Part 2
Tireless as well as prescient, Marc Faber has warned Roundtable readers repeatedly that the Federal Reserve would keep interest rates unnaturally low "as far as the eye can see." Well, the eye has just seen to the end of 2014, given the Fed's disclosure last week that it will pin short-term rates near zero at least until late in that distant year, in its anxious attempt to juice the laggard economy.
What is bad for savers, however, is manifestly good for gold, and great for shares of companies that pay fat and rising dividends. And, as luck would have it, both get top billing in this week's third and final installment of our 2012 Roundtable, which took place Jan. 9 in Manhattan. Sure, our 10 experts hungered for grub by the end of our 10-hour session, but that's nothing compared with investors, who are starved for yield.
Up first this week is Brian Rogers, a Roundtable newcomer, though he is a familiar presence at T. Rowe Price, where he serves as chairman and chief investment officer, as well as manager, for nearly 27 years, of the $23 billion T. Rowe Price Equity Income Fund. As Brian tells it, he looks for companies whose success has gone unnoticed by the market. Plenty fit that bill these days, especially financials such as JPMorgan Chase (ticker: JPM).Brad Trent for Barron's From left, Fred Hickey, Abby Joseph Cohen, Brian Rogers and Scott Black.
Abby Joseph Cohen, the learned head of Goldman Sachs' Global Markets Institute, deftly grabs the baton next, to show how dividends and stock buybacks in tandem can deliver effective yields of 7% or 8%. That is surely the case with ExxonMobil (XOM), one of Goldman's top picks, and several other stocks beloved by the bank's analysts and illustrative of her point.
Scott Black, the boss at Boston's Delphi Management, always burns the midnight oil boning up on his Roundtable picks. And it showed, once again, in this year's masterful analysis of four big-cap stocks with puny price/earnings ratios, and two intriguing and high-yielding real-estate plays.
Fred Hickey, down from New Hampshire and up on all things tech, closed the proceedings with a rousing endorsement of gold, and the cheery news that the 12-year bear market in technology stocks is coming to an end. Microsoft (MSFT), he predicts, will finally get the respect it deserves, as will some lesser-known names in tech land.
To learn why, please read on.
Barron's: Brian, you seem to be surviving well so far. What do you make of the market these days?
Rogers: I now realize why I didn't have as much fun last year as I thought I would. As Bill describes it, due to near-zero interest rates, I have been suffering from financial repression, which I didn't realize was an affliction. But now I have come to view it as such.
That's the next step.
Rogers: And the step after that is medication. Everything I see tells me the U.S. is getting a bit better. Last year we had a sloppy market globally. The U.S. was a nice place to be. India, China and some parts of Europe were rugged places to be. The asset class that outperformed all was 30-year Treasury bonds, which very few people foresaw 12 months earlier. Even within the U.S. market there were pockets of relative strength, and pockets of weakness. Almost anything with cyclicality was penalized.
Now it is early 2012, and I look at the carnage that has hit some good companies in the past 12 or 18 months. Companies have performed better fundamentally than they have been rewarded in the market. I look for situations in which there is a disconnect between a company's performance and the market's response. Emerson Electric [EMR] is an example. It is a great American company.Jennifer Altman for Barron's Brian Rogers (left): Companies have performed better than the stock market has acknowledged.
What makes it so?
Rogers: You have to love a company that states on the cover of its annual report, in bold letters, that it has increased dividends for 55 years. Its stock was down 18% last year despite the fact that earnings were positive in the fiscal year that ended in September. The stock yields 3.5%—not as much as some of the companies in Singapore and Hong Kong that Marc mentioned, but a healthy yield in today's world. Also, when a company says it has raised its dividend for 55 years, the odds it goes up in years 56, 57 and maybe 58 are good.
Emerson is a leader in electrical equipment, factory automation and climate technology, or air conditioning. It earned $3.27 a share in fiscal 2011. It will probably earn something in the $3.50-ish range for the year ending this September, and on the order of $4 for fiscal 2013. In a year when earnings, the dividend and cash flow were up, and the company bought back a ton of stock, you paid a multiple of 14 times earnings. The stock trades today for $47, and we see it in the high $50s in the next year. Add a $1.60 dividend and the total return could be attractive.
Where does Emerson's output go?
Rogers: The majority of sales are outside the U.S. One reason Emerson's order activity slowed was due to the impact of flooding in Thailand. About 45% of sales are in the U.S.
Cohen: U.S. companies have been affected by significant shocks to their supply chains overseas, including the floods in Thailand and the earthquake and tsunami in Japan. With lean inventories almost everywhere, supply disruptions have caused a rethink by companies that are now relocating some manufacturing back to the U.S.
Rogers:I'd like to tell David Farr, chairman and CEO of Emerson, that he can open a big plant in Baltimore and attract a lot of workers.
You just did.
Rogers:Emerson has been penalized because it is a cyclical company. Ingersoll-Rand's [IR] stock suffered last year because of cyclical concerns. Its shares were down almost 40% last year. It is in some of the same businesses as Emerson. It has a big climate-solutions business, and makes Schlage locks and Ingersoll-Rand tools. The yield is a little light at 2%. The balance sheet is good. The stock is $32, down from a high of $52, and we estimate the company bought back about 30 million shares last year. They should buy back more in 2012. The stock sells for 10 times 2012 earnings, so the selloff has wrung a lot of excess valuation out. Ingersoll could earn $3 a share or $3.10 this year, and as much as $5 two or three years out. Put a 10 multiple on it, which isn't heroic, and you have a $50 stock.
Black: The company bought Hussmann, a refrigeration company, at the top. They took a major loss years later because it wasn't strategic. They destroyed a lot of capital. Also, earnings are untaxed. Ingersoll-Rand is run from New Jersey but is registered in a tax-free zone [Dublin]. The P/E [price/earnings ratio] isn't real, if you apply a 35% tax rate to earnings.
Rogers: The guy behind the Hussmann deal has left the company. Now there is a slightly different cast of characters. But it isn't without controversy, which often creates opportunities. Ingersoll has real snapback potential.
Financials were the worst-performing market sector last year, in the U.S. and probably globally. One has to look at companies that have been hit hard in that sector but will be around for a long time, and where you can believe in management. That is the case with JPMorgan Chase, which is selling around $35 a share. It was down 20% last year. It performed as weakly in 2011 as it did in 2008, which really surprised me, because 2008 felt like a much more difficult period than 2011. The company raised its dividend last year and yields 3%. It also bought back about $9 billion of stock.
It is tough being a financial-services company now, because you need Federal Reserve clearance to do anything. But the Fed will approve JPMorgan's capital plan, and they may raise the dividend again this year and buy back more stock. The financial sector has been the most traumatized in the past few years, and you might as well bet on the strong horse in a field of weak ponies. Sentiment is so bad that you can't find anyone looking at financial stocks. But the headwinds are well known, so you have to ask, what is the stock price? JPMorgan's tangible book value is $34 a share. Stated book is $46. Some day they are going to earn between $5 and $6 a share.
What do you think they'll earn this year?
Rogers: They will probably earn $4.50 to $4.75 a share in 2012, versus $4.50-ish for 2011. [JPMorgan reported on Jan. 13 that it earned 90 cents a share in the fourth quarter, below analysts' estimates, and $4.48 per share for the full year.] No one hit me for recommending a bank stock, so that is a good sign.
Witmer: You're new.
Rogers: Thermo Fisher Scientific [TMO] is a combination of the old Thermo Electron and Fisher Scientific, which merged in 2006. The stock is at $47.60, and it was down about 20% last year. The company serves just about every pharma and biotech company, every life-sciences research institute and governmental agency involved with health care. They provide the guts of everything that goes into medical and scientific research. Whether it is a simple microscope used in high-school biology or a fancy molecular spectroscope, they make it.
Thermo was hit hard in the fall amid Washington's budget debate and fears that funding for the National Institutes of Health would be cut. This is a clean company financially. It should be a high-return-on-capital business when you look at what they make and who they sell it to. It is a pretty good company from a cash-flow standpoint. They bought back about $1 billion of stock last year. The market capitalization is roughly $18 billion, and they will buy back another $750 million of stock this year. Balance sheet is pristine. You just have to make a bet that long-term health-care research will be a fertile field.
Schafer: The large pharmaceutical companies are merging because they don't have much growth because of generic competition. After merging, they reduce duplicative research and development. These companies are buying bio-technology companies and will then cut R&D, as well. So it is possible Thermo's end markets aren't expanding, but shrinking.
Rogers: Even in a shrinking market, they probably earned $4.14 a share in 2011 and will earn $4.75 in 2012. The stock sells for $47.62, or 10 to 11 times earnings.
Witmer: Did management pay a lot more than the current stock price to buy back shares? Companies buying back shares at too high a price is a pet peeve of mine.
Rogers: Any shares they bought back in 2011 would have been higher than the year-end price.
Schafer: Meryl, they can't be in the business of predicting the stock price.
Witmer: Right, but they can be in the business of allocating capital carefully.
Schafer: Was last year's $4.14 a share up or down from 2010?
Rogers:It would be up from $3.57 in 2010.
Schafer: It doesn't sound like a shrinking market.
Rogers: For 10 times earnings, you're getting interesting products serving important health-care customers. Despite the issues surrounding health-care spending, people want to get better and live longer. Thermo will have the wind at its back.
In our research meetings, we talk about companies that grow at 15% a year long term. They should have a sustainable competitive advantage because so few companies do that year in and year out. If I told you Microsoft had grown revenue at 11% and earnings at 16% compounded over the past 10 years, that would be better than all but probably 5% of the companies in the S&P 500.
Microsoft's stock is another story.
Rogers: The stock was probably 40 times earnings 10 years ago and now is nine or 10 times earnings. It was one of those companies, like Intel [INTC], Wal-Mart Stores [WMT] and General Electric [GE], that sold for 35 to 45 times earnings in 2000. You have had 12 years of value compression. Microsoft, at $28, with roughly $6 a share in cash and a yield of almost 3%, earned $2.69 a share for the year ended last June. In the current fiscal year it could earn $2.70 to $2.80. The company is in the midst of a $40 billion stock-buyback program.
Culturally, Microsoft is a little tired of being sneered at. You never want to criticize anybody for 16% compound earnings growth. They were hit hard for acquiring Skype. As a corporation, they don't get the respect they deserve. The stock sells for three multiple points less than some utility stocks.
What will change the market's attitude?
Rogers: A new Windows 8 product cycle is coming later this year. What is the downside risk? Maybe $2 or $3 a share. And what is the upside? If you put a 12 multiple on fiscal 2013 earnings per share, you theoretically could get a $35 stock sometime in the next year, with the dividend yield on top of that. They raised the dividend in the fall. Their pattern of capital return to shareholders is another catalyst. Will they continue to take the dividend up aggressively? Will they continue to buy back shares? Will Windows 8 be a success? There are all sorts of ways to win.
Juniper Networks [JNPR] is a bit dicier. It has had some execution issues. The shares were down 45% last year and trade at $20.50. It has $6 a share in cash. The market value is $10.5 billion, and revenue is $4 billion a year. The balance sheet is good. Debt to total capitalization is about 13%. Juniper is best viewed as a little Cisco Systems [CSCO] in the type of networking equipment it provides. It is a very important company to IBM [IBM].
There is a chance a lot could go right here, primarily because a lot has gone wrong in the past year. The short term looks murky, but in 2013 they could earn $1.80. Put a 14 or 15 multiple on that and add back the cash, and you could see the stock rising to $30 to $35. There has always been a small chance Juniper would become an acquisition target. You aren't paying a lot for that possibility.
Thanks, Brian. Let's go to Abby.
Cohen: Economic growth in the U.S. will be OK but not great in 2012. We expect global GDP [gross domestic product] to decelerate to 3.2% from 3.5%, owing to the recession in Europe and deceleration in China. In the U.S., momentum was good at the end of 2011, and we will be watching carefully to see whether that continues. Even so, the market's valuation isn't unappealing. The S&P is selling today at a level that implies an annual 13% decline in the five-year path of earnings growth. Long-term valuation is attractive, but we expect short-term volatility.
Last year we saw extremely high correlations. At year end, the correlation among sectors was 0.88 in the U.S. Among stocks it was 0.64, which ought to make any stockpicker a little concerned about doing a lot of homework on companies and stocks and not getting the benefit from it. Despite the near-term head winds, there is an opportunity later in the year for valuations to improve. Carefully selected equities could generate good performance.Jennifer Altman for Barron's Abby Cohen: "The market's valuation isn't unappealing."
What is the biggest risk to your view?
Cohen: Will Europe have the political will needed to resolve the situations in the euro zone? In addition, a recession in Europe has a direct and negative impact on U.S. companies. Then there is political risk here. We talked earlier today about the inability of Congress to deal in a policy-friendly way with some of the decisions that need to be made, instead of making more political decisions. This is a presidential election year, so it isn't likely this is going to improve before the end of the year.
Edwards Lifesciences [EW] isn't all that sensitive to the economy. It closed Friday [Jan. 6] at $72.88. The company designs and manufactures products that treat late-stage cardiovascular disease. It is the leader in heart valves, catheters, hemodynamic monitoring devices and so on, and recently received Food and Drug Administration approval for a product that will give it a commanding position in the U.S.
Can you give us some numbers?
Cohen: We estimate the company earned $1.98 a share in 2011. This year they will earn $2.75, and in 2013, $3.60. While the P/E is a high at 26 times 2012 earnings, this has been a fast-growing company. The expectation is earnings growth can compound by 25% to 30%. Margins could expand from 21% to 25% in the coming year.
My next two stocks are much more cyclical. I recommended Boeing [BA] in the midyear Roundtable ("Buy Low, Stay Nimble," June 13, 2011), and we still like it. Boeing trades for 14 times our 2012 earnings estimate of $5.20, versus the consensus of $4.95. It yields 2.3%. The company is benefiting from the end of the development of the 787 Dreamliner. They are done with the R&D and other spending, and they are seeing orders come in. We also like Brazil's Embraer [ERJ], a dominant maker of regional jets. These are highly desired not just in North America, but increasingly in emerging markets because many have short air routes. The ADR [American depositary receipt] trades in New York.
Black: What is your assumption on the Brazilian real versus the dollar? Sales of Embraer jets primarily are denominated in dollars. If the real goes up, they get killed on labor costs in Brazil.
Cohen: The dollar will be a stronger currency in the next several months, in particular. The Brazilian market was down in 2011, which is one reason the stock's valuation is cheaper. Demand for regional jets has been good. Embraer won almost every new order in the past two years. If you compare them to their primary competitor, Bombardier [BBD/B.Canada], Embraer has sold 200 planes versus 12 for the Bombardier. The aerospace industry in general has record backlogs.
We estimate Embraer earned $1.82 a share in 2011. We are estimating $2.70 for 2012, compared with the consensus forecast of $2.42. Our S&P 500 earnings estimates are below consensus. Our GDP numbers are below consensus. When we find companies about which our analysts feel better than the consensus, we are increasingly comfortable with those names. In addition to a reasonable P/E of 9.6 times 2012 earnings, Embraer yields 3%. The stock is $25.99.
Black: There is another kicker for Boeing. It just made a huge sale of F15s to Saudi Arabia.
Cohen: I recommended ExxonMobil last year and we still like it. Shares trade for $85.12. There is some question about aggregate demand for oil, given the deceleration in economic growth in Europe and China. But the supply situation is tight, and crude prices could rise. Brent crude could trade in a range of $120 to $130 a barrel in the next two years.
Our earnings estimates for ExxonMobil are above consensus, as is our crude-oil forecast. In 2011 Exxon likely earned $8.75 a share, compared with a consensus forecast of $8.35. Our 2012 forecast is $9.60 a share. The consensus expects a decline in profits. As a consequence, the stock trades for 8.9 times earnings. It yields 2.2%. Much of Exxon's attraction, and that of some other stocks we like, has to do with the way shareholders are treated and capital is allocated. If you look not just at the dividend yield but the yield in terms of a stock buyback, both contribute to shareholder return. If you add back the cash returned to shareholders in the form of share repurchases, the effective yield would be a much higher 7% or 8%. That is the right way to look at it.
Exploration and production growth could be in the low single digits. Yet Exxon has new projects, and scale in terms of shale in North America. In choppy markets for equities and crude oil, we would rather stick with super-majors like ExxonMobil.
That makes sense. What else do you like?
Cohen: JPMorgan, as it also is on my list. It will continue to return cash to shareholders in rising dividends and share repurchases. The dividend-payout ratio is 25% of earnings. The estimated payout ratio in terms of share buybacks is 28% this year, so the total payout to shareholders is 53%, for an effective yield of 7.8%. In addition, JPMorgan and some other major U.S. banks will benefit from the stress in Europe. As European banks shrink their balance sheets, well-positioned banks elsewhere will have an opportunity to buy assets at a discount.
There is a reason financial stocks are trading at a discount to book value. Investors are nervous. There are questions about the performance of equity and credit markets in the future, and some ongoing losses from mortgage banking. But the valuation and the return to shareholders look good. JPMorgan estimates that in the case of "disaster" in Europe, they stand to lose about $3 billion, which in the context of the size of the company is manageable. The bank is doing well in private-client asset management.
American Express [AXP] closed Friday at $48.27. Like many other U.S. financials, it looks good on Basel III Tier 1 capital requirements. [The Basel Accords are global regulatory standards on bank capital adequacy.] Tier 1 is currently at 12% of total capital. They have a strong ability to do additional buybacks. The dividend yield is 1.5%, but they can add to that with share repurchases, which could result in an effective yield of 7.5% in 2012. American Express' credit losses this year are expected to be 3%, well below peers'. They seem to be benefiting from improving consumer trends, especially among the relatively higher-end consumers they deal with. They are also experiencing good growth outside the U.S., with the exception of Europe. The credit losses are moving lower, and they are acquiring more merchants. American Express will benefit from the convergence of online and offline markets.
My last company is Domino's Pizza U.K. and IRL [DOM.U.K.]. That's Domino's in the U.K. and Ireland. As a proud New Yorker, I always like the local pizzeria. But having traveled recently and tasted the Domino's product outside the U.S., it is surprisingly good.
This is a new form of securities analysis.
Cohen: Shares trade for 437 pence [4.37 pounds]. The U.K. economy will grow about 1%, which is modest but better than Europe. In the U.K. there is a structural trend toward home delivery. We see that in some other places, as well. Domino's has 48% of the U.K. pizza-delivery market. Since 1997 there has been 20% annualized growth, half from new stores. We forecast 19.11p in earnings for 2011 and 22.35p for 2012, versus this year's consensus estimate is 21.38p. The stock yields 2.8%.
Rogers: How big is the market cap?
Cohen: It is £703 million [$1.1 billion].
Gabelli: If the stock does well, which I expect, I also expect Abby to bring in Domino's Pizza for lunch next year. You can have it delivered.
Thanks, Abby. Scott, what did you bring us this year?
Black: I assume the U.S. economy will grow 2.3% in real terms, so there is no recession. Corporate profits in the U.S. will grow only around 6.5%, but balance sheets will remain solid. Global growth is slowing to 2.7%. I have four stocks with sustainable earnings and real revenue growth, free cash generation and low P/Es. The other two are yield plays—REITs [real-estate investment trusts].
Apache [APA] trades for $97 a share. There are 400 million fully diluted shares, and the market cap is $38.8 billion. The company will have record earnings this year of $12.50 a share. Daily production is about 750,000 barrels of oil equivalent, up dramatically year over year. Organic drill-bit growth [production gains from drilling] is 6% to 12%. Reserves are 70% oil, 30% gas. Apache is getting $4.44 per Mcf [thousand cubic feet] for gas worldwide, and $101 a barrel for oil. Gas prices in the U.S. are $3 per Mcf, but the bulk of their production is overseas. Operating margins are 48.5% on projected revenue of $18.39 billion, giving you operating income of about $8.92 billion. Taxed at 44%, you get to $12.50 a share. Shares sell for 7.8 times earnings, which is cheap. Adding back depreciation and deferred taxes gets you $26 a share of discretionary cash flow. Shares sell for 3.7 times discretionary cash flow.Jennifer Altman for Barron's Scott Black (left): "Some macro trends are working for FedEx. One is e-commerce."
Why is that?
Black: About 10% of reserves are in Egypt, which also contributes 25% of revenue. Investors are worried about political risk. Apache's return on equity is 16%. The ratio of net debt to equity is 0.24. The company will step up capital spending next year from $8 billion to a minimum of $9 billion, and still will generate $1.2 billion of free cash flow. Apache is diversified around the globe, with 70% of reserves in the U.S. and Canada, some reserves in Australia and some deep-water plays that could be home runs. Every one dollar change in the price of oil means an 18-cent change in earnings per share, and every 10-cent switch in the gas price means a 10-cent change in earnings. Apache has a 12% hurdle rate [minimum required rate of return] on projects, based on $80 oil and $3 gas. With oil around $100 a barrel, they have a margin of safety.
Next, CBS [CBS] doesn't get much respect, but Les Moonves, the CEO, has done a good job. Revenue in 2011 was an estimated $14.4 billion, and earnings per share were $1.89, versus $1.11 in 2010. Revenue is increasing by 3% a year, but there are some kickers this year. They will generate $200 million from streaming content to Netflix [NFLX], Amazon.com [AMZN] and Hulu. Retransmission fees will total $200 million to $250 million, and political adverting on owned and operated television stations will be another $180 million. Total revenue will rise 5.3% this year. Operating income is 19.1% of revenue, and earnings per share will be $2.25. The P/E multiple is 12.3. Margins are rising because streaming revenue is incremental and drops to the pretax line. The same is true of retransmission fees.
Witmer: What is the stock price?
Black: The stock is $27.79. CBS pays a 40-cent dividend and yields 1.4%. The market cap is $18.7 billion. The company will earn $1.5 billion this year and free cash flow could be $1.8 billion. Capital spending is mostly for outdoor billboards, including digital billboards. They also have a big presence in the U.K., home of this year's summer Olympics. The CBS television network has dominated in the ratings. They have 20 of the top 30 shows. It looks like this will be a banner year for the network.
Gabelli: Will Les monetize the outdoor business, or buy something?
Black: He just got authorization to buy back an additional $1.5 billion of stock. That pushes earnings per share up. The bottom line is growing faster than revenue.
FedEx [FDX] is doing well, and earnings will accelerate this year. The company will generate revenue of $42.8 billion in the fiscal year that ends in May. Operating margins are about 7.5%, and interest expense is nominal as there is more cash than debt on the balance sheet. FedEx is the only airline company in the world that is essentially debt-free. Pretax profit of $3.2 billion, taxed at 36%, will translate into $6.45 a share in earnings for fiscal 2012. For fiscal '13 we see revenue growth of 6%, but profit growth of 10%. FedEx bought a bunch of Boeing 767s, and will replace their 727s and old MD 10 planes, which were energy-inefficient. Earnings could rise to $7.30 for the May 2013 year. The stock is $85.49, and on a calendar basis, the company will earn $6.80 a share in 2012. It sells for 12.6 times calendar-year earnings, and 11.7 times fiscal 2013 earnings. Return on equity will be 13% for the next year, versus 17% to 18% at prior peaks. They think they can get back to peak levels.
Will higher oil prices clip profits?
Black: Fuel as a percentage of revenue has gone up this year. But they have more efficient planes coming on, and they impose fuel surcharges. They are strict on capital budgeting, with all projects surpassing an 8.5% after-tax hurdle rate. And some macro trends are working for them. One is e-commerce. Also, companies like Apple [AAPL] that make high-value-added goods depend on quick mobility and global sourcing, which helps FedEx. United Parcel Service [UPS] is also a beneficiary but shares trade for 15 to 16 times forward earnings.
What else do you like?
Black: One of the few sectors that has done well and will see terrific long-term growth is agriculture. Deere [DE] is one of the few domestic companies still doing well in Europe. If Europe's economy stays flat, Deere could have revenue of $33.6 billion in the fiscal year ending in October, up 14% from fiscal 2011. The company could make $3.2 billion after taxes, or $7.80 a share, up from $6.63. For fiscal 2013, assuming the world economy slows, we see a 5% increase in revenue and $8.30 in earnings per share. Based on calendar 2012 earnings, Deere has a P/E of 10.
Free cash flow, excluding a financial subsidiary, will be $2.85 billion in the current fiscal year. The company says it is hellbent on keeping its single-A rating, since it has an active commercial-paper program to finance customer receivables. Credit losses are a negligible .04% worldwide. Last year Deere had a headwind on margins because it had to roll out more fuel-efficient engines. By next year, margins will improve. Also, they will be able to knock out a total $700 million of costs, with $300 million already cut.
Gabelli: Are there opportunities for Deere beyond construction and farm equipment?
Black: Agricultural equipment is 71% of the business. Construction and forestry equipment is 18%, and commercial and consumer, 11%. The real opportunity is diversifying by region and selling to India and China and Brazil, especially for the sugar cane harvest in Brazil.
What are your yield plays?
Black: Normally at Delphi we can't own biotechnology stocks. Someone once said there is never an earnings disappointment among biotech companies because there are no earnings. However, BioMed Realty Trust [BMR] is a surrogate play on the industry. It is based in San Diego and trades for $18.14. There are 155 million shares, and the market cap is $2.8 billion. The company builds suites of biotech facilities. Its strongest aggregation is in the Boston-Cambridge area, which brings in 34.4% of the rent. San Francisco accounts for 16.2%; San Diego, 14.7%; Maryland, 15.1%, and so forth. We look at the implicit capitalization rate [net operating income divided by total capitalization] based on net operating income, not funds from operations. The run rate is $80.9 million in NOI per quarter. Annualized, that's $323.6 million. Enterprise value, including the market cap and net debt, is $4.189 billion, so the implicit cap rate is 7.7%.
BioMed is growing same-store net operating income by about 10% a year, so the cap rate is 8.5% based on next year's pro forma NOI. The trust pays an 80-cent dividend and yields 4.4%. The stock sells for 1.16 times book. The companies they lease to are high-quality tenants—universities like Harvard and big drug companies like Pfizer [PFE]. About 20% of their space is used by mid-sized and smaller companies. Their average rent per square foot is about $38.28. These are triple net leases [the lessee must pay real-estate taxes, building insurance and maintenance]. In the next five years, only 18.4% of rents will roll over. Biomed has almost $750 million of untapped credit lines. They are an investment-grade credit, rated triple-B-minus. It is an interesting play and you get paid while you wait.
Schafer: If there is consolidation in the industry, what happens to the real estate?
Black: Schools like MIT and Harvard are expanding. Companies are moving from Europe to the U.S. because of our research centers.
Digital Realty Trust [DLR], based in San Francisco, is a play on hosting data centers. It sells for $66.72 a share and has a $6.8 billion market cap. It pays a $2.72 dividend and yields 4.1%. Eighty-nine percent of its space is in North America—in New Jersey, northern Virginia, Silicon Valley and so on. Only 9% by square footage but 11% by rent is in Europe. They are contemplating moving into Hong Kong and Shanghai. They have major customers like Facebook, Morgan Stanley [MS], AT&T [T] and Amazon. Their top 10 tenants pay 36% of the rents.
Witmer: What is the price-to-book value?
Black: It sells for 3.6 times book, which is hefty. But the implicit cap rate is 6.9%. Net operating income probably will rise 12% or 13% next year. The balance sheet is strong, and interest coverage is 4.1. The dividend coverage is 1.32, and the payout has room to rise. They have $1.1 billion left in credit lines, and only 6.4% of their rents roll off next year. They seem to be disciplined on capital usage, and again, you get paid while you wait for the stock to rise.
Thanks, Scott. Fred, you're up, at last.
Hickey: I remain overweight gold. The secular bull market in gold isn't over. A negative interest-rate environment is bullish for gold, and rates keep getting more negative as central banks keep cutting rates that aren't yet zero-bound. Where interest rates are close to zero, as in the U.S., the U.K. and Japan, they engage in quantitative easing.
Why have gold-mining stocks been weak?
Gabelli: Some governments expropriate lucrative mines. Also, mines are subject to strikes and floods.
Hickey: Newmont Mining [NEM], which I recommended last year, outperformed. [The stock rose 5.5% through Dec. 30.] The driver is gross margin expansion. Gold prices are up by a factor of six through this bull market, yet costs have roughly doubled. The company has had tremendous cash flow, leading to dividend increases. Newmont has tied its dividend policy to the gold price. If the price rises, you are guaranteed more dividends. The money won't be wasted on bad acquisitions. In 2008 Newmont earned under $2 a share. It could earn $4.82 for 2011, and $5.96 in 2012. There's no reason these stocks should be so cheap.
As Felix has said, owning physical gold is important. In addition, you can own gold through exchange-traded funds, such as the GLD [ SPDR Gold Shares]. They are audited. The U.S. government's gold holdings haven't been independently audited in decades. The GLD charges fees of 0.40% of assets. The IAU, or iShares Gold Trust, charges only 0.25% of assets. It trades for about a hundredth of the price of gold, so it is selling for $15.76 a share. It has been around since 2005 and has $9 billion in assets and 171 tons of gold. It stores its gold in vaults around the world. Last year I recommended stocks. This year I like the GDX, or Market Vectors Gold Miners ETF. It gives you diversification with 31 names, including a few silver stocks. Barrick Gold [ABX], Newmont and Goldcorp [GG] account for 41% of assets. At some point gold stocks will outperform bullion.
What do you favor in tech these days?
Hickey: I have been bearish on tech for a long time, but the secular bear market has been very long. I have played the cyclical rallies, but now I want to be bullish in a significant way. Tech stocks are starting to get attractive on a valuation basis. If Felix is right, as I expect, the stock market could turn down sharply in the second half of this year, and that could be the bottom for tech stocks. We might finally get to the point of capitulation. We're almost there. I have started to add to some positions.
Last year the Morgan Stanley High-Tech 35 Index dropped another 11%, and some stocks fell much more. At this point even the highfliers are having trouble. Salesforce. com's [CRM] chart looks dismal. You want to see all the enthusiasm wiped out at the end of a secular bear move. I am picking through the 52-week-lows list every week and looking for solid companies I have known for years. Some are at multiyear lows.Jennifer Altman for Barron's Fred Hickey: As a value investor, "! am picking through the 52-week-lows list every week."
Hickey: BMC Software [BMC] could becomea takeover target. It used to be a mainframe-software developer, but now provides back-end systems-monitoring and performance-management software for servers, networks and databases. It has also become established in cloud computing. The stock was higher in mid-2011 on this notion. BMC offered a poor outlook in the latest quarter and blamed part of it on Europe. Also, government spending on tech was weak in the U.S., as Oracle [ORCL] noted when it issued its shocking earnings warning in December. Oracle has grown through acquisitions and has been rumored as a buyer for BMC. I don't want to wait for BMC to go lower. It is $32 a share now.
What could it be worth in a takeover?
Hickey: It could go out in the $40s, or higher. Cisco has a close relationship with BMC and has also been mentioned as a potential buyer.
Black: What could BMC earn this year?
Hickey: Analysts are looking for $3.24 a share, so the stock is selling at 10 times estimated earnings. The forecast for the fiscal year ending in March 2013 is $3.50 a share. Utility-like, the company throws off tremendous amounts of cash. It would have to be a pretty significant recession before they would have any slips. They have been buying back shares over the years, and have $6 a share in net cash. Gross margins are high, ranging from 75% to 80% in the past couple of years. They had 241 million shares outstanding in 2002 and now have 170 million, down 30%. They buy back shares every year. They have had one insider purchase recently, which is interesting, as well.
On the bombed-out list of semiconductor companies, I like Marvell Technology Group [MRVL]. The stock was hit because of flooding in Thailand. They make hard-drive storage controllers and supply the big disk-drive makers, which reported there would be a significant shortfall in the number of drives produced at the end of the fourth quarter and in this quarter. Almost any company that had anything to do with the disk-drive market got hit. In addition, Research In Motion [RIMM], a Marvell customer, isn't the best customer to have in the wireless-phone area. Marvell lowered revenue and profit guidance in both storage controllers and wireless, and the stock fell.
Black: All the mixed-signal chip companies are rolling over. It isn't only Thailand, but the business itself is declining.
Hickey: This is a second-half play. The disk-drive market will rebound in the second half.
Marvell trades for $15.72, down from the low-20s and up from a recent low of $11 and change. It has a market cap of $9 billion and is expected to earn $1.29 a share in the year ending Jan. 28. It trades for 12 times future earnings. The company generates a lot of cash. It doesn't have its own factories but uses Taiwan Semiconductor's foundries, so it has high gross margins.
Black: Marvell historically sold for more than 20 times earnings, so this is the lowest multiple in years.
Hickey: Marvell is developing a semiconductor chip that will be used in the Chinese smartphone market. The acronym for the technology is TD-SCDMA. They just got a significant design win from ZTE, a major Chinese phone maker. The demographics in China are tremendous.
Black: How does their chip compare in power usage and speed with the ARM chip used by Apple?
Hickey: This is a lower-end chip.
Finally, Brian recommended Microsoft, and I'm sticking with it, too. The stock has been penalized because we are in a bear market, but there have been concerns about technological obsolescence, too. There have been worries that Office and Windows would lose share as we moved into cloud computing. Microsoft Office 365 is the company's response to the cloud market. It was shipped in June. EWeek, one of the premier trade magazines in the tech business, named Office 365 one of the top five new products in 2011. The iPad was No. 1. CRN Magazine named it the top cloud application of the year. Microsoft's primary competitor in this market is a Google [GOOG] app, but Google suffered a blow last month when Los Angeles abandoned plans to give 13,000 law-enforcement personnel access to Google's system software due to security concerns.
Tell us about Windows 8.
Hickey: The Windows 8 Metro interface has been well-received in the Windows phone world. It will be on new ultrabook PCs, and drive an upgrade cycle late in the year.
Toshiba and others are excited about Windows 8 on tablets. They think the Metro interface will allow them to succeed against Apple. In the phone market, all the carriers would like to see a third alternative to Apple and Android. Lots of things are positive for Microsoft this year. The only negative is the economy, and the disk-drive business at the beginning of the year.
Gabelli: What is [Microsoft CEO] Steve Ballmer's status at the company?
Hickey: Some people in the financial industry would like to see a change in management because they think the stock would rally, and it likely would. But Ballmer isn't threatened right now.
Thanks, Fred, and everyone.