Monday, July 25, 2011

Sonosite Delivers Revenues and Earnings Below Estimates

Sonosite MicroMaxx ultrasound machine

Ultrasound manufacturer Sonosite $SONO gave results which were below analyst forecasts and also below the company’s internal forecasts. Although this is a disappointment, it is not as bad as it superficially appears and looks to be part of the usual ‘variance’ that happens with fast growing companies. Nevertheless, I would expect the stock to be marked down.

Firstly, turning to the results

  • Rev 72.7m vs. 73.8m forecast
  • EPS of -8c vs. 10c forecast
  • Full year guidance maintained as per conference call

In other words this is a 17c miss on earnings and revenues were light. This is not a good headline but delving deeper into the results and conference call, it looks like this is more to do with a timing of orders than any protracted weakness.

Sonosite’s Missing Orders

Essentially, the management is saying that there were $4-5m in orders in Q2 which were delayed and are due to be rolled over in the next quarter. Now, if I had a dime for every time I’ve heard that sales that hadn’t been booked were just about to ‘come in’ I’d probably have enough to make up Sonosite’s shortfall myself! The market will approach the issue with the same level of skepticism. As for the earnings shortfall, this is explained by the fact that Sonosite has over 70% gross margin, a few million lost in sales will drop through heavily into the bottom line. Had the orders come in, then Sonosite would have handily beaten estimates.

Skepticism aside and having listened to the conference call, I thought that Sonosite were very specific about these orders and were quite willing to put credibility on the line in outlining their belief that they were part of a non systemic and incongruent sequence of events. For example, 25% of the shortfall was due to VisualSonics (VSI) and this amounts to just three orders. Moreover, most of the shortfall has subsequently come in and only $300k has ‘evaporated’. According to the management, if there was a systemic weakness, it was to be found in the UK. In addition, guidance has been kept the same for the full year, so clearly they are expecting to beat pre-existing forecasts for the next quarter.

Sonosite’s Opportunities in the Second Half

The results in the first half were categorized by an increase in R & D costs and SG & A which saw total Operating Expenses rise to 66.2% of sales from 64% last year. This increase in expenses is largely due to integrating Visual Sonics and too the launch of new products as part of the three year strategic plan. Indeed, the management concluded the conference call by pointing out that margin improvements were due to take place in the second half.

One cause for concern is the rising working capital requirements. This is natural in a business that is about to accelerate revenues, but as shipments were lighter than expected in the quarter, Sonosite saw inventories rise. In conclusion, if there is a pronounced correction on the back of this result than a decent buying opportunity could be being created. GE $GE gave results recently and reported good growth in compact ultrasound shares and with Sonosite affirming that it had -at least- retained market share in the US, this looks like a timing of orders issue rather than a cause for sustained weakness.

Sinnerschrader Offers High Yield Plus Growth

Sinnerschrader is a micro-cap German listed company with huge potential to see a substantial stock price appreciation in the next few years. The transition from high street retail towards e-commerce is still ongoing and represents a key secular growth area in the economy and, interactive agencies like Sinnerschrader look set to benefit. Ebay $EBAY buying interactive agency GSI Commerce can be seen as an affirmation of how good prospects look for this industry. It is an interesting stock to do an equity research report on because it offers a blend of strong growth plus high cash generation, with a very strong balance sheet. There is even a high dividend yield too!

Sinnerschrader is an Exciting Growth Stock

The company is one of the top 10 interactive agencies in Germany and currently receives 89% of its revenues from ‘interactive marketing’. This involves developing and marketing internet based activities for a range of companies. In the past, Sinnerschrader has been highly dependent on a few large customers, however this risk is being reduced following the strategy of pursuing growth in new customers. I will discuss this again later. The other two segments are ‘interactive media’ which involves buying online ads for their clients and ‘interactive commerce’ whereby Sinnerschrader develops online shops for its clients.

The important thing to understand with this type of business is that it is relationship based. This carries risks- the staff could walk away with some clients- but also offers great reward as once a client is onboard the opportunity for a recurring ‘annuity’ type income stream is very strong. Indeed, the good news is that Sinnerschrader is aggressively pursuing new customer acquisitions which should lead to increased cash flows in time.

Growth Strategy

Not only are existing markets looking strong, but I believe the opportunity for future growth from areas like mobile applications is very good. Increasingly, the convergence between telecommunications and internet usage is being manifest in the growth of smart phone usage. Email and social networking are the ‘killer app’ for the internet and smart phones are capable of supplanting computers in this aspect. All of which, will mean increased demand for agencies that can integrate clients online offerings towards mobile. In addition, if mobiles are going to be the next payment device than there is an obvious synergy in companies marketing themselves to the customer via mobiles.

Sinnerschrader Results Statement and Stock Evaluation
The company gave its Q3 results on the 14th of July and they can be read here. I was pleased to see that Sinnerschrader is chasing growth, albeit at the detriment of reducing initial margins. With the new emphasis on growth, analyst estimates for revenue growth for this year are 25% to E30m with further revenue growth of 17% for next year. Ebitda for the next three years is forecast at E3.5m, E4.6m and E5.5m respectively. Now considering that the Enterprise Value of Sinnerschrader (stock price of E2.35) is E20.1m than on an EV/Ebitda basis this stock is far too cheap. Similarly, despite the working capital requirements necessary to fund the growth in the business, analysts have Sinnerschrader generating nearly 7% of its Enterprise Value in Free Cash Flow. Again, this is far too cheap for a company set to grow EPS by around 30% pa for the next two years.

Sinnerschrader trades on a forecast forward (Aug 2012) PE ratio of 10.7x and forecast dividend yields of  4.2% and 7.5% for 2011 and 2012 respectively.  I think this is too cheap.

Sunday, July 24, 2011

Is McDonalds a Low Price Offering?

McDonald's But Not as You Know it!

McDonald’s $MCD is a fantastic business that is firing on all cylinders. The recent results sailed ahead of estimates and the company is clearly grabbing market share from Yum Brands $YUM and other competition. However, is all of this fully priced in?

As a potential investment McDonald’s has a strong appeal due to a number of factors which I’ve listed below

  • From a macro-economic perspective it offers a play on austerity in developed markets as unemployment remains high and McDonalds offers a value meal proposition
  • Within Emerging Markets, McDonald’s has a ‘Western aspiration’ brand that benefits from rising disposable incomes and urbanization
  • McDonald’s has successful repositioned itself away from fast food junkies and leveraged its brand into launching newer healthier alternatives
  • Customers are-thus far-tolerating price increases but price pressures are increasing

Around a decade ago, McDonald’s made a master stroke in taking a strategic stake in PrĂȘt-A-Manger (in order to ‘learn’ how to service a different market) which has partly been behind the successful re-branding. Back then, it would almost have appeared inconceivable that McDonalds would be discussing the kind of product offerings and innovations that peppered the recent conference call. For example, beverage sales were up 29% and McCafe has seen far better than expected growth in sales per store. Premium chicken sandwiches, smoothies, oatmeal breakfasts and wraps are now alongside the traditional burgers, fries and milkshakes in the product mix.

Not only has McDonald’s successfully rebranding but they have managed to diversify and tailor the product offering to differing regions. Delving deeper into the Q2 numbers for regional sales reveals how this plays out

Q2 Comp Sales Increase
Q2 Op Inc Increase
5.2 %

Clearly, the US is the laggard in terms of both metrics, however, it is the most developed region for the company and it has been grabbing market share from Yum as its rival focuses on Emerging Market growth. Moreover, Europe is actually the biggest market for the company and these results represent strong execution.

Commodity Costs Coming

On a less positive side, commodity costs are on the increase and although customers absorbed them well, margins fell in all three regions for McDonald’s. This is an obvious concern-not least for the demographics of a typical customer- but also for future margin expansion. No one likes to be a business with challenged margins. However, I think that with slower growth, going forward, within emerging markets, we could see a moderation in things like beef prices, which could help out McDonald’s margins.

Wheat - Monthly Price (US Dollars per Metric Ton) - Commodity Prices - Price Charts, Data, and News - IndexMundi

In this report, the company saw cost increases of around 4-5% generally but that figure could come down going into next year. In addition, I think that the value proposition of McDonald’s means that demand should still grow even if the Asian economies start to slow.

International expansion

Turning to expansion plans for this year, here is a break down of where new store openings will be

New Restaurants for 2011
Latin America

APMEA is how the company bundles Asia Pacific with the Middle East. Within the APMEA numbers, new stores for China are 200 and 100 and 30 for Japan and South Korea respectively. It is a misnomer to suggest that only Yum are expanding in emerging markets!

McDonald’s Stock Evaluation

Frankly, I think it is fairly priced and would struggle to see much upside from here. I know most commentators are saying this, but that doesn’t mean I should force myself into thinking something different for the sake of novelty!  The opportunity for margin expansion does exist via lower food prices and the growth strategy looks assured but at a current price of $88.56 the stock trades on 17.3x forward estimates. This drops to 15.8x for 2012 but should investors pay this evaluation for two years out earnings, given that earnings growth ($5.6 from $5.12) is likely to be less than double digits?

I think the answer has to be negative. The yield at 2.9% is decent and it’s a decent stock to tuck away long term, but this evaluation doesn’t look cheap enough to me. I will monitor and hope for a dip.

Friday, July 22, 2011

Weakness in European Technology Spending?

It’s been a good week for technology in general but three stocks stand out as being the big losers. Fortinet $FTNT , Riverbed $RVBD and, F5 Networks $FFIV have all seen significant declines. Why?

These companies have been written about on EarningsView. For example, Blue Coat Earnings Write Up , F5 Networks Growth Looks Solid , Fortinet Delivers Strong Results

What all three have in common is that they all reported weaker spending in technology in Europe and were on evaluations that appeared ‘stretched’ to say the least. I’ve decided to go through the conference calls and see what each said about Europe.

European Commentary
F5 Networks
‘We have taken a fairly conservative forecast in terms of Q4 for EMEA as well. So, we are not looking for much growth sequentially there at all’…    …‘much like last quarter we saw weakness in some of the more macro affected economies in EMEA. Germany wasn’t great, UK wasn’t great. But the rest of the country did pretty well, excuse me, rest of the theater did pretty well.’
Riverbed Technology
‘Sales in EMEA were weaker than expected.. ..we attribute the softness both to the environment and our own execution’…  …‘Looking at Europe specifically, the weakness was in a surprising place, which is our central region headquartered in Germany, and Germany is supposed to have one of the stronger European economies. So that's what tells me there was some execution problem there.’
‘In terms of geographic breakdown of the billings growth Americas was at 32%, EMEA 2% and APAC 41% compared to Q2 2010. While Americas and APAC had very strong quarters, softness in EMEA from a macro perspective as well as timing of some of our large transactions resulted in lower billings growth for this region in this quarter. However, pipelines remain strong and we do expect to resume good growth in EMEA during Q3 and the balance of the second half.’…  …’ I don’t think it's totally ourselves, but what I’ve heard from some others that EMEA was, there was a little bit of malaise in EMEA, but that’s not an excuse, we think we will do better’

All three companies are leaders within their respective niches in technology and signs of weakness should be taken seriously. F5 Networks is a leader in application delivery networking, Riverbed is the top firm in the WAN (Wide Area Network) Optimization market and Fortinet is a global leader in UTM (Unified Threat Management) which is security solution primarily offered to small and medium sized enterprises.

European Macro Economic Woes Weighing on Technology

There is no doubt that firms in Europe have somewhat slowed purchasing decisions in response to fears over the macro environment and in particular European peripheral Sovereign Debt. I suspect this is a late quarter event because surveys up to June were indicating conditions that were holding up quite well in Europe. For example, here is the Optimism Index from Duke/Fuqua School of Business CFO Survey for June

Business Optimism Duke CFO Survey

Moreover, with regards to Riverbed we could be seeing the results of competitive pressures from the restructuring at rival WAN Optimization firm Blue Coat Systems International $BCSI. It will be worth seeing the results of Blue Coat because that company’s restructuring has been a long time coming.

Sovereign Debt Issues or Evaluation

I suspect, assuming a successful resolution of the European debt issues (Italy is the key) that these companies could report some upside surprise in EMEA revenues in the second half. So does this sell off in the stocks create a buying opportunity?

I’m not so sure and this view is principally due to the current evaluations. All of them looked stretched and were priced to perfection. In these cases, the slightest disappointment will see the stock price take a substantial hit. Even given the disappointing statements on Europe, these companies beat estimates and guidance was hardly weak, but it still leaves them on high evaluations.

Stock Price
Next Q Guidance vs. Analyst Est
Current PE
Forward PE
F5 Networks
97-99c vs. 98c
21-22c vs. 23c
9-10c vs. 9c

Frankly, I think the disappointment over the European statements is sending a warning over how highly rated these companies are. They are all attractive but, for now, these evaluations look a bit rich for me.

Wednesday, July 20, 2011

Check Point Raises Estimates

Check Point $CHKP gave results and both revenues and earnings were above consensus. Furthermore, Check Point raised revenue and earnings estimates for the full year, and the stock responded by crashing through a 52 week high. So is everything looking positive for the stock? I think it is.

Check Point was covered in an EarningsView research report linked here and this should provide some good background for the current results. Turning to these results a few key takeaways are

  • Q3 Revenues forecast at  $300-308m
  • Full Year Revenues Forecast raised to $1.23-1.25bn vs. a previous estimate of $1.19-1.23bn in January
  • Full Year EPS forecasts raised to 277-284c vs. a previous forecast of 265-275c

Check Point Sequential Revenues

To put these numbers into context I’ve broken down the sequential revenues here.

(m)Q4 08Q1 09Q2 09Q3 09Q4 09Q1 10Q2 10Q3 10Q4 10Q1 11Q2 11
Seq growth %-10.4%14.7%4.5%16.5%-9.9%6.5%4.6%16.6%-11.7%6.9%
Cur Defer Rev290.0283.1330.0322.8384.3380.9377.0362.9424.2421.9413.4
Seq growth %-2.4%16.6%-2.2%19.1%-0.9%-1.0%-3.7%16.9%-0.5%-2.0%
LT Defer Rev40.841.932.137.441.038.937.733.440.438.643.5
Seq growth %2.8%-23.4%16.4%9.8%-5.1%-3.0%-11.4%20.8%-4.5%12.9%
Tot Defer Rev330.8325.0362.1360.1425.3419.8414.8396.3464.6460.4457.0
Seq growth %-1.7%11.4%-0.5%18.1%-1.3%-1.2%-4.4%17.2%-0.9%-0.7%

Clearly, these results are good on a historically sequential basis and, it is no surprise that revenues and earnings forecasts were upgraded. Check Point is a relatively mature business that generates high amounts of cash flow conversion and provides investors with a compelling mix of value and growth. It is often compared with the likes of Fortinet $FTNT but Check Points end markets tend to be the larger enterprises who are in need of a comprehensive Network Security solution. In addition, the company is capable of scaling up margins and cash flow when markets are good because they offer a number of ‘blades’ with different functionality. In other words, once a company buys the platform from Check Point than they immediately become a potential customer for more blades.

Frankly, Check Point is the best in class in the sector and given continued global economic growth there is no reason why the company cannot continue to generate margin expansion. The main competition for Check Point comes from Juniper $JNPR and Cisco Systems $CSCO and with the latter in a stage of restructuring, for now, Check Point looks capable of growing market share. The question is whether the stock is correctly priced or not?

Check Point Evaluation

Turning to analyst estimates of EPS of $2.78 and $3.08 it seems that Check Point is set for low double digit growth in the next couple of years. At the current price of $59.3 (an EV of $11.43bn) Check Point trades on 21x and 19.2x earnings. Although, this seems rich, the high free cash flow conversion (around $684m) means that the share presents a compelling value proposition and I think there is a 15% upside potential to the price. A target price of $67.5 seems better value and I will wait for a dip before buying back in with that target in mind.