I've noticed a few queries as to my opinion of whether financial stocks will get better or if the worst is behind us. I actually thought I made my viewpoint clear. Obviously not, so let me be a bit more blunt. Things are going to get very ugly, starting this week - and from there it will get even uglier - and after that the bad part will start. Since I cannot predict the future I will shy away from X will happen in Y months, but the world's credit and real asset markets are in a bad way and need a severe correction to reach a level of peaceful equilibrium. The central banks and governments appear to be dead set against letting capitalistic nature take its course, thus we will be in a tug of war akin to farmers trying to prevent tornadoes from destroying their crops. Best efforts may appear valiant, but in the end fruitless. Don't mess with Mother Nature. I will put a post up in a few hours (partially free) that consists of the research that finally explains, in explicit detail, the industrial/manufacturing portion of my investment thesis and leads into the official global macro theme (it's 33 pages and consumed a lot of resources at a very trying time, so the bulk of it will be for subscribers), followed by bankruptcy candidates that made it to the shortlists but were not selected for final analysis.

Published in BoomBustBlog

The Butterfly Effect: Paulson, Bernanke, the Asset Securitization Crisis & their impact on the Industrial and Manufacturing Sectors - Part 27 of Reggie Middleton on the Asset Securitization Crisis

The Butterfly Effect (adapted from Wikipedia): refers to the idea that a butterfly's wings might create tiny changes in the atmosphere that may ultimately alter the path of a tornado
say from an open corn field to the center of a crowded urban populace; or delay, accelerate or even prevent the occurrence of a tornado in a
certain location. The flapping wing represents a small change in the
initial condition of the system, which causes a chain of (oft unforeseen) events leading
to large-scale alterations of said events. Had the butterfly not flapped its
wings, the trajectory of the system might have been vastly different.
Of course the butterfly cannot literally cause a tornado. The
kinetic energy in a tornado is enormously larger than the energy in the
turbulence of a butterfly. The kinetic energy of a tornado is
ultimately provided by the sun and the butterfly can only influence
certain details of weather events in a chaotic (and upnredictable) manner.

The moral to the story: Regulators should be quite cautious when playing with, capturing, aiding or killing butterflies. The resultant tornado could be devastating. Special "shout out" to SEC Commissioner Cox for banning short selling and guaranteeing a literal crash in financial stocks, Mr. Paulson and Bernanke for saving Bear Stearns and AIG but allowing Lehman Brothers to fail, central bankers worldwide led by Mr. Greenspan for keeping rates very low in an attempt to prevent a natural correction (thus causing an unnaturally violent correction ~ butterflies), and a whole host of other government butterfly afficiandos... Note: I realize that the role of Central Banker is not an easy one, but we must be cognizant of our errors if we wish not to repeat them!

Before we go on, I would like to mark our current location in the Asset Securitization series. I consider this a very useful roadmap that clearly illustrates how we got to where we are today. It is so much more than a subprime or credit crisis...

Published in BoomBustBlog
Thursday, 25 September 2008 01:00

The next step in my investment thesis

The plan was to lay out my entire macro argument for my thesis, then trickle out the shortlists and final candidates of the thesis, but the recent extreme market volatilty has set me off schedule. Since this particular stock has seen some aggressive price movement, I am releasing this report now for paid subscribers. Be aware that this has not even receieved a final proofing, but a few grammar erros won't hurt anybody since time may be of the essence.

The following is an excerpt from the summary:

st1:*{behavior:url(#ieooui) }

... the largest pork processor in the US, is expected to face tough times in the near-to-medium term in the wake of compressing margins and expected slowdown in pork export demand. With internal hog production constituting only 41% of the total domestic live hog requirements of the company's pork segment, the expected surge in hog prices will dent the company's pork segment's operating margins over the next two years. Further exacerbating the margin decline for the pork segment is the increasing proportion of fresh pork, which generates lower margins than the processed pork products, in the company's product mix. While the company's hog production segment otherwise provides a natural hedge to the company's pork segment in the times of rising live hog prices, the negative margins in the hog production segment expected to continue over the next few quaters owing to rising feeding costs would perceptibly mitigate the benefit of this natural hedge. With the pork segment constituting the largest proportion of the company's revenues (~86% over last two years), we expect Smithfield's overall margins to face downward pressure dragging down the company's valuation. The negative outlook on the company is further strengthened by the fact the chairman of the company's board of directors and its largest shareholder, Joseph W. Luter III, has sold substantial portion of his holdings in the company stock over the past months, indicating the negative sentiments surrounding the company's future prospects, particularly in the near-to-medium term. Using a combination of relative valuation and discounted cash flow (DCF) valuation approaches, we estimate Smithfield's stock at a value of...

This report and subject matter is a prime example of the differece between the retail subscription and the professional/institutional subscriptions. There is a wealth of information, graphics and background industry research, complete with assumptions and full pro formas in the latter that fill in the gaps left in the valuation and business argument of the former. Both are priced extremely competitively, in my opinion, but then again I am a bit biased, aren't I...

Retail subscribers download here - icon SFD_Retail Report_Final_240908 (185.94 kB 2008-09-25 01:38:21)

Professional/institutional subscribers download here - icon SFD_Pro Report_Final_240908 (286.98 kB 2008-09-25 01:32:23)

Published in BoomBustBlog
Thursday, 25 September 2008 01:00

The natural progression of my investment thesis

The plan was to lay out my entire macro argument for my thesis, then trickle out the shortlists and final candidates of the thesis, but the recent extreme market volatilty has set me off schedule. Since this particular stock has seen some aggressive price movement, I am releasing this report now for paid subscribers. Be aware that this has not even receieved a final proofing, but a few grammar erros won't hurt anybody since time may be of the essence.

The following is an excerpt from the summary:

st1:*{behavior:url(#ieooui) }

... the largest pork processor in the US, is expected to face tough times in the near-to-medium term in the wake of compressing margins and expected slowdown in pork export demand. With internal hog production constituting only 41% of the total domestic live hog requirements of the company's pork segment, the expected surge in hog prices will dent the company's pork segment's operating margins over the next two years. Further exacerbating the margin decline for the pork segment is the increasing proportion of fresh pork, which generates lower margins than the processed pork products, in the company's product mix. While the company's hog production segment otherwise provides a natural hedge to the company's pork segment in the times of rising live hog prices, the negative margins in the hog production segment expected to continue over the next few quaters owing to rising feeding costs would perceptibly mitigate the benefit of this natural hedge. With the pork segment constituting the largest proportion of the company's revenues (~86% over last two years), we expect Smithfield's overall margins to face downward pressure dragging down the company's valuation. The negative outlook on the company is further strengthened by the fact the chairman of the company's board of directors and its largest shareholder, Joseph W. Luter III, has sold substantial portion of his holdings in the company stock over the past months, indicating the negative sentiments surrounding the company's future prospects, particularly in the near-to-medium term. Using a combination of relative valuation and discounted cash flow (DCF) valuation approaches, we estimate Smithfield's stock at a value of...

This report and subject matter is a prime example of the differece between the retail subscription and the professional/institutional subscriptions. There is a wealth of information, graphics and background industry research, complete with assumptions and full pro formas in the latter that fill in the gaps left in the valuation and business argument of the former. Both are priced extremely competitively, in my opinion, but then again I am a bit biased, aren't I...

Retail subscribers download here - icon SFD_Retail Report_Final_240908 (185.94 kB 2008-09-25 01:38:21)

Professional/institutional subscribers download here - icon SFD_Pro Report_Final_240908 (286.98 kB 2008-09-25 01:32:23)

Published in BoomBustBlog
Thursday, 18 September 2008 01:00

Navistar update

I have decided to release the Navistar update early, in draft form, to the site's paid subscribers. You can download the reports below.


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I. Summary

By August 2008, US auto sales had witnessed ten months
of consecutive decline as housing markets meltdown and financial crisis drag
overall economic growth. Economic slowdown coupled with higher gasoline price
(~more than $3.8 per gallon) and higher inflation is adversely impacting the
sales of automobiles, with sales of truck and SUV segment being hit
particularly hard as customers continue to shift towards alternative smaller
fuel-efficient vehicles. As the global financial crisis led by Lehman
bankruptcy and takeover of Merrill Lynch creep into the manufacturing sector in
the form of further tightening of credit in an already credit-scarce market,
demand for automobiles and commercial trucks is expected to remain subdued in
the near-to-medium term. Although owing to the 2010 emission norms we expect
2009 commercial truck sales to pick up, we expect only a modest level of
pre-buy activity in 2009 compared with the similar situation in 2006.

Navistar has demonstrated a strong resilience against
economic headwinds by foraying into military segment. As a result, the company
reported robust 3Q2008 results, ahead of our and analyst expectations. Going
forward, as revenues from more profitable military segment remain more
sustainable (until 2010), Navistar's earnings are expected to be positively
impacted. However Navistar's core commercial trucking business, engine segment
and financial services segment will continue to bear the major brunt of
economic downturn, in our view. This along with increasing likelihood of non
sustainability of current high level of gross margin over the long-term is
likely to drag its valuation to
...

pdf Navistar Update - retail (335.47 kB 2008-09-17 23:06:30)

pdf Navistar Update - pro (214.22 kB 2008-09-17 23:07:58)

Published in BoomBustBlog
Friday, 05 September 2008 01:00

Preview of analysis on tap, USG Corp.

This is my proprietary Z score analysis of USG Corp. I will be posting a summary and full forensic report on this company for subscribers very soon. The debt rating is a rough draft of my own proprietary system. It needs some work, but I included it anyway.

usg_financial_model_final_10980_image003.png

USG Corp

Z-score analysis - Interpretation of Z-score

Above 2.99

Indicates financial soundness

Between 1.81 and 2.99

Indicates warning signals - potential financial problems

Below 1.81

Indicates serious financial trouble and a high probability of bankruptcy

Debt Rating (Stand alone entity)

2005

2006

2007

2008E

2009E

2010E

2011E

2012E

Working Capital / Total Assets

0.26

0.37

0.15

0.13

0.12

0.13

0.15

0.17

Retained Earnings / Total Assets

(0.10)

(0.06)

(0.05)

(0.08)

(0.09)

(0.07)

(0.04)

0.00

EBIT (trailing 12 months) / Total Assets

0.12

0.18

0.04

(0.04)

0.00

0.05

0.07

0.08

Market Value of Equity / Book Value of Total Liabilities

0.36

1.09

1.74

1.16

1.06

1.03

1.01

0.98

Sales (trailing 12 months) / Total Assets

0.84

1.08

1.13

1.00

1.02

1.09

1.15

1.22

Z-score ( Standalone entity)

1.62

2.71

2.40

1.61

1.68

1.92

2.10

2.26

Debt rating

D

CCC

CCC-

D

D

CCC-

CCC-

CCC-

usg_financial_model_final_10980_image001.png

Debt Rating (Stand alone entity)

4Q-06

1Q-07

2Q-07

3Q-07

4Q-07

1Q-08

2Q-08

3Q-08e

4Q-08e

Working Capital / Total Assets

0.37

0.21

0.20

0.18

0.15

0.14

0.14

0.13

0.13

Retained Earnings / Total Assets

(0.06)

(0.06)

(0.05)

(0.04)

(0.05)

(0.06)

(0.06)

(0.07)

(0.08)

EBIT (trailing 12 months) / Total Assets

0.18

0.18

0.13

0.08

0.04

0.00

(0.03)

(0.04)

(0.04)

MV of Equity / BV of Total Liabilities

1.29

1.80

1.89

1.46

1.53

1.44

1.10

1.04

1.06

Sales (trailing 12 months) / Total Assets

1.08

1.22

1.17

1.13

1.13

1.08

1.02

1.00

1.00

Z-score ( Standalone entity)

2.83

3.07

2.90

2.42

2.27

2.03

1.67

1.56

1.55

Debt rating

CCC

CCC

CCC

CCC-

CCC-

CCC-

D

D

D

Published in BoomBustBlog
Thursday, 04 September 2008 01:00

More info on the intitial shortlisted four

The following is additional information on the four shortlisted companies that I posted yesterday (subscribers, only). Provided are the key factors that led to the shortlisting. I will be posting additional short candidates later on today, since their share prices are moving rather quickly. The forensic reports are not ready yet, but I will post a little about them in an attempt to provide timely data. The chart is wide, so you will have to scroll your browser left to right.

Published in BoomBustBlog
Thursday, 04 September 2008 01:00

Navistar’s results analysis

Navistar’s results analysis:

In 3Q2008, Navistar reported revenues increased 34% to $4.0 bn over $3.0 bn in 3Q2007 as increased contribution from military products and improved pricing helped the company to more than offset the weakness in traditional truck markets, engine parts and financial segment. Navistar’s U.S military sales increased significantly to $1.2 billion in 3Q2008 compared to just $59 million in 3Q2007 (over a 20x increase, a exasperatingly unbelievable pop that raises many questions) . As a result of higher military sales, Navistar’s largest customer exposure tilted from Ford (a company struggling with its own solvency issues that actually ended up on our short scan) previously to the U.S government in 3Q2008. The U.S. government contributed the largest proportion to company’s sales with 32% of revenues in 3Q2008 as against 3% in 3Q2007. Besides higher military sales, Navistar’s pricing improved substantially due to change in product mix and introduction of ProStar products. Navistar’s unit price in the truck segment increased 55% y-o-y while engine unit price increased 13.5% y-o-y leading to expansion of margins. Despite a 28% increase in cost of product sold, Navistar’s gross margins increased to 21.2% as against 17.9% in 3Q2007 while its operating margins increased to 6.6% in 3Q2008 versus a negative operating margin of 0.6% in 3Q2007. However despite improved pricing and increased contribution from military segment, Navistar’s traditional truck and engine segment continued to face challenges. In 3Q2008 shipments of school buses shipments and expansion markets cloaked a y-o-y volume decline of 16% and 4%, respectively while engine shipments excluding intercompany sales witnessed a decline of 68% in 3Q2008 over 3Q2007. Segment profit from the engine segment declined 92.3% to $5 mn in 3Q2008 from $65 mn in 3Q2007 while financial services reported a loss of $1 mn as against profit of $40 mn in 3Q2007. However higher profits from the truck segment at $357 mn in 3Q2008 against $7 mn in 3Q2007, helped Navistar to report profit before tax of $280 mn versus $5 mn in 3Q2007. Overall improved pricing and higher military sales resulted in Navistar’s net income to increase to $272 mn (or $3.68 per share) versus a loss of $4 mn (or $0.05 per share) in 3Q2007. As a result of record growth in 3Q2008, Navistar has raised its guidance for full year. Earlier in August 13, 2008 (just over two weeks ago) Navistar issued full year EPS guidance between $4.26 and $5.72.

Published in BoomBustBlog
Thursday, 04 September 2008 01:00

An analytical view of the Navistar surprise

Navistar came up with its 3Q2008 earnings
release yesterday reporting net income of $272 mn as compared to a loss of $4 mn in
3Q2007. This was powered by improved pricing and higher contribution from
military segment as contribution from military segment increased to $1.2
billion in 3Q2008 versus only $59 million in 3Q2007.

Navistar’s earning came as a
surprise to the investor community surpassing analyst and our EPS expectations
of $1.42 and $0.93, respectively. Following its robust reported 3Q2008 earnings, Navistar
raised its full year 2008 guidance nearly 50% or $2 per share to between $6.35
and $7.45.  It actually seems that the robust results left the company itself by
surprise which had recently one month ago, in August 2008, had issued FY2008
EPS guidance between $4.26 and $5.72. 
Navistar’s timing of muted
guidance in August 2008 with only 1 month away from 3Q2008 results raises
serious questions about the company management’s precision and confidence
on their own numbers - or possibly something a little less benevolent. Since I don't want to jump to conclusions and to be as fair as possible we will wait for the conference call and do a little more digging.

We have carried out variance analysis
between our expected
results and a summary of financial highlights for Navistar (please refer
to the previous post – 3Q2008 result analysis).  The primary reason
for difference between our expected earnings and Navistar’s earnings was
due to higher than expected pricing improvement. We expected Navistar’s
revenues to increase by 23% while the company reported revenue growth of 34%. This
was primarily due to higher-than-expected improvement on the pricing front.

Published in BoomBustBlog
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