Fastenal Confirms US Construction Acitivity is Solid

Fastenal $FAST gave earnings and demonstrated good growth. The Fastenal story is a good one and stock investors can find a detailed write up and earnings analysis of the company’s fundamental evaluation in the link at the bottom. However, for now the important thing to takeaway from Fastenal’s earnings report is that-if the US was in isolation- a double dip recession looks unlikely. Fastenal is a good company to look at because it sells the kinds of fasteners and hardware equipment that are used in construction activity.

The best way to conclude this from the results is to look at the sales figures for stores that have been open for more than five years. These stores tend to be more cyclical in their revenues because they are more mature in their market share within their local markets. Here are the numbers for revenue growth…

	Jan.	Feb.	Mar.	Apr.	May	June	July	Aug.	Sept.	Oct.	Nov.	Dec.
2011	15.3%	17.9%	19.2%	19.1%	17.9%	18.2%	17.3%	15.2%	14.5%
2010	-2.1%	-0.5%	7.4%	14.9%	17.3%	16.2%	19.8%	18.2%	18.9%	17.9%	13.2%	16.0%
2009	-12.4%	-14.3%	-21.5%	-25.2%	-25.2%	-26.3%	-26.6%	-24.7%	-24.2%	-21.7%	-15.0%	-12.1%

…and it is clear that US construction activity hasn’t fallen off a cliff just yet!

Further Reading

http://earningsview.blogspot.com/2011/01/fastenal-set-for-good-growth-but-what.html

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

FedEx Lowers Earnings Forecasts

FedEx lowers earnings forecasts and talks of a slower global economy

‘FedEx projects earnings to be $1.40 to $1.60 per diluted share in the second quarter and $6.25 to $6.75 per diluted share for fiscal 2012, compared to the company’s previous full year forecast of $6.35 to $6.85 per diluted share’

Interestingly they cite particular weakness in Asia

‘While FedEx Ground and FedEx Freight achieved improved operating results despite lower than expected growth, the more rapid decline in demand for FedEx Express services, particularly from Asia, outpaced our ability to reduce operating costs. We have slightly reduced our earnings forecast to reflect current business conditions and are aggressively working to adjust our cost structure to match demand levels.’

This is very disappointing, especially given their previously bullish outlook. Their previous outlook was featured in an Earnings View post linked here. This is undoubtedly a sign that global growth is slowing and the idea of a second half snapback in Global GDP growth is a myth.

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.

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.

Company	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.’
Fortinet	‘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.

Co	Stock Price	Q EPS Est	Q EPS Act	Next Q Guidance vs. Analyst Est	Current PE	Forward PE
F5 Networks	$101.5	91c	97c	97-99c vs. 98c	30.1x	28.7x
Riverbed	$32.3	21c	21c	21-22c vs. 23c	44.9x	36.3x
Fortinet	$21.3	8c	9c	9-10c vs. 9c	76x	59.2x

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.