"Goldman, unlike the rest of the street and practically the rest of the I banking world, is ratcheting up off balance sheet risk!!! Is BoomBustBlog the only one inquiring as to WHY??? We have a few reasons in mind... And to think, many thought the Enronesque days of off balance sheet "hide the sausage" games have come to an end..." Go through your sell side analyst's quarterly update and if you don't find these tidbits of information thoroughly explained, but instead see a Goldman fan boy(girl) cheering section, come back and subscribe to BoomBustblog. At the very least, we tell it like it is!
My opinion and updated valuation for Goldman and its 3rd quarter performance is available for download to all paying subscribers: GS 3rd Quarter 2010 Update. While I can't spill the beans on the entire contents of the subscription document, there are a few issues (as usual) and observations that I would like to make public.
To begin with, I must commend Goldman's management. They do a helluva job massaging numbers and attempting to right their ship, particularly in relation to some other banks. Anecdotally, I'm aware of their losing some talent on the equities side but I am sure they have no problem replacing it. There is also the issue of their subprime servicing unit, Litton Loans, which I am sure will bring them nothing but heartache in the near to medium term, but at least that aspect of the business has been recognized by the sell side, if not under appreciated in terms of potential risk. Despite its small size in relation to Goldman's aggregate operations, it carries with it material reputation risk as well as the prospects for significant litigation and more.
Now, on to the aspects which the sell side decided not to cover - or somehow overlooked. Goldman was applauded for having strong accounting earnings. In Four Facts That BANG JP Morgan That You Just Won’t Hear From The Sell Side!!!, I warned of the danger at looking at accounting earnings as if they were actually a legitimate barometer of a companies actual economic value. If that were the case, wouldn't accountants be the best investors in the world? I will delve into the folly of relying strictly on accounting earnings later on this missive as well, particularly in regards to a company with management as crafty and capable as Goldman - but before I do let's realize that even those accounting earnings were down significantly from previous periods...
The full 3rd quarter forensic analysis and valuation update for JP Morgan is now available for all subscribers: JPM 3Q 2010 Forensic Update. The download is a much more detailed version of the (not so) quick overview I posted the day after earnings that reveals some very interesting points. All in all, the JPM quarter was quite bad, considerably worse than the media appears to be making it out to be. I have taken the liberty to include some of the highlights of interest in this blog post. While the hardcore actionable stuff is reserved for clients, I feel there are a few topics of discussion that demand public attention. I would like anybody who reads this to go to their local broker (or prime broker) and get a copy of their JP Morgan quarterly research opinion and update - regardless of the source(s). If the four issues that I have discussed in this blog post are NOT PRESENT in your (prime) broker's report(s), I respectfully request that you do yourself a favor - subscribe to BoomBustBlog.com and download the report linked above, which includes valuation as well. I will be offering an extra download for professional and institutional subscribers interested in granular, detailed loan, charge-off and derivative holdings in the near future.
FACT ONE: First and Foremost, JP Morgan has been DESTROYING Shareholder Value for TWO Years Running, and I Don't See It Getting Much Better Any Time Soon! That Two Years Is Exclusive Of The Devastating 2008 Market Crash!
Getting back to the issue of Wall Street's sell side analysis, the biggest problem I have with them (outside of rampant conflicts of interest, which is probably not the fault of the individual analysts) is the abject reliance on accounting figures to measure and value an economic entity such as a business as an ongoing concern. Let' be frank here, accountants, albeit probably quite smart, don't necessarily make the world's best investors. As a matter of fact, practically every accountant I know comes to me for my investment opinion and I make a horrible accountant. Try and try as I might, I can only think of one accountant that has ever excelled at investing over time (not to disparage accountants, of course, with all respect due). Granted, this man is probably a damn genius, and he knows how to identify quality when he sees it - having created Canada's largest independent brokerage and independently its premier asset management firm with ~$6 billion under management - including the innovative physical gold trust. He has said, and I quote from Crain’s New York:
“His work is so detailed, so accurate, it’s among the best in the world,” says Eric Sprott, CEO of Sprott Asset Management, a Toronto firm that manages about $5 billion and subscribes to Mr. Middleton’s research.
Yeah, I know that was cheesy, but I couldn't help myself :-) . Back to the matter at hand, accountants have not been - and currently are not, trained in the economic realities of corporate valuation. They are trained to tabulate business operations data. There is a marked and distinct difference. That difference is as stark as night and day for investors, yet despite this stark difference, Wall Street still reports corporate performance metrics strictly in accounting terms, and the media (both mainstream and the more specialized financial media) simply follow suit.
Listening to many investors scream as a result of logical, unbiased (I don't even have a position in Apple... Yet) analysis and off the wall thinking that is just so different from what the retail is used to getting from the sell side shops that routinely rip them off, or the institutions that pay 2 and 20 for leveraged beta rides that often do little else than follow the crowd... I've decided to throw some more fuel on the fire to see if I can make some baked Apples :-). Bloomberg did an article on a survery of 2500 analysts, and the number one ranked analyst since Jan. 2008 only racked up 38% in correct calls, see Did Reggie Middleton, a Blogger at BoomBustBlog, Best Wall Streets Best of the Best? I dare you to compare that to BoomBustBlog! I am not trying to impinge upon the sell side guys that give it their honest all, for I know there are a lot that work hard under very political conditions, but the investing public should know better by now.
You see, I thought it was rather prescient to call margin compression, live on CNBC (3:40 into the video), just hours before Apple announced... Margin Compression... At a time when just about everyone who could spell Apple shouted Buy! Buy! Buy! Buy! Buy!!! It's not as if the stock didn't tank. It's not as if I didn't tell you so. I actually like Apple as a company. It's quite successful and a whiz at marketing and product design. What I don't like is how everyone decides to shut their brain off and let their hearts do the talking (and investing) when it comes to Apple - and to do so with passion if not downright blind idolism at that. Because of this "social phenomenon" that used to be research and analysis, I'm giving it raw, straight up, and uncut. Many have emailed me and said the margin compression was due to the inability to source components, not competition. Well, my dear future and potential BoomBustBloggers - that makes no sense. Competition will always challenge margins, and competition on the scale that Apple is going to encounter will do so even more. You cannot separate component sourcing from competition, and in the case of Apple, the two are literally joined at the hip, to Apple's disadvantage as I will illustrate in graphic detail below.
So, following up on the piece that I did just a few hours ago - Reggie Middleton Wasn’t the ONLY Openly Apple Bear in the Blogoshpere, Was He? along with this cute chart...
I wanted to excerpt a few snippets from this Bloomberg piece, which actually had money managers thinking realistically on Apple as well as a few comments by Steve Jobs, in order for me to set the stage for illustrating how we at the BoomBust attempt to model reality. First, we start off with a realistic way of thing...
The latest on Apple's earnings that went so far in corroborating what I've been preaching for months to a bunch of crazed, excitable Apple fanatics who simply refused to see facts for what they were:
Apple surpassed quarterly earnings expectations again with the help of strong sales of its iPhone, but iPad sales and margins disappointed [strong demand, but the smart money is waiting to see what the Android tablets are capable of - I don't think they'll be disappointed], and its shares sank.
Weaker-than-projected gross margins [exactly as I anticipated - see How Google is Looking to Cut Apple’s Margin and How the Sell Side of Wall Street Will Enable This Without Sheeple Investor’s Having a Clue] and iPad shipments disappointed investors who had expected more from a company that had smashed Wall Street's targets in each of the past eight quarters. Apple shares dropped 7 percent in late trading after initially being halted. The stock finished the regular Nasdaq session [AAPL 318.00 3.26 (+1.04%) ] more than 1 percent higher. Sales of Apple's popular iPhone jumped 91 percent to 14.1 million units in the quarter. The company sold 3.89 million Macs, an increase of 27 percent. Apple sold 9.05 million iPods, marking a decline of 11 percent year over year. The company 4.19 million iPads in the quarter....
As I sit in the car, surrounded by thick NYC traffic, on my way to the highly anticipated CNBC interview (the Squawk on the Street show) on JP Morgan, banks, real estate and related issues, guess what I happen to drive by... MORE construction - causing me to ponder what additional damage will be done to banks that backed these deals. Then, less than an hour later I read from CNBC and Bloomberg that JP Morgan's analysts predict that forced repurchases of soured U.S. mortgages may be the “biggest issue facing banks”. Bloomberg goes on to state:
Future losses from repurchases of home loans whose quality failed to meet sellers’ promises will likely total $55 billion to $120 billion, or potentially $10 billion to $25 billion for the next five years, the New York-based mortgage-bond analysts led by John Sim and Ed Reardon wrote in a Oct. 15 report.
I immediately blurt out, "Now hold the hell on a minuted!!!" That report of the 15th sounds an awful lot like the article I published on the 12th, “The Robo-Signing Mess Is Just the Tip of the Iceberg, Mortgage Putbacks Will Be the Harbinger of the Collapse of Big Banks that Will Dwarf 2008!” (Hey, no peeking, no copying, fellas!) which, among many other things, reiterated what I said in the 4th quarter of LAST YEAR!!!.
To be fair, the JP Morgan report is very similar to mine in content, scope and gist - JUST A YEAR OR SO TOO LATE! I quote (again) "Reggie Middleton on JP Morgan’s “Blowout” Q4-09 Results":
Bloomberg reports: Google Profit Beats Estimates as Companies Boost Ad Spending; Shares Climb
Oct. 14 (Bloomberg) -- Google Inc., owner of the world’s most popular search engine, said third-quarter profit increased as businesses spent more on advertising to attract online consumers. The shares jumped in after-hours trading.
Net income rose 32 percent to $2.17 billion, or $6.72 a share, from $1.64 billion, or $5.13, a year earlier, Google said on its website. Profit excluding some items was $7.64 a share, exceeding the $6.68 average of estimates compiled by Bloomberg.
Google is benefitting from increased spending on search- based ads as it pursues opportunities in mobile communications and display advertising. Online spending is expected to account for 15 percent of total U.S. advertising this year, up from 12 percent in 2008, according to EMarketer Inc. in New York.
“The underlying strength in the core search business basically means advertisers are spending healthily on search,” said Clayton Moran, an analyst at Benchmark Co. in Boca Raton, Florida, who recommends buying the shares. “They beat on the top line and also on the bottom line.”
Google, based in Mountain View, California, climbed as much as 9.6 percent in late trading to $592.82. It closed at $540.93 at 4 p.m. on the Nasdaq Stock Market. The shares have dropped 13 percent this year.
Excluding revenue passed on to partner sites, sales were $5.48 billion, topping analysts’ average estimate of $5.26 billion.
As those that follow me know, I have been bearish on US banks since 2007. That bearish outlook resulted in massive returns ensuing years, just to have nearly half of it returned due to rampant shenanigans and outright fraud. Needless to say, it pissed me off - but it did much more than that. It created a re-bubble before the bubble that was bursting had a chance to fully deflate. As a result, what we have now is one big mess that is getting messier by the minute.
On Friday, July 16th, 2010 I posted "After a Careful Review of JP Morgan’s Earnings Release, I Must Ask – “What the Hell Are Those Boys Over at JP Morgan Thinking????”. The impetus of such was that this bank that all seem to be in awe of was taking a big risk in order to pad accounting earnings for a quarter or two. Below is an excerpt of my thoughts:
Trust me, the collateral behind many more mortgages will continue to depreciate materially as government giveaways and bubble blowing for housing fade!
The delinquency and NPA levels drifted down a bit, but they are still at very high levels. Charge-offs came down but the reduction in provisions has been quite disproportionate bringing down the allowance for loan losses. In 2Q10, the gross charge- offs declined 26.6% (q-o-q) to $6.2 billion (annualized charge off rate – 3.55%) from $8.4 billion in 1Q10 (annualized charge off rate – 4.74%). But the provisions for loan losses were slashed down 51.7% (q-o-q) to $3.4 billion (annualized rate – 1.9%) against $7.0 billion (annualized rate – 3.9%) in 1Q10. Consequently, the allowance for loan losses declined 6.2% (q-o-q) from $35.8 billion from $38.2 billion in 1Q10. Non performing loans and NPAs declined 5.1% (q-o-q) and 4.5% (q-o-q) respectively. Thus, the NPLs and NPAs as % of allowance for loan losses expanded to 45.1% and 50.7%, respectively from 44.6% and 49.8% in 1Q10. Delinquency rates, although moderated a bit, are still at high levels. Credit card – 30+ day delinquency rate was 4.96% and the real estate – 30+ day delinquency rate was 6.88%. The 30+ days delinquency rate for WaMu’s credit impaired portfolio was 27.91%.
While the lower provisioning was able to beef up the bottom line in this quarter, the same is not sustainable in the future as JPM cannot afford to reduce its allowance for loan losses substantially. This is a one shot, blow your wad and go to sleep deal! There is no margin for error in the future, and one can only assume that the reason this was done was to pad accounting earnings and to take advantage of the extremely short term, and obviously naïve, memory of the financial media and retail/institutional investor. Given the high charge-off rates and delinquency levels, the provisioning will probably need to be bolstered again in the not too distant future.
We have incorporated data from GET's most recent filings and have updated our model's and findings accordingly. Subscribers can download the document below, as well as the quarterly review, and the original forensic analysis:
A few days ago I warned my subscribers that the lodging industry, and the economy as a whole, were not truly recovering to any material extent (see The Most Recent Lodging Co. Forensic Analysis is Available and We Think Management Have Been a Little Optimistic). Y-o-Y comparisons made everything look good when you are on the verge of insolvency last year! Well, in the headlines today we have:
- Weekly Claims Show Surprise Gain in Wobbly Jobs Market: and exactly who is it was surprised by this??? Obviously someone who doesn't read BoomBustBlog! See “Are the Effects of Unemployment About To Shoot Through the Roof?”
- Many Retailers Post Weak July Sales, Short of Estimates: and exactly why were estimates so unrealistically high? There is close to no optimistic macro news out there, and fundamentals are worth doo doo.
Then there is the mainstream media and there reporting of earnings, without bothering to look past the marketing spiel put out by management. I can't blame management for this, I would probably do it to if it worked. Reference "Gaylord 2Q revenue up despite Nashville closure" 12 Jul 2010 - The Associated Press. Actually, revenue was down - and down materially, but why let a few facts get in the way. Here is an excerpt of our review of Gaylord Entertainment's 2nd quarter earnings:
Buoyant stock prices are defying the physics of fundamentals. Equities are also floating on mist despite the gravity of the macroeconomic outlook as we believe the equity market falls prey to over-exuberance and excessive optimism. I query, have we entered into a double-dip recession? I'll answer my own question here, No! The reason is because I do not feel we have organically left the previous recession. The positive GDP prints and "green shoots" were the direct result of government bubble (re)blowing through fiscal and monetary stimulus, culminating in QE v1.5. As the effects wear off, we start to see were the economy really stands. Let's just grab the first four headlines today from CNBC.com a day after a 2%+ rally in the S&P:
- Pending Home Sales Plunge as Housing Market Weakens: Contracts for pending sales of previously owned U.S. homes fell to a record low in June as buyers sat on the sidelines, a survey from the National Association of Realtors showed on Tuesday. Of course, we at the BoomBust made it very clear this was a foregone conclusion, see As I Made Very Clear In March, US Housing Has a Way to Fall.
- US Factory Orders Drop for Second Straight Month: As was expected.
- Consumer Spending, Incomes Flat in June; Saving Up: No surprises here.
- US Unemployment Could Rise Before It Drops: Geithner: Of course, I guess Geither just read my piece from the "Green Shoots" era, “Are the Effects of Unemployment About To Shoot Through the Roof?”
Despite the flurry of the truth finally emerging from among rampant disinformation negative economic news, the markets is only off 2 points today after rallying 24 points for nothing yesterday. Bubble, Bubble, toil and trouble. Needless to say, this happy slappy effervescence cannot (and will not) go on forever. A typical example of said over exuberance is the highly economy and consumer sensitive US hospitality sector where the entire pack of hotel stocks have witnessed a substantial rebound from their lows in March 2009 owing to the recovery seen in the occupancy levels, while the markets ignore the weak prices that are offsetting most of the revenue gains and are undermining a healthy recovery in the sector. The sector is still struggling with the demand–supply gap that developed over the last two years when demand was pummeled by the economic downturn in combination with new supply that continued to add to the vacant rooms. Rooms are being booked at rates below the 2009 levels (post economic bust!) to boost occupancy with group bookings rates showing significant weakness. The subject of the accompanying forensic analysis’s business model is particularly vulnerable as the company derives nearly 78% of the revenues from group bookings and the prices are being slashed at all of its hotels. Price cuts have been more severe at its hotels in Washington and Orlando because of relatively higher supply-demand gap in these areas. Further, price cuts at a time when costs are increasing due to input inflation are likely to hit the margins at the same time that said inflation outstrips wages, income and asset appreciation, creating a profit sapping stagflationary environment. See Continuing the Deflation/Inflation/Stagflation/Depression/Recession Rant… for more on this topic.