Friday, February 28, 2014

Cloud Computing Stocks to Buy

There are no prizes for guessing that cloud computing is the IT sector's hot buzzword is right now. Blue chip tech companies like Google, IBM, Oracle  and Microsoft are all investing in offering infrastructure as a service, or IaaS, solutions to their customers. In addition, there is an ongoing trend of incumbent software companies shifting toward software as a service, or SaaS, based models. For example, Intuit, Adobe, and Autodesk are all making the change, but what is in it for them? Moreover, what are the tangible benefits of cloud computing for these companies?


Thursday, February 27, 2014

Caterpillar and Joy Global, Set for a Better Year?

It would be an understatement to say that mining had a difficult year in 2013, and it was even worse for the mining equipment suppliers like Joy Global (NYSE: JOY  ) and Caterpillar (NYSE: CAT  ) . However, investing is about what happens next, and the case for buying into the sector is based on the hope that mining companies' capital expenditure plans will improve in 2014. So, what do Foolish investors need to know before warming to the idea?

Mining capital equipment sales
The market took heart from Caterpillar's recent results, and this should be taken as a marker that the sector can go higher given any signs of a bottoming out in spending plans in the mining sector's spending plans.

Tuesday, February 25, 2014

Can Cognex's Growth Justify its Valuation?

Machine vision company Cognex (NASDAQ: CGNX  ) has long been one of the most attractive growth stories in the industrial sector, but gaining an entry level into the stock hasn't been easy in the last year. The good news is that it fell more than 8% on the day that its fourth-quarter results beat analyst estimates. The bad news is that it rose more than 7% the next day. Why the sell-off? Why did buyers come back in? And what are its prospects for its coming year?

Read the full article LINKED HERE

Rackspace's Challenges in 2014

Shareholders in cloud provider Rackspace (NYSE: RAX  ) endured a rough time after the stock fell 15% on the week of its results. While the numbers were slightly better than analyst estimates, investors reacted badly to the announcement that CEO Lanham Napier was leaving the company. Has the market overreacted and made the stock a good value?

Rackspace racks up uncertainty
Napier's announcement certainly shocked the market, and negative surprises are the last thing that a company clouded in uncertainty like Rackspace needs right now. Essentially, there are two fears hanging over the stock. The first is well-known, but the second might prove even more problematic in the long term.

Monday, February 24, 2014

Cisco isn't Performing, but it can Still go Higher

Cisco (NASDAQ: CSCO  ) is under-performing. Its stock price is nearly 20% worse off than the S&P 500 on a yearly comparison. The company's recent acquisition history has been underwhelming, and its corporate execution has been disappointing. The company appears to be moving into a zone whereby all it has to do is internally execute, and the stock price will likely go higher. For this reason alone, Cisco is worth a Foolish look.

What you already know about CiscoCisco's second-quarter results came in with an 8% sales decline, when the company had previously forecast a fall of 8%-10%. In addition, its sales decline is hurting gross margins because they came toward the bottom end of its 61%-62% guidance range. Given that it's guidance for the upcoming third quarter was for a 6%-8% sales decline, it's reasonable to assume that gross margins will be relatively weak in the next quarter as well.

While this was obviously new news to the market, Cisco's results actually told investors more about what they already knew about the company. 

Sunday, February 23, 2014

Is Titan Machinery a Buy?

The only thing for sure about Titan Machinery's (NASDAQ: TITN  ) next set of results is that they are likely to spark some significant volatility in the stock price. The agriculture and construction dealership faced a multitude of issues in 2013, not least from strong competition from Deere (NYSE: DE  ) and AGCO (NYSE: AGCO  ) in Titan's core agricultural market. Meanwhile, Caterpillar's (NYSE: CAT  ) attempts at reducing construction machinery inventory are likely to have hurt its other segment.

Moreover,Titan's main supplier, CNH Industrial (NYSE: CNHI  ) , has been rolling out machinery with new Tier 4 technology (higher emission standards), and Titan has found it hard to pass pricing on to its customers. All told, the stock has had a lot of bad news priced in and is down nearly 47% in a year. Is now the time to buy it as a value play?

WESCO Equity Research and Analysis

The industrial sector's winter of discontent continued with industrial supply company WESCO (NYSE: WCC  ) managing to miss estimates in the fourth quarter. There is no doubt that weather has had a serious effect on the industrial sector, but anecdotal evidence suggests that long-cycle industrial orders are doing well. Meanwhile, companies exposed to short-cycle orders are seeing an inevitable slowdown. Is this creating a buying opportunity whereby growth will snap back rapidly? Moreover, which sectors are seeing growth?

WESCO misses estimates
Sales came in below internal expectations for the fourth quarter, and WESCO further disappointed the market by announcing that its January sales to date were down 4%. All of which must make Foolish investors wonder how the company is going to hit its guidance of flat to 3% growth in sales for the first quarter.

Friday, February 21, 2014

What you Need to Know About Boeing

There are two key questions that Foolish investors will be asking after Boeing's latest results. The first is what is its order book going to look like in 2014? The second is whether its disappointing earnings per share, or EPS, guidance of $7.00-$7.20 for 2014 signals a slower delivery schedule or not?

Boeing's order book prospects in 2014
Essentially, Boeing's orders are a proxy for global economic growth. However, they are also guided by industry fundamentals. The good news is that the commercial aviation sector is in better shape than it has been for many years. For example, in December the International Air Transport Association, or IATA, increased its forecast for airline profitability in the coming years.

Read the full article linked here

Thursday, February 20, 2014

Johnson Controls is Favorably Exposed to EconomicTrends in 2014

Most of the companies reporting in the industrial sector have seen a similar kind of narrative around their recent results. The general story is of some softness caused by a weather-affected fourth quarter, but the underlying conditions are seen as positive. Paradoxically, automotive and building products supplier Johnson Controls (NYSE: JCI  ) disappointed the market, because the bad weather was expected to boost its results more than it did!

Johnson Controls, but can't control the weather
There wasn't a lot wrong with Johnson's latest results, but the market sold off its shares nonetheless. One of the market's issues seems to be that its power solutions segment results were not as strong as expected.

Wednesday, February 19, 2014

3M Equity Research and Analysis

A mega-cap industrial like 3M (NYSE: MMM  ) is never going to escape being tied to global economic growth. However, 3M shareholders can expect the management to generate every piece of operational efficiency and growth that it can out of its sprawling empire. Fortunately, 3M's management is doing a pretty good job of it in the middle of a slow global economy.

3M reports mixed geographic results
A company of 3M's market size and geographic reach will never see all of its parts firing on all cylinders at the same time. In its fourth quarter, it was the turn of its emerging market results to come in with disappointing results. In particular, Latin America was weaker than expected with just 2.2% growth in constant currency. Meanwhile, Asia-Pacific grew 3.3% in constant currency.

Monday, February 17, 2014

Check Point Software is Returning to Form

Over the last few quarters, Check Point Software (NASDAQ: CHKP  ) has quietly returned to form. The network security company remains a prodigious generator of cash, but it's also managing to grow its product sales again. In doing so, it's managed to expand sales in the data center market, and established sales in the small and medium-sized, or SMB, market. Check Point remains one of the highest quality companies in network security, and its valuation makes it attractive for value investors.

Read the full article linked here

Saturday, February 15, 2014

BE Aerospace, Set to Fly Higher?

Shareholders in airplane cabin manufacturer B/E Aerospace    watched their stock rise more than 75% in 2013, so the recent sell-off shouldn't come as a surprise. Unfortunately, stocks can't go in one direction forever. The question facing investors now is whether the recent fall presents a buying opportunity or not?

B/E Aerospace still headed for a great year
First things first, there was nothing in B/E Aerospace's recent fourth-quarter results to suggest that the company is not going to have a great year in 2014. Although, internal EPS guidance of $4.25 was below analyst consensus of $4.34, it still represents earnings growth of nearly 20%. Moreover, the International Air Transport Association, or IATA, recently upgraded its forecast for airline profitability in 2014.

The industry backdrop looks positive. More airline profitability usually means more spending on new planes and retrofitting of older aircraft too. It's all good news for B/E Aerospace.

Growth initiatives
In addition, the company recently announced a number of growth initiatives:

  • A contract enhancement with United Technologies  to supply fasteners, hardware, logistics, and consumables to its aviation units. B/E estimates the deal has a value of $950 million to 2022

  • A contract with helicopter manufacturer AgustaWestland to provide logistics and consumables. The deal's estimated value is $200 million, and goes till 2018.

  •  Its modular lavatory system (shaped to create additional seating on planes) is now being shipped to Boeing   with 14 Boeing 737s in service with the system. More growth is expected as Boeing's demand is expected to increase.

  • In a departure from its core activity, B/E made two acquisitions in the oil and gas consumables market. 

The contract announcements were obviously good news, and the ramp up in lavatory systems shipments (the first system was shipped as recently as the third quarter) is a confirmation of strong demand for an exciting new product.

However, the move into the oil and gas consumables market is more subject to scrutiny. When questioned on the conference call, B/E's CEO, Amin Khoury, argued that the oil and gas consumables services business is four times the size of its opportunity in aerospace, and is growing twice as fast with similar margins. Moreover, he sees it as reducing the volatility in the business, because prospects for oil and aerospace are inversely related.

Unfortunately, this argument looks weak. The reality is that airline profitability is cyclically based on the economy, and the price of oil is too. Moreover, airlines have got a lot better at dealing with high oil prices then in the past. All told, the move looks likely to increase cyclicality rather than reduce it, but this doesn't mean it is a bad idea!

Valuation, valuation, valuation
All told, BE is headed for a strong year, but the problem is that its valuation has largely priced this in. In order to look at the kind of assumptions made in its stock price, consider that BE only converted 61% of its net earnings into free cash flow in 2013, and management forecasts only around 65% for 2014.

Assuming that 65% of earnings are converted into free cash flow on a long-term basis, and plugging in analyst estimates to 2017, gives the following estimate of its free cash flow. Its current share price is $79.4 with an equivalent enterprise value (market cap plus debt), or EV, of $96.


Unless its free cash flow conversion gets markedly better in future years, or its earnings are better than consensus forecasts, it's hard to see how B/E is a good value. Indeed, B/E has struggled with cash flow conversion in the past. The essence of the issue is that working capital requirements and inventory always goes up in order to service new orders.

Where next for B/E Aerospace?
The valuation doesn't look cheap and the assumptions needing to be made in order to make it look cheap are relatively optimistic. Based on the IATA outlook, there is certainly good reason to expect commercial aerospace to outperform in 2014, but who can predict where the economy will be in 2017?

Moreover, Fools need to appreciate that even if Boeing and Airbus have historically strong order books, if the economy turns down then orders will be cancelled and B/E will suffer. You can never fully discount risk. As attractive as the company undoubtedly is, it's hard to make a case for it based on anything other than earnings momentum

Friday, February 14, 2014

Triumph Group Equity Research

It's been a wonderful year for investors in the aerospace industry, and the indications are that 2014 will also be a strong year for the industry. All of which could lead you into a false sense of complacency. However, the recent results from aerospace component manufacturer Triumph  $TGI should go some way to dispel that notion. Triumph did anything but, but are its results a warning signal for the sector or merely a company issue?

Triumph lowers guidance
The manufacturers that supply aircraft structures and components to Boeing  $BA and Airbus are always interesting industries. In line with many other heavy manufacturers, they tend to have high fixed costs which means their earnings tend to be super-cyclical to the aerospace sector. In addition, they typically need to ramp up capital expenditures and working capital requirements in order to service new orders that flow when the industry turns. All told, they tend to have highly cyclical cash flows, and also carry a substantive amount of operational risk when they increase production.

Unfortunately, Triumph's recent results reminded investors of some of these factors. The market had priced in good prospects thanks to the strong order book at Boeing (responsible for 44.7% of Triumph's sales in the last quarter), and an anticipated step up in Triumph's earnings and cash flows in future years. Moreover, Fools know why aerospace is set for a good year in 2014. However, Triumph disappointed investors by lowering full-year guidance by $0.50 to $4.75 for three main reasons:

  • Issues relating to building out the new Boeing 747-8 aircraft aerostructure caused a lowering of full year guidance by around $0.22

  • Military aircraft after-market demand has remained under pressure and demand did not come back as expected.

  • The quarter was marked out by a "surprising number of customer deferrals".

It's time to look at these issues in turn.

Did Triumph just wave a red flag?
First, the Boeing 747-8 issue looks like a manifestation of the operational risk outlined above. Moreover, with aircraft getting ever more complex, it wouldn't be surprising to see other manufacturers have such issues. According to its management, Triumph incurred extra costs in replacing parts with "internal quality issues" on the program, because the 747-8 is a "relatively new aircraft". While this problematic for Triumph ( the 747 is its biggest program), it doesn't read across as an industry issue.

The second issue is a bit more of concern for the industry, and serves as a salutary reminder that military aerospace spending remains under pressure. The bifurcation in prospects between military and commercial aerospace is well known to the market. For example, on its recent conference call General Electric  $GE recently outlined that its fourth-quarter commercial aviation spares market was up 16%. Meanwhile, GE's military spares market was down 3%, due to sequestration issues and reduced flying hours. Overall GE reported 11% growth in services demand.

Tuning back to Triumph, its management described weak military spares sales as being "primarily" responsible for the remaining $0.28 taken off full-year guidance. It's obviously disappointing news for Triumph shareholders, but it doesn't represent any new trend in the industry. Moreover, military spending is always lumpy due to political considerations. Its overall aftermarket orders may well bounce in coming quarters.

The third issue is more worrisome. When pushed on the issue on the conference call, CFO David Kornblatt outlined that the deferrals affected programs like the Boeing 737 and 777, and the Gulfstream 650. These are commercial orders, and although Triumph's management believes they will come back in due course, this is slightly a concern. It's one thing to point at Boeing's burgeoning order book and conclude that the aerospace industry is set for long-term growth, but the truth is that customers do defer or cancel orders when the economy turns down. Customer deferrals are about as good an early warning signal as you will ever see.

What does it all mean?
In conclusion, it looks like Triumph stumbled with some operational issues with which it's managing to overcome. Looking forward, internal guidance is for EPS of $5.75 and $6.75 for 2015 and 2016, respectively. In other words, Triumph expects its earnings to grow more than 42% from this year's forecast of $4.75, over the next two years. If you are bullish on aerospace then the current fall might create a good buying opportunity for you.

On the other hand, its customer deferrals are a small warning light for the industry. It's not significant, because bellwethers like GE, Alcoa, and Boeing continue to make positive outlooks on the industry. Indeed, Triumph may well get these orders to pick up again in due course. However, it's something for aerospace followers to keep an eye on.

Wednesday, February 12, 2014

RPM International, not Cheap, but Possibly Good Value

First things first, specialty coatings company RPM International  $RPM   is not a cheap stock. Its current P/E ratio is close to 28, but investing isn't really about where a stock has been. In the case of RPM, Foolish investors are looking at a stock with significant leverage to any upside to the U.S. commercial construction markets. Moreover, its restructuring activities, new product launches and geographic growth initiatives promise more growth in the future. It's not cheap, but if you buy a recovery in commercial construction, then you might want to buy RPM.

Introducing RPM International
Paintings and coatings companies with large housing exposure like Valspar  $VAL  and Sherwin-Willliams  $SHW outperformedin 2013 thanks to a recovering U.S. housing market. Meanwhile, a company with more of an industrial focus like PPG Industries  $PPG also outperformed, partly due to its household paints products, and partly due to its convenient exposure to aerospace and automotive -- the standout areas in the industrial sector.

But why has RPM underperformed the sector?

SHW Chart

SHW data by YCharts

The answer is that RPM has much more exposure to commercial construction, and growth in the industry has been lackluster at best. For reference, RPM's consumer businesses only made up 35.6% of its sales in the first half; it's the industrial business that counts.

The simple idea behind buying RPM is that, historically speaking, the commercial construction sector (which its industrial business is focused on) tends to lag behind residential. And since the residential market started a recovery in 2013, then commercial should follow.

Unfortunately, this argument has been somewhat weakened by recent falls in the commercial/industrial index from the Architectural Billings Index. However, this is possibly due to the unseasonally bad weather; a similar effect can be seen in the dip in the Spring of 2013.

Ultimately, it only makes sense to buy RPM if you believe that the commercial construction market will be stronger in 2014. However, there are many other reasons to like the stock.

Why RPM is attractive
First, the company has demonstrated an impressive ability to expand margins in its consumer segment.  For example, earnings before interest and taxes, or EBIT, margins have expanded more than 360 basis points over the last three years. This is partly due to new product introductions and restructuring initiatives, but it's also due to a stronger housing market pushing up its consumer sales up over the last two years. In fact, consumer sales rose an impressive 11.2% in the last quarter.

Meanwhile, industrial margins have been lackluster. However, if commercial construction picks up then it's reasonable to expect its industrial margins to do so as well. And margin expansion plus revenue growth equals larger profits.

Source: company presentation

Second, RPM has also restructured its European operations and, according to management on the conference call, " modest increases in this fiscal year in revenues are resulting in strong bottom line leverage." 

Third, in the commentary on the conference call, management gave a cautious outlook on U.S. commercial construction. When questioned on the matter in relation to its guidance for 2014, RPM's management answered:

We're not planning on any real pickup in end markets. I think we're planning on -- but we're not planning on any deterioration. I think you'll see continued sequential improvements, in part because, from a cost perspective, we're better positioned to leverage revenue growth to our bottom line

In other words, any upside from the U.S. commercial construction market isn't baked into RPM's full-year EPS guidance of $2.05-$2.10. =

Fourth, significant investments are being made to expand its product reach in Latin America, and since RPM starts from a low base, it should generate growth by grabbing market share alone.

Why RPM is unattractive
The headline risk is obviously concerning the commercial construction market, and it should be noted that RPM's management did not make positive noises on the state of the current market.

In addition, the weather has been a factor for construction activity, and RPM may disappoint in its next quarter. Furthermore, its free cash flow is a bit of a concern. Excluding the effects of a contingency payment, operating cash flow fell to $83.3 million in the first half from $127.6 million in last year's first half. Around $18.1 million of the difference is due to spending more on inventory (to support faster growth), but CEO, Frank Sullivan was candid that he wasn't "satisfied" with RPM's working capital management.

The bottom line
As noted above, RPM isn't conventionally cheap (cyclicals rarely are just before their cycle is about to turn), and if commercial construction doesn't pick up then the stock is likely to suffer.

On the other hand, it has raised guidance twice already this fiscal year, and it's operationally leveraged to a market that could turn up in 2014. If you like its end markets, then this is a stock well worth watching in order to buy some in the current market sell-off.

Sunday, February 9, 2014

Roper Industries Equity Research

Roper Industries  $ROP is one of the most interesting industrial stocks, not least because it appears to be more of philosophical concept than a typical industrial conglomerate. In essence, it's a collection of four disparate businesses that operate within their own highly profitable niche markets. The common philosophy behind each segment is that they are high-margin and highly cash generative companies operating with relatively asset-light business models. While this strategy has been working very well for Roper shareholders so far, is the stock a buy right now?

Roper reports full-year results
In order to quickly outline how Roper makes money here is a chart of its segmental operating profits in 2013.

Source: company presentations

Having disappointed in the previous quarter, Roper reported some better numbers in the fourth quarter resulting in adjusted revenue up 9% and net earnings up 11% for the full year. Moreover, there are six key reasons why Roper can do well in 2013.

Margins and cash flow, increasing software, and growing orders
First, Foolish investors should appreciate how well the management has increased margins and cash-flow generation. Roper's gross margin was around 58% for the full year, but note how it has increased over the last few years, particularly when compared to companies like Danaher   and Dover Corp $DOV .  The latter two are not perfect comparisons, but they do provide a good benchmark to judge whether Roper's gross margin performance is merely a function of the economy or not.

DHR Gross Profit Margin (Quarterly) Chart

Clearly, Roper is outperforming its peers in terms of gross margin, so this isn't just about the economy.  Moreover, its free cash flow generation and conversion is outstanding. Roper generated $760 million in free cash flow last year, representing a conversion rate of 141% of its net earnings. Looking into 2014, management predicted that operating cash flow conversion would be 140% of earnings. Based on my calculations, and Roper's guidance for full-year EPS, its free cash flow will amount to around $8.35 in 2014. In other words, it's on a forward free cash flow yield of around 6%.

Second, one of the reasons that Roper is generating increased margins and cash flows is due to its increasing amount of software sales. On the conference call, CEO, Brian Jellison outlined that "If you look just like the SaaS businesses, pure software businesses, we get more than a fourth of the Company's EBITDA out of that." Moreover, he also argued that if application software was included, the figure would be closer to half.

Usually, software as a service, or SaaS, based businesses tend to generate recurring revenues over longer periods. Indeed, Jellison disclosed on the conference call that Roper has "a lot of recurring revenue in radio frequency and in medical" and the fact that deferred revenue jumped 12.6% to $209 million bears that out. This implies that Roper is increasing the amount of long-term value it gets out of its orders.

Third, Roper's order book looked good in the last quarter, its book-to-bill was 1.01 versus 0.95 in the fourth quarter last year.

Q4 2013 Order Book Growth
RF technology 11%
Industrial technology 3%
Medical and scientific technology 12%
Energy systems and controls 14%
Company 10% organic, 16% reported

Source: company presentations

Recovering businesses, underlying guidance is better, end markets improving
Fourth, the businesses that had difficulty in the previous quarters managed to recover well in the quarter. Imaging (medical and scientific technology) orders were surprisingly strong with a double-digit increase. Meanwhile, its nuclear inspection business, Zetec, was described on the conference call as being weak "as expected", but its orders "tell us that really the worst is behind us". These two nuggets of good news help to de-risk the stock somewhat.

Fifth, superficially Roper disappointed the market by issuing full-year EPS guidance of $6.05-$6.25 when the analyst consensus was $6.20. However, there is an extra tax charge of $0.20 in 2014, without this charge the guidance would have been a more impressive $6.25-$6.40.

And finally, prospects in some of its end markets are looking better. For example, its water pumps business, Neptune (industrial technology), will benefit from increased housing starts. According to Halliburton and Baker Hughes the U.S. oil and gas rig count will at least stabilize in 2014, and this could be a positive for elements of Roper's energy systems and controls segment.

Is Roper a good value?
On a P/E basis, Roper is not the cheapest stock in the sector.

ROP PE Ratio (TTM) Chart

Moreover, on a forward P/E ratio of around 22 times earnings, it's hard to argue that it is anything more than fair value at the moment. On the other hand, Roper is a high quality company and for the reasons articulated above, it has upside earnings potential in 2014. Foolish investors may want to keep an eye out for any buying opportunity should it dip from here.

Friday, February 7, 2014

More Key Takeaways From GE's Report

Whenever General Electric  $GE gives results, the market tends to listen very closely. Its recent earnings report was broadly positive with orders up 8% and guidance of double-digit industrial earnings growth for 2014. However, a company of this size will never have all its industry sectors working well at any one time. In a previous article, its power and water, oil and gas, and lighting and appliances segments were looked at. Now it's time to look at its aviation, health care, and transportation units.

GE's profit split
In order to see the importance of its relative segments, here is a breakout GE's segments profits in 2013:

Source: Company presentations.

Of the four most important sectors, aviation and oil and gas put in the best performances in 2013. Power and water disappointed -- particularly in the first half -- but orders and revenue came back strongly in the second half. In the fourth quarter alone, power and water equipment orders were up 81%, and segment profits rose 9%. Meanwhile, its health care performance was relatively mundane with just 4.4% profit growth in the year.

Source: Company presentations.

GE's health care segment and Covidien
Despite its relatively mundane performance, GE's health care results are interesting because they highlight a bifurcation in global health care spending on capital machinery. Austerity measures and cash pressures are putting pressure on hospitals in developed markets, while emerging markets are more willing and able to spend. For example, in its fourth quarter, GE's health care orders were flat in the U.S., with Europe only up 2%. Meanwhile, Latin American orders were up 15%, with China up 8%.

These trends play to the strengths of a company like medical device company Covidien  $COV . The company's is characterized by having relatively low-ticket medical devices; something very attractive to emerging markets. Indeed, its growth prospects and investment plans are weighted toward emerging markets. Covidien grew sales to the BRICs by 25% in its last quarter, and it plans to generate at least 20% of its total sales from emerging markets by the end of 2014.  All told, Covidien has the potential to outgrow its markets.

GE's aviation segment
Aviation has been the star performer in GE's industrial segment, and for a host of reasons the commercial aerospace market has bright prospects in 2014. On the conference call, GE's management predicted that its jet engines "will be up to 2,500 units, versus about 2,378 in 2013", but the most interesting commentary was concerning its 16% rise commercial spares demand. In answering an analyst question on the subject, Immelt replied that flying hours were "improving dramatically", and airlines were restocking as they had cut back on inventory levels in 2012. Meanwhile airline fleets are growing and aging as well.

All told, this is great news for a company like Heico  $HEI . Heico generates two-thirds of its sales from its flight support group whose services include parts, repair and distribution for airlines. The segment put in a stellar performance in 2013 with sales and net income rising 17% for the full year. Moreover, it estimates overall sales growth of 12%-14% for 2014. If passenger demand remains strong and airline profitability continues to increase, then Heico is likely to have another strong year.

Mining still not globally joyful
In general, it was a positive report, however there were some notes of caution. Transportation segment orders were 2% lower, with mining being the main culprit. Mining orders declined 60% with demand for mining parts described as weak. All of which is not good news for mining equipment company Joy Global $JOY .

The mining industry has suffered this year as commodity prices have fallen, and in the words of Joy Global's executive vice president, Edward Doheny,  "[Years] of investment in additional production capacity finally caught up with demand. This resulted in most major commodities currently in a significant supply surplus".  The outlook doesn't look great. Growth is slowing in China and the government taking steps to reduce coal capacity; the outlook is still murky. Moreover, prices for a commodity like copper -- traditionally seen as the most cyclical of all metals -- continue to decline.

Copper LME Settlement Price Chart

The bottom line
In conclusion, it was a broadly positive report from GE. Aviation and emerging market health care look strong in 2014, but developed market spending on health care capital equipment looks moderate at best. Meanwhile mining looks headed for another difficult year unless China can reaccelerate its growth rate.

Tuesday, February 4, 2014

Baker Hughes Equity Research

As ever when looking at oil services stocks like Halliburton  $HAL  and Baker Hughes $BHI , your long-term outlook will be defined by your view on the future of oil prices. While this rule still applies, there are also many changing trends within the oil services market, which Baker Hughes has positioned itself to benefit from. If you are bullish on oil, then Baker Hughes looks particularly well placed.

A bifurcated market in oil services
The biggest story in oil production in recent history is the wide-scale adoption of fracking technology in energy production in the U.S. -- the result of which has been the reversal of a seemingly inevitable decline in U.S. crude oil production.

US Crude Oil Production Chart

The good news for the oil services companies is that production has gone up over the last two years, but the bad news is that oil prices have been relatively flat. Moreover, the most wildly followed barometer of the U.S. oil and gas services industry (rotary rig counts) has been in decline over the last couple of years.

WTI Crude Oil Spot Price Chart

All told, the result has been to bifurcate the global oil services market into good growth in emerging markets versus weaker growth in the U.S. Moreover, if oil prices fall then some current U.S. production will prove commercially unviable.

What the industry is saying
Indeed, some of the underlying issues were touched on in General Electric's  $GE recent conference call. When questioned by an analyst on the outlook for GE's oil and gas segment, CEO Jeff Immelt articulated the bifurcation in oil and gas services prospects between North America and the rest of the globe:

"If you look at the national oil companies versus the integrated oil companies, our view is that the NOCs really haven't backed off at all...the place that we still think is reasonably weak is maybe around North America, some of the drilling and surface stuff"

It was a similar story from Halliburton. Its North American revenue declined 4.9% in 2013, while outside of North America its revenue increased 13.5%. Halliburton's management sees the current North American market as "driven by increased drilling and completion efficiencies with a relatively flat overall rig count and industry overcapacity."

Putting these elements together, a picture is emerging of a bifurcated market that is seeing U.S. oil services companies being challenged in their core domestic market. In addition, North American subsea/deepwater operations are outperforming vertical onshore drilling. Meanwhile, increased usage of fracking has enhanced productivity, which further contributes to overcapacity in North America.

How Baker Hughes is adjusting
Baker Hughes' last earnings report was quite impressive, not least because it highlights the adjustments that the company is making to deal with changing conditions. There are four key factors:

  • Baker Hughes' share of total pre-tax profits from North America was only 43.7% in 2013. Latin America was weak, but the other segments (Europe/Africa/Russia, Middle East/Asia Pacific, and industrial services) saw pre-tax profits grow 14.9%

  • Its North American pressure pumping business (heavily reliant on fracking activity) is seeing improved profit margins as the company takes action to overhaul the business in response to overcapacity

  • The company sees itself as a deepwater specialist, a sector that is outperforming most of the oil industry

  • Management has taken impressive measures to decrease working capital and increase cash conversion,  the result being a record $1.5 billion in free cash flow

Where next for Baker Hughes?
Looking ahead, Baker Hughes' management sees the U.S. onshore rig count as being "essentially flat," while Halliburton expects a modest increase. However, recall that Baker Hughes is taking measures to improve margins, and its forecast for the onshore well count is for a 5% increase. In addition, U.S. offshore rig count is expected to increase 5%. Conditions appear to be getting better.

Meanwhile, its international operations are forecast to receive a boost due to an estimated 10% increase in the international rig count. Add in the improved operational efficiencies and increased cash flow generation, and the stock is starting to look attractive. In fact, analysts have it on a forward P/E ratio of less than 14 times earnings, as I write. If you are bullish on the outlook for oil, then Baker Hughes is well worth looking at for 2014.

Monday, February 3, 2014

GE Earnings Takeaways

Whenever a bellwether like General Electric $GE gives results investors will want to analyze them in great detail to see what they mean for other stocks in other sectors. GE's latest earnings were solid enough, but there were many interesting subplots to the story. The global economic recovery has been pretty uneven and inconsistent since 2009, and this theme was further confirmed in its fourth-quarter report.

General Electric's fourth-quarter earnings
GE generated around a third of its segmented profits from its capital division in 2013, but what about the industrial side? The following chart demonstrates the most important industrial sectors for GE.

Source: Company presentations.

GE ended the year strong in its power and water segment with profits up 9% in the fourth quarter, but for the full year the segment's profits actually declined 8%. Of the other three largest segments, oil and gas profits grew 13% in 2013, with aviation up 16% and health care rising only 4%.

The company's order book was up 8% in the fourth quarter, and when discussing the results on the conference call, GE's management guided toward "double digit industrial earnings growth similar to the second half of '13" and "4% to 7% organic growth with expanded margins".

In short, GE looks set for another solid year, and this portends well for the industrial sector, but what are the key takeaways from the results?

Power and water, oil and gas
Gas turbine orders came in at 65 in the fourth quarter versus only 26 in last year's fourth quarter. This was somewhat surprising, because Alcoa  $AA had already estimated that its industrial turbine end market would decline 8 to 12% in 2014. However, the difference in the outlooks may be because Alcoa's forecast is based on production while GE's positive news concerns its orders. If this logic is correct then, provided GE's orders continue to strengthen, investors might expect Alcoa's industrial turbine business to improve in future.

There was mixed news in the oil and gas segment. There are fears over capital spending plans of the major integrated companies, but on the conference call, CEO, Jeff Immelt argued, "If you look at the national oil companies versus the integrated oil companies, our view is that the NOCs really haven't backed off at all, and that's where we see a ton of activity." However, he also said that activity around North American drilling and surface was work was still "reasonably weak" and this tallies with the Baker Hughes  $BHI  US oil and gas rotary rig count.

US Rotary Rigs Chart

Baker Hughes is a leading oil services companies and its North American operations contributed nearly 44% of its segmental operating profit before tax in its first nine months. However, North American segment profits decreased 8% in its third quarter, but strength elsewhere ensured that Baker Hughes' overall segmental profit grew 8%. If GE's commentary is accurate, then that pattern is likely to continue for Baker Hughes.

Home appliances and lighting
As the first graph above outlines, the home and business segment isn't hugely important to GE, but what it says about the segment is useful for shareholders in a white goods company like Whirlpool  $WHR . GE's appliances and lighting revenue grew 6% with its appliance revenue up 9%. Indeed, its appliance sales saw a marked pick-up in the second half:

  Q1 2013 Q2 2013 Q3 2013 Q4 2013
GE Appliance Sales Growth 3% 8% 11% 9%

Source: Company presentations.

This is good news for Whirlpool, because its outlook for North America has tended to match what GE is saying about its appliance business. In fact, in its first quarter Whirlpool estimated its full-year 2013 industry demand to grow at 2%-3%. This figure was raised to 6%-8% in the second quarter, and then 9% in the third. In the light of what GE just reported, is Whirlpool likely to upgrade estimates for 2014 at its next set of results?

The bottom line
On the whole, GE delivered a solid set of results with some interesting puts and takes in the sectors it covers. The following article will cover the health care, transportation and aviation segments. As for the segments covered in this article, there was some good news. Power and water prospects are improving and, internationally at least, oil and gas remains solid. Meanwhile, appliance and lighting sales continue to benefit from the housing recovery.

Saturday, February 1, 2014

Will IBM hit its own Guidance in 2014?

To believe or not to believe, that is the question facing IBM  $IBM shareholders. IBM's fourth-quarter results were not well received, as they pointed toward weakening trends in its business. However, management's outlook for 2014 puts the stock at an attractive forward valuation. If IBM hits guidance, you can feel confident the stock will go higher, but will it make those numbers?

IBM delivers positive guidance
Stopping for a second and putting the 2014 guidance into its appropriate context would demonstrate just how cheap IBM is:

  • Guidance of non-GAAP earnings per share, or EPS, of $18 implies a forward P/E ratio of around 10 times earnings

  •  Free cash flow guidance of $16 billion in 2014 implies that IBM will generate 6.9% of its current enterprise value (market cap plus debt) in free cash flow

  • Non-GAAP EPS guidance of $18 implies a 10.6% increase from this year's $16.28 despite the tax rate rising from 16% in 2013 to 23% in 2014

  • IBM's management reiterated its long-term forecast of $20 of EPS in 2015

These are impressive figures and growth assumptions by any standards, and somewhat startling when you consider that IBM's Non-GAAP gross profit actually decreased by 4.9% to $14.6 billion in the fourth quarter. Furthermore, its revenue growth has been disappointing this year.

IBM's slowing growth                         
A chart of IBM's segmental revenue growth reveals how lackluster its growth was in 2013.

Source: IBM Presentations.

The underperformer is obviously its systems and technology (hardware) segment, which suffered in 2013 due to its System Z mainframe maturing in its product cycle. Furthermore, IBM's management cited "challenges in our hardware business model specific to power, storage, and X86." All told, IBM made a pre-tax loss of $507 million on systems and technology in 2013.

If this wasn't bad enough, IBM's management predicted the hardware segment would be flat in 2014. Furthermore, the segment is inordinately hit by its weakness in China. Although other companies have reported slowing growth in China, IBM's major rival, Oracle  recently reported "good growth" in China. In fact, Oracle's own hardware systems sales came in at the high end of its guidance, only declining 2% versus guidance of -1% to -9%.

All told, IBM does appear to be underperforming with its hardware business, therefore the intended $2.3 billion sales of its x86 servers business appears to be a good move. Incidentally, the benefit from this sale is not included in IBM's forecast being discussed in this article.

Software and Services to the rescue
One of the big themes behind IBM in recent years has been its willingness to forego revenue growth in favor of profit and free cash flow generation. However, IBM needs to do more than this now. If it's going to hit the targets outlined above, it will need to successfully execute its plans for software.

Its software segment was responsible for 48.3% of segmental profits in 2013, but profit only grew 2.7% on the year. IBM's plans involve shifting its revenue toward areas like big data analytics, cloud computing, and security. In fact, management described its big data analytics business as being responsible for $16 billion in revenue (its original target for 2015), and has now taken its 2015 target to $20 billion. Meanwhile, its cloud solutions revenue grew 69% to $4.4 billion, and it continues to invest in software centers in order to expand its reach.

All told, IBM does have growth initiatives, but considering that its software profits grew slowly last year, it's tough to see how it can rely on software alone. Moreover, global business services profit (14% of total segmental profits) only grew 7.7%, and global technology services (30%) grew a paltry 0.3%.

So how exactly is IBM going to hit its aim of $18 in earnings?

Growth in 2014
The answer to this question comes from a variety of sources which IBM's management discussed on he conference call:

  • Growth from big data analytics, cloud computing, and security will replace slowing growth elsewhere

  • IBM is taking workflow rebalancing in the first quarter, which will reduce earnings in the quarter, but cut costs later in the year

  • More additional benefits from the rebalancing taken in the second quarter of 2013

  • Currency could prove less of a headwind in 2014, as management believed that currency cost IBM "as much as $600 million on a pre-tax basis" in 2013, equivalent to around 3% of full-year pre-tax income

  •  The second and third quarters will have easier comparisons from weak results in 2013, particularly in hardware

  • Its strong free cash flows can be used to repurchase stock and push earnings per share higher

Will IBM hit guidance?
On the negative side, its earnings reports were weaker than expected in 2013, and there is a fear that its focus on hitting its target of $20 in EPS in 2015 is hurting the quality of its earnings. In other words, it may be cost-cutting and pruning just in order to hit its guidance growth, but these actions may result in making revenue growth harder to generate in future.

On the positive side, a lot of what IBM needs to do involves internal execution (workflow rebalancing, cutbacks) and investing in areas (cloud, big data, security) that are already growing strongly. Moreover, IBM has a long-term reputation for hitting guidance, and its divestitures and investments all make logical sense. There is a good case for giving its management the benefit of the doubt.