Weakness in China Telecom Spending?

In the light of the recent profit warning from Ixxia $XXIA I decided to take a closer look at what other players in the industry such as $ARX Aeroflex, Spirent and Anite are saying. In summary, there does appear to be some weakness in emerging market network infrastructural spending. However, this may prove temporary and, merely a consequence of some caution from OEM manufacturers in the light of macroeconomic concerns relating to Japan and Euro zone sovereign debt fears.  In addition, handset and wireless appear to be growing well, so a pick up later in the year is possible.

As a note of caution I have sold off my Spirent position but retain Agilent $A as the co is more focussed on wireless solutions and the division does not make up more than 17% of revenues. The next company to issue a statement is likely to be Spirent in the UK when it gives half year results on the 4^th of August.

Company	Date	What they said	Global Markets?
Spirent	4th May	‘Trading performance for the period is in line with the Board's expectations and continues the positive trend that Spirent reported in its full year 2010 results’.	‘We expect to maintain progress throughout the remainder of 2011’
Finisar	15th June	‘Despite the decline in revenues compared to the prior quarter, we were able to achieve non-GAAP gross margin of 34.2%, exceeding our prior guidance of 32% to 33%’	‘The sequential decline in revenues was primarily driven by soft demand from our telecom customers, particularly Chinese OEMs’
Anite	29th June	‘Network Testing's prospects have been enhanced by the Invex acquisition and its growing global presence. Its broad suite of products means that it is well set to continue to grow, albeit in the first half it is unlikely to exceed the very strong comparative period last year.’	‘While Network Testing's revenue in EMEA increased by 33%, to £12.2m, and in the Americas by 44%, to £5.6m, in Asia it declined by 9%, to £6.3m.’
Aeroflex	7th July	‘Delays in shipment approvals from and orders of test equipment by U.S. government entities have caused Aeroflex to reduce its estimated ranges of net sales and Adjusted EBITDA to $198 million to $200 million and $56 million to $59 million, respectively’	‘we had some major achievements this quarter, including record sales of wireless test equipment, our first significant order from a major global manufacturer of wireless infrastructure equipment for next generation LTE(A) TM500 products’
Ixxia	7th July	‘Total revenue for the second quarter of 2011 is expected to be in the range of $67.0 million to $69.0 million, below the company's previous guidance of $78.0 million to $82.0 million.’	‘Second quarter 2011 revenue was impacted by several factors, including lower than expected revenue from Asia Pacific and from certain large equipment makers, as well as orders received late in the quarter that could not be fulfilled in the second quarter’

Network Testing Heading for a Weak Quarter?

I think that it is not unreasonable to expect Spirent to report some softness in this quarter, although it is not clear whether this is the start of at trend or a temporary pause. No matter, I have sold my position and will await their update. Ixxia have confirmed what Finisar said last month so it does appear that Chinese OEM’s have held back on spending.

 I suspect this is a consequence of a reaction to the events in Japan or alternatively part of the same forces that are holding back China LED street lighting expenditure. The latter is a subject well covered on this blog. It will be interesting to see how these pans out with Spirent’s next statement. In view of the sustained weakness in China LED street lighting I have decided to be cautious here.

Standard Chartered and the Property Market in China

Standard Chartered $STAN gave a bullish trading statement today and the market received it warmly, however the share price move looks to be a blip in a pronounced downtrend

I suspect the main reason for this is that investors have been pricing in a slowdown in Asian growth following tightening measures by China. In addition, the knock on effect of a temporary slowdown in industrial production following the disaster in Japan has scared investors. So is Standard Chartered a stock worth buying?

Is Standard Chartered Worth Buying?

I think not. Turning to the Standard Chartered statement, it seems quite positive...

“Standard Chartered is on course to deliver another strong first half.  We anticipate delivering cost growth broadly in line with income growth for the first six months of 2011. The credit environment remains benign across Asia. We are advantaged by a very strong balance sheet which remains highly liquid, very well capitalised, diverse and conservative; and are capturing increasing levels of business from our markets across Asia, Africa and the Middle East. "

...however, if we look into Standard Chartered said about regional performance, there is a red flag waving here...

“Sources of income growth remain well diversified, both by product and geography. Whilst income in India is lower than in the first half of 2010 and growth in Africa has been muted, this has been more than offset by very strong performances in Hong Kong, Singapore, Malaysia, MESA, China and Indonesia.”

...and the continued strength of Asian credit expansion is supported by other evidence. In normal circumstances, this would not be a matter for concern however China has been consistently raising reserve requirements in order to tame domestic demand and commodity price inflation.  The good news is that commodity price pressure is abating...

..but it is not clear if this is the start of a gently managed moderation or the beginning of a prolonged crash. The former would be good news for Standard Chartered but the latter would be damaging.

Anthony Bolton on China

It was interesting to read what top fund manager Anthony Bolton of Fidelity China Special Situations said recently concerning inflation and property prices in China. For example on inflation...

“I would not want to say that inflation is not a problem but I do not think it will stop the bull market unless it gets completely out of control. The authorities must tread a delicate path between slowing the economy to alleviate inflationary pressures and suppressing growth too much but I believe they will strike the right balance. I am expecting growth to fall back to 7-8% compared with last year's 10%, but that is still a very attractive level relative to the developed world.”

On the property market in China, Bolton cites the reports of empty cities and the speculation over 65million empty apartments. However, he concludes that the mortgage debt held against the properties is not high so he feels the long term picture is ‘very favourable’.

I’m not so sure and I think a cautious approach should be taken here. The good news is that the Chinese Government has the reserves to stimulate the economy if there is a sustained slowdown in housing. However, if there is a crash, China related equity investors-particularly with the US housing crash in their minds- won’t be slow to price this in negatively.

Veeco LEDS market down with guidance

LED Street Light

LED equipment manufacturer Veeco reported record results but disappointed with guidance. The stock is down in the after market. I previously featured LED manufacturer stock Cree in a previous article which you can find via this link

Turning to what Veeco said in these results...

“Q1 2011 revenues will be lower than Q4 2010 because we are planning to ship 12-20 MOCVD reactors in the new MaxBright “cluster” format, and will not be recording any revenue on these systems in the first quarter. Timing of revenue is also being impacted by the longer order-to-revenue cycle times associated with the high percentage of business currently coming from China, primarily due to customer facility readiness. The average time to convert orders to revenue is currently several months longer in China than in other regions.”

...and this means that Veeco's end customers in China have started to slow spending. Since Korea and Taiwan have already slowed spending growth than this is an unwanted-if not unexpected-development.

It is not unexpected because Cree and SemiLEDS had previously made noises about a pause in China street light demand and an inventory work down with their LED bulb customers.


Conclusions for Veeco, SemiLEDS and Cree?

Veeco is higher up the supply chain, so it usually takes a while to feed through. However, Veeco are seeing the slowdown relatively early on. This suggests that there is an issue of over capacity in the industry. This capacity will only be utilised if/when China restarts spending on street lighting. Furthermore, any subsidy cut will hurt the industry on the whole. I'm also somewhat concerned by the possibility for European austerity measures to reduce growth.

Despite the fall from $63 to $52 Cree stock is hardly cheap on a forward PE (June 2011) of 22x and investors will want to wait to see when/if the Chinese resume spending on LED street lighting. I would look to SemiLEDS next results before taking a definitive view.

In the last results SemiLEDS made specific mention of pricing pressures and this is widely believed to have come from Cree. This sort of activity is usually a sign of over capacity and does not auger well for Veeco or indeed for Cree and SemiLEDS. All three stock prices have been weak. Furthermore, gross margins for all three of them could come under pressure, unless end demand picks up. No need to rush in just yet.

Coach is a Luxury Retail Play Exposed to Fast Growing Emerging Markets

What the Chinese Middle Class Want

High end hand bags and accessory company Coach gave good earnings and demonstrated  that the high end of the retail market is where you should be looking to buy stocks in the sector. The dichotomy between the high and bottom end of retail has been previously discussed here

In summary, I think Coach is the sort of stock that would suit a lot of portfolios. Coach has a well regarded management team and the company has a number of profit drivers. In addition, many of these revenue streams are on fire at the moment. Coach generates a lot of cash and is a good stock to be looked at for inclusion in a Growth At Reasonable Price (GARP) structured portfolio.

Before I discuss the results, I want to describe the profit drivers.


Coach Profit Drivers

They are numerous and this is why Coach's stock has had such a great year

• Emerging middle class in China making aspiring to the Coach brand
• Recovery in discretionary spending at the high end of Western markets
• Shift of production to lower cost manufacturing centers
• Increasing online sales and opening men's stores
• Consumers 'traded down' during the recession and bought Coach instead of premium luxury brands like Louis Vuitton or Gucci

All of which, have contributed to Coach's top and bottom line. Coach is an established and very well regarded brand in Japan and, this has translated well over to China. There is potential for expansion in China as they only have 52 retail stores there, as opposed to 171 in Japan and a combined (retail & factory) of 478 in the US.

On a less positive note, they are exposed to rising raw material costs and they appear to have held back margins. Furthermore, any fashion business is exposed to the constant challenge to innovate and keep the brand popular.


Coach Q2 Earnings

A brief look at the earnings

• Gross Margins were flat at 72.4%
• Inventories rose 36%
• EPS diluted of $1 vs. 97c estimates
• Revenues increase 19% for the quarter
• Free cash flow of $382m for the quarter

Coach don't give EPS or revenue guidance but here are a few points from the conference call

• CapEx for 2011 forecast at $150m
• Gross Margins for 2011 forecast at 72-73%
• Operating Margin for 2011 seen flat at 31.5%
• High single digit same stores growth forecast for the rest of the year in North America

The market was disappointed with the flat gross margins in the quarter plus the outlook for margins in future. In this quarter margins were held back by a larger proportion of sales taking place lower margin factory stores. This could be a structural issue, but it appears unlikely. It could also be the phenomenon (which has been observed at Burberry in London) of a pick up in purchasing by Far Eastern purchasers who want to buy Coach products in 'bulk' at factory stores.


Higher Raw Material Costs

In addition, higher raw material costs are holding back margins and, this issue looks set to continue. Coach will have to rely upon top line sales growth, unless they can raise prices. The co could find this relatively difficult because they are known to be at the lower end of the luxury spectrum. The good news is that Coach is generating good top line sales growth at the moment.

Inventories were high in order to support a combination of the strong growth in sales in North America, new store openings and the Asian distribution center.


Coach Evaluation

Coach is exposed to good growth trends. Flat margins are a concern but, they are generating good top line growth. Trailing free cash flow is at $879m which puts them on a FCF/EV of 5.84% with a current stock price of $54 this looks good value, for a company set to grow earnings in the low teens. The main concern would be a dramatic fall off in demand in Asia, if China falls into a real estate slump. This is a possible outcome for 2011, but not one to worry about unduly for now.

Analysts have this on EPS of $2.89 and $3.29 to Jul 2011 and 2012 respectively. I think this is cheap. Nevertheless, I run a hedged portfolio and already hold Nordstrom in the retail space (less exposure to China) so I won't be picking up Coach just yet. However, I do think it deserves a good look and will put it on monitor. Should China appear to be successful at smoothing inflation/real estate markets than Coach will probably be bought if it is at this kind of evaluation.


If you like this article than why not add a twitter feed from 'EarningsView' by clicking on the 'birdie' link on the left border of this blog.  Alternatively, add us on facebook at 'Earnings View', whereby articles will be automatically linked.

Cree's Results Confirm SemiLEDs weakness

LED manufacturer Cree gave a disappointing set of Q2 results. Cree missed EPS estimates and revenue forecasts, recording 55c and $257m as against expectations of 58c and $277m. In addition Q3 guidance was below estimates. Cree forecast revenues of $245-265m and EPS of 38-45c, analysts had previously forecast $288m and 68c. What went wrong?

In the conference call Cree cited two issues...

'This was primarily due to lower sales for LED component distributors in Asia, due to an inventory correction at their customers. The inventory correction has been caused by a pause in the China LED streetlight demand and lower-than-expected growth in LED bulb applications.'

...and looking specifically at the China streetlight issue...

'The China streetlight slowdown is related to a pause in the market as new specifications were being developed by the government. The specifications were published last quarter, and a number of companies were recently approved under the new guidelines. We have design wins at the majority of these companies and expect new projects to start being awarded after the Chinese New Year. '

...turning to the LED bulb weakness...

'The LED bulb slowdown is related to our customers working off inventory that was bought in Q1 ahead of end customer demand. The application is growing, but not as fast as our customers had anticipated, which has resulted in the short-term inventory correction.'

Growth to Return for Cree?
Whilst the management made reassuring remarks about a return to growth after China restarts spending on LED street lighting, I'm not sure that this make Cree a stock to buy, even if this occurs.

Firstly, according to LEDs Magazine a smaller competitor SemiLEDS Corporation gave a warning recently. SemiLEDS warned of pricing pressure and declared the Co had lost a key account to a larger competitor solely based on price. Since, over 80% of its sales are in Asia and they are focused on general lighting (where Cree is aiming for growth)  not back lighting.  So pricing competition appears to be an industry issue, as well as current high inventory.

Secondly, whilst longer term there is a clear industry growth trend, this will not come without innovation and, this costs R & D and capital expenditure. Margins could be under pressure as Cree try to develop technologies in order to encourage demand.

Thirdly, it is still unclear whether austerity measures in Europe, let alone the US, will have an effect on LED road infrastructure spending.

Finally, there are fears that ramping up of capacity and production in the LED market has caused significant oversupply. This, if true, would likely play out in pricing pressures for Cree.


Cree Evaluation
All of which suggest a lot of uncertainty with Cree, however every stock has its price. Is Cree Good Value?

Frankly, at $62.71 I don't think so. Cree's rolling free cash flow yield is 1.44% and it trades on a trailing PE of 36. All of which could work, if I accepted the analysts five year growth forecast of 22% pa. I think that these growth assumptions are far from being assured. Whilst industry growth looks assured, it is far from clear that Cree will be able to maintain margins and market share.

I would expect the stock to get weaker from here. I like the industry but think it is too early and too expensive to get into Cree, in order to benefit from the expected resumption in Asian demand. I will monitor.



Source:

LEDs Magazine 'SemiLEDS Shares Suffer on Weak Oulook' , Accessed Jan 19, 2011

Joy Global's Growth is Dependent On China Housing Market

China Construction holds the key to JoyGlobal Prospects?

Mining equipment company Joy Global gave results yesterday  and not only were they impressive, but the outlook statement was very positive too...

mining companies are realizing strong demand and prices, with the expectation of significant increases in demand during the next 3 to 5 years. As a result, they are making major increases in their capital expenditures for mine expansions. Mining companies have announced capital expenditures that are up 30 to 35 percent this year, and are approaching the levels of 2008. In addition, announced capital expenditures for 2011 are expected to rise another 15 to 20 percent.

..so everything looks rosy according to Joy Global's earnings release. With Joy Global and the likes of UK's Fenner, you have upside from a few strategic profit drivers.

Firstly, there is the resolution of economic growth and industrial capacity utilisation in the developed industrialised nations. This strengthens demand for commodities such as copper and coal.

Secondly, there is the secular trend towards shifting energy production towards using coal and away from oil. Not only is this a response to geopolitical risk with oil supplies but also it is reflective of the global shift towards manufacturing in the Far East. Coal is the major commodity that China is rich in.

Thirdly, there is the significant investment being planned in infrastructural projects within emerging markets. Many of these projects are pre-planned and committed and are essential for the long term growth of these countries.

Finally, there is the marginal demand from residential housing and construction in the World.

China's Construction Market is the Marginal Demand Driver

Of all of these profit drivers, I would view the key marginal  (housing and construction) as being the most important. My view is that Europe's banking sector will face more Sovereign Debt issues next year and this will cause some disruption to their recovery in the first half. Turning to the US, frankly, I don't think the US is in a position yet to see strong increases in new construction activity...

...and this is mainly due to the ongoing high vacancy rates

and also a result of a large number of foreclosed homes still waiting to come onto the marketplace.

So much depends upon whether China's property and construction markets are in a bubble or not?

China Property Market. An Asset Price Bubble?

Poetic symmetry seems to demand a bubble here. Japan had it, the US had it, the UK had it in the 90's and even Sweden had it in the 90's. Furthermore, with China you have a situation whereby currency manipulation (they are buying US Dollars and selling RMB) is flooding their internal markets with RMB which could be causing a local asset bubble. Throw in the extra stimulus efforts made by the Communist regime and you have all the ingredients for a bubble.

However, the tricky part here is to try and quantify the nature of the mass urbanisation movement within China. Jim Chanos claims that 60% of China's GDP is due to Fixed Asset Investment whilst only 5% is due to exports. You can see the importance of this kind of growth on global steel production here...


source: worldsteel

...and with so much of other emerging markets (Russia, Brazil) dependent on commodity exports to China, the knock on effect of a slump in China's property market is significant.

China Housing Vacancy Rates?

The problem that Chanos and others have is that there are no official figures for China's vacancy rates. However, we do know that according to the National Bureau of Statistics of China (NBSC)  Investment in Real Estate Development Enterprises is currently growing at a yearly rate of 34.2%

I do not think this is sustainable and also note that the Chinese are trying to deal with overheating in commodity prices and real estate, by successively raising banks reserve requirements. They may engineer a 'soft landing'. Who is to know? I'm sympathetic to Chanos' arguments on China and housing but the exact timing is hard to predict. Nevertheless, I do not think that now is the time to be meaningfully overt in this sector.




source:

Fortune Magazine "Chanos vs. China" (accessed Dec 2010)

NBSC "Investment Completed and Growth of Real Estate Development Enterprises"  (accessed Dec 2010)