Alcoa Kicks off Earnings Season With Weakness

Alcoa $AA gave results and its always interesting to look at them and do some equity research analysis because it is a bellwether for the upcoming US earnings season. Alcoa is also a key cyclical stock that gave good forward guidance as to where the economy is headed. No need to dwell too long on the earnings because most investors will know that they missed –already reduced- analyst EPS forecasts. Alcoa reported 15c in EPS against a forecast of 22c. The commentary on the conference call also confirmed the weakness in the global economy and, interestingly, seemed to confirm that this mainly caused by corporation holding back expenditure in the face of macro economic uncertainty.

Alcoa Earnings

 The macro issues will be put aside for the moment, but for now, it’s useful to look at what was said about Alcoa’s end markets. The following table is derived from the presentation and indicates year-on-year growth by semester and region. The regional split is not available for aerospace and industrial gas turbines.

	N America	Europe	China	Global
Aerospace				-4%     12%
Automotive	4%       0%	14%       -16%	2 %        2%	-4%        4%
Heavy Truck Trailer	28%    23%	14%       -11%	5%     -24%	10%     -14%
Beverage Can	0%     -2 to -3%	6%         2-3%	10-15%  15-20%	2-3%    2-3%
Commercial Cons	-9%    -3 to -4%	-4%     -2 to -4%	10-12%	1-3%
Industrial Gas Turbine				5-10%

So what are the key takeaways and conclusions from Alcoa’s earning report?

• Europe is weak across the board and this is a consequence of macro economic uncertainty
• Aerospace looks strong going forward as commercial jet deliveries are forecast to grow at 9% CAGR until 2014
• European automotive looks like it is falling off a cliff but global growth is accelerating thanks to China automotive sector
• Industrial turbine growth remains solid
• Beverage looks attractive because global growth looks solid and their appears to be a structural story in China as the consumer shifts to using cans

Given these factors, any stock that is a user of aluminum and has it as a major part of its fixed costs could see margin expansion and increased profitability if their end markets hold up. So for example, beverage can manufacturers like Rexam, Crown Holdings $CCK or Ball Corp $BLL could do well. Rexam tends to hedge a lot so it might not be the best stock to play this theme but the other two are worth a look provided their emerging market exposure is good. Similarly, aerospace manufacturers and suppliers to Boeing and Airbus could also see margin expansion.

Of course, all of this is predicated on continued weakness in aluminum prices…

…and given slowing global growth, this could be a safe assumption. The one area of circumspection in Alcoa’s report related to China and commercial construction. If the likes of Jim Chanos are right in their bearish predictions of a major slowdown in China’s residential and commercial construction market then things could get nasty for Alcoa.

Alcoa Reports Slowing Growth in Europe

Another key conclusion from this report is how badly Europe is faring. This will particularly affect Germany because it is heavily exposed to heavy machinery Capex. Indeed, the Dax has performed very badly this year and, it is safe to conclude that a satisfactory resolution to the Euro zone debt crisis is very much in their interest.

As the Alcoa CEO, Klaus Kleinfeld said in the conference call..

I guess that's all the time we have today. Let me sum it up. I mean, we've seen strength in many of our markets despite the sharp slowdown in Europe that hurt our sequential results. And I'm, as I just said, more concerned about the lack of confidence than about market fundamentals. It almost looks like the world is worrying itself into another recession and that should not be allowed to happen.
I think the problems that we have today, I mean, around Europe and some of the discussions here, I think are all problems that can be solved. And I hope the solutions get accelerated and we'll be able to restore confidence. Confidence, I said many times, is the air, the oxygen that every economy needs to grow.

…it really is all about returning confidence to the markets.

Source:

Alcoa Earnings Presentation

Sonosite Delivers Revenues and Earnings Below Estimates

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.

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 Prêt-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

Region	Q2 Comp Sales Increase	Q2 Op Inc Increase
Global	5.6%	11%
Europe	5.2 %	10%
USA	4.5%	6%
APMEA	5.9%	19%

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.

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

Region	New Restaurants for 2011
Global	1115
Europe	225
USA	150
APMEA	650
Latin America	90

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.

Sirona is an Attractive Healthcare Growth Stock

Sirona CAD/CAM Systems Give Single Visit Restorations

Sirona Dental Systems $SIRO is a dental healthcare stock which is exposed to favourable demographic tailwinds and the expansion of the rollout of its global leading technology. Sirona gave results recently and they were very well received by the market. However, the evaluation and prospects look compelling and, it looks like there is more to run. Analysts will be keen to upgrade estimates in their equity research reports


Growth Drivers for Sirona

Sirona looks set to benefit from an ageing demographic, because as people get older they require more teeth maintenance. Furthermore, the trend is towards people having more teeth as they are older, which means more restoration work and ultimately more demand for Sirona's products.

Whilst the demographic argument is well worn in healthcare plays, it should carry more weight with Sirona because of a relative lack of insurance reimbursement issues with dentistry products and solutions. Indeed, the industry is shifting towards private from public pay and much of what Sirona does is aimed at the high end market.

The company is very well run and a global technology leader. Sirona spends around six to seven percent on research and development every year and is investing $15m in setting up a major new innovation centre in Bensheim, Germany. The balance sheet is solid, having seen the company engage in deleveraging the business over the last few years. Sirona is now in a position to make some acquisitions and I would expect some activity on this front.


Sirona Business Divisions CAD/CAM

A graphical breakdown of Sirona's business divisions for Q1

Q1 2011	Revenue	% total Rev	GP	% total GP	GP Margin
CAD/CAM	83.4	35.4%	59	42.2%	70.7%
Imaging	76.3	32.4%	46.1	33.0%	60.4%
Treatment Centres	49.8	21.1%	22	15.7%	44.2%
Instruments	26.1	11.1%	12.7	9.1%	48.7%
Total	235.6		139.8

Source: Company Accounts, Earnings View

...and then looking at how margins and revenues have moved...

% constant currency	Rev Growth	GP growth	GP Margin growth (bp)
CAD/CAM	18.5	18	180
Imaging	11.2	6.5	-50
Treatment Centres	23	20.1	290
Instruments	8.4	3.2	150

Source: Company Accounts, Earnings View

Sirona is best known for its CAD/CAM system Cerec, which allows dentists to make a tooth restoration in a single client visit in 95% of cases. This is advantageous for the patient because he gets an immediate treatment as opposed to a seven to ten day wait, which involves the restoration being created and then fitted in a second visit. Among Sirona's distributers are companies like Patterson and Henry Schein, who have helped establish the Cerec system into low double digit penetration in developed markets. Although impressive, it does suggest that there is plenty of room for growth. It is a proprietary system which is backed up by patents and Sirona's research leadership.

Clearly, many dentists will baulk at paying the sticker price of $100-120k for the system but it actually delivers an impressive return on investment. Sirona estimates that with 25 restorations a month, the cost savings of using the Cerec system should pay for itself within one year. Nevertheless, it is not hard to see that penetration has begun with the high end practices. For less active practices, Sirona has Cerec connect which gives dentists in option to tap into the Cerec technology but at a lower initial cost.

Looking at the results for CAD/CAM it is noticeable that International sales (up 23.3% in constant currency) far outpaced US sales (up .9%) and this is seen as being a result of a tougher US comparison. Sirona had record US sales growth in the comparable quarter last year. Margin expansion was good and came as a result of natural leveraging and a favorable shift in the sales mix.


Sirona Imaging Systems

Sirona are also a leader in Imaging Systems and, this division saw strong growth. However, there was some margin compression due to pricing pressure. This will be somewhat alleviated in the second half of the year when/if Sirona gets FDA approval to sell the new Ortho Plus XG 3D product. It may well be that dentists are holding off buying some of Sirona's other products while they wait for this to be approved.

Thinking longer term, Sirona has 40-45% penetration in this market place. Although, this sounds prohibitive to future growth, the 'penetration' refers to at least one sensor in the practice. Therefore, Sirona should have the opportunity to be able to sell more of them into this established base. Sirona intends to sell a few sensors into a given practice after establishing a presence.


Treatment Centres

Sirona saw very impressive growth in constant currency and margins. Sirona's treatment centres are focussed on the high end and have seen a resumption to growth as the economy recovers. Demand growth was stronger in Asia and Europe (Sirona has very strong in Germany) and I would expect this to continue as teeth surgery for cosmetic reasons is something that the wealthy can afford.


Sirona Stock Evaluation

Tabulating previous results for Sirona and some estimates assuming the current share price of $49.86 and a market cap of $2.76bn with an Enterprise Value of 2.86bn....

(m)	2008	2009	2010	Trail to Q1	2011E
Rev	757	713	770	791	850
Gross Profit	346	346	399	417	470
margin	45.6%	48.5%	51.8%	52.7%	55.3%
Op Income	64	85	128	141	158
margin	8.4%	11.9%	16.6%	17.8%	18.6%
Net Income	29	53	90	101	124
Change WC	-42	-27	1	-26	-25
Op Cash Flow	95	120	176	158	200
Free Cash Flow	59	99	152	130	150
% revenue	7.7%	13.9%	19.7%	16.4%	17.6%
FCF/EV	2.0%	3.4%	5.2%	4.5%	5.2%

Source: Company Accounts, Earnings View

...demonstrates that Sirona does a very good job of converting income into cash flow and debt has fallen dramatically over the years. However, it is noticeable that working capital requirements (accounts receivables in particular) have risen to accommodate the growth in the quarter.

The full year results to Sep 2011 are expected to be front end loaded, but Sirona raised full year guidance to revenue growth of 9-10% (previously 7-9%) and operating income (excluding amortisation of $54m) of $208-216m which represents over 23% growth in operating income.

Current consensus EPS figures are for $2.88 to Sep 2011 but I think Sirona will report closer to $3.05 and I also think that the estimated free cash flow figure (above) is a bit light because they are spending $15m on a new innovation centre. The usual capex run rate is 3-4% so assuming 4% (34m) gives adj FCF=$166m. Assuming a 'fair' evaluation is a forward FCF/EV, of around 5% I think Sirona is better priced at closer to $58.

I bought some.