04/21/13 ~ Online Business Reviews

While other healthcare companies including Covidien (NYSE:COV) and Abbott (NYSE:ABT) have seen fit to split their drug and device businesses, it's perhaps lucky for Johnson & Johnson (NYSE:JNJ) shareholders that their company has not gone the same route. While it wasn't really so long ago that JNJ's drug business was struggling, now it's the consumer and device business that need the pick-me-up. Even with the strength of the drug business and the wider healthcare sector, though, it's hard to see a lot of surplus value in the shares at these prices.

SEE: Healthcare Sector: Play Or Stay Away?

Very Respectable, But Uneven, Results In Q1
Johnson & Johnson logged a basically in-line revenue number for the first quarter, as sales grew nearly 10% on an “operational” basis, but a bit above 3% on an organic basis. Growth was led by the pharmaceutical business, which saw sales jump 11%. While JNJ certainly benefited from a Medicaid rebate reversal and some Stelara stocking orders, sales in general were quite good, with products like Zytiga selling quite well.

It's lucky for JNJ shareholders that the company's pharmaceutical graduating classes of 2011 and 2012 are doing so well. While the consumer business is picking up with product reintroductions and fading memories of the company's product recalls and quality control problems, growth here was still only about 3%. Devices, though, have become an ongoing source of disappointment – there was barely any organic growth at all this quarter, and nearly every business was weak.

JNJ's margin situation is a little shaky as well. Gross margin fell more than a point and missed expectations by a similar amount. Operating income improved 8%, though, and the company did spend less on SG&A and R&D than expected.

SEE: Zooming In On Net Operating Income

The Device Business Is Struggling
Johnson & Johnson still has plenty of work to do to get its device business back on a growth trajectory. Now it's certainly true that this is not completely the company's fault – procedure volumes haven't been great and hospitals and payers (insurance companies and national health agencies) are pushing back hard on price.

That said, the atrial fibrillation segment within cardio looks like about the only JNJ business growing at a double-digit clip, and I'm not sure if JNJ will hold that sort of growth indefinitely with Medtronic (NYSE:MDT) and St. Jude (NYSE:STJ) both hungry for growth as well). Surgery is not doing too well (general surgery down 5%, specialty up 1%), with competition from Covidien and perhaps Intuitive Surgical (Nasdaq:ISRG) and Stryker (NYSE:SYK) taking a bite.

Ortho, diagnostics, and diabetes are all also pretty weak. Diabetes was down about 10%, though Roche's (OTC:RHHBY) results indicate this is an industry-wide problem (largely due to reimbursement). Diagnostics is down about 5%, and the company's stated willingness to sell this business could be making matters worse. Last and not at all least, orthopedics (which is about one-third of the device business) is at best flat, though I'm not sure Zimmer (NYSE:ZMH) or Stryker are really making much headway either as this is another market with bruising reimbursement pressures.

Will Pharma Keep The Momentum Up?
On a longer-term basis, I don't see why the device business can't or won't recover. Core markets like surgery, orthopedics, cardiology and diabetes should all grow at rates at least in the low-mid single digits, with even more growth possible in emerging markets. The big question for JNJ is whether management has the discipline to continue reinvesting in R&D even while shareholders want ever-higher dividends and share buybacks.

SEE: Buying Into Corporate Research & Development (R&D)

In the meantime, shareholders will look for the drug business to keep the sales growth going. Major new drugs like Zytiga and Xarelto should deliver, but the jury is still out on whether the company's efforts in diabetes (Invokana was recently approved), hepatitis C, and neurology/psychology will pay off as expected. If competition (or reimbursement) prove more damaging than expected, there would definitely be some downside risk – risk that probably cannot be offset in the near term by the Consumer or Device businesses.

The Bottom Line
Johnson & Johnson has rarely been a favorite pick of mine in the healthcare space. I've liked companies like Sanofi (NYSE:SNY) and Roche (which I own) better in the drug space, and they've out-performed JNJ. Likewise, I think Stryker and Covidien are better picks in devices, even though JNJ has outperformed them in the stock market over the past year. Still, JNJ does offer a rare mix of pharmaceutical, OTC, and device exposure, and perhaps some turnaround upside within the device sector.

If JNJ can grow its free cash flow (FCF) at a long-term rate of nearly 7% (above the historical growth rate of about 5%), these shares seem worth about $87 today. That's not great potential relative to the current price, but there's a decent dividend and the prospect of higher estimates if management can continue the margin improvements and deliver a full turnaround in Consumer and Devices.

At the time of writing, Stephen D. Simpson owned shares of Roche.

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Dover May Be Bottoming, But The Street's Already Thinking Recovery

Posted on 2:41 AM by Unknown | No comments

Dover (NYSE:DOV) is one of those industrial conglomerates that is so diversified, it's not hard to feel a little sympathy for the analysts that cover the stock. From energy to smartphones to commercial refrigerators and gas pumps, covers the gamut of end-market exposures.

To that end, it doesn't say anything especially great about the economy that first quarter results were pretty weak, though the book-to-bill and management's optimism about a second-half recovery are encouraging. When it comes to the stock, however, it's a little hard for me to believe that the Street hasn't already skipped ahead a few pages and priced this stock for a recovery.

Q1 Sluggish, But Basically On Target
Although Dover had a soft first quarter, it was pretty much in line with expectations.
Revenue rose 4% as reported, but fell 1% on an organic basis. By segment, engineered solutions was the weakest with a 5% organic revenue decline, while communications was strongest with a 4% improvement. Energy came in flat with its organic revenue growth, while the printing & ID business was down 1%.

Even though Dover saw a 1% decline in volume and nearly always has one or more acquired businesses to integrate, gross margin declined only 10bp from the year-ago level and came in a little better than expected. Operating income was flat on a reported basis, while segment operating profits increased 1% (printing and energy were strong, communications and engineered solutions were weak) and came in almost in line with expectations.

SEE: Analyzing Operating Margins

Will Management See Its Big Turnaround?
Dover management is continuing to make the case that results will improve in the second half of 2013. Remember that while the news (and anticipation) cycle has already moved on to the future, what we're seeing reported here was the end result of pre-election spending/ordering worries coupled with adjustments made to cope with sequestration.
Management is looking for an improvement in drilling activity (Dover competes with companies like Baker Hughes (NYSE:BHI) and National Oilwell Varco (NYSE:NOV) for drilling-related products like drill bits and downhole equipment), and the Baker Hughes rig count has been getting better. The expected recovery in Europe may be a riskier bet, but other Dover-specific factors like easier comps in refrigeration and new products in consumer electronics and printing will also help.
On one hand, Dover did report a 1.09 book-to-bill for the first quarter, with results no worse than flat in the four major categories. On the other hand, major competitors like Danaher (NYSE:DHR) and Illinois Tool Works (NYSE: ITW) have been a little more cautious in their outlooks (though to be fair, both have a reputation for being conservative with their projections).

A Good Business, But Be Wary Of Outsized Expectations
There's a lot to like about Dover. The company runs over 30 independent companies under its umbrella, and has been pretty consistent with generating solid returns on invested capital. What's more, the company is no dilettante or dabbler – the Phoenix Hill company is a major name in commercial food service, Knowles is a dominant supplier of MEMS microphones, and Heil is a major name in garbage trucks.

SEE: Cash Cows Or Corporate Chaos?

What I don't like so much is the tenor of expectations. Analysts are pretty bold with their projections of ever-higher margins at Dover, even though management has already boosted margins from the very low double-digits in 2003-2005 to the mid-teens over the last two years. This isn't a Dover-specific problem, but rather a market problem and I think investors and analysts may be getting too bold in just assuming that margins can go higher and higher forever. So it's not that I think Dover is likely to do poorly, but rather I worry that investors are baking almost impossible-to-achieve expectations into today's valuations (not unlike what happened in the tech bubble over a decade ago).

The Bottom Line
While Dover has grown its revenue and free cash flow at rates of 7% and almost 8% over the past decade, I'm looking for about 5% and 6% growth over the next ten years. If Dover can achieve that, the stock's fair value today should be around $76. That's not too bad relative to a current price below $70, particularly when there aren't all that many bargains to be found these days.

I'd be cautious about buying Dover today, but really only because of my worries that the second half rebound may disappoint, that the market may be due for more correction, and/or that the “Peak Margin” hypothesis may have some validity. Outside of those macro worries, I like Dover just fine and I think it's a more than respectable industrial name to consider today.

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Mediocre Performance Clouding BB&T's Long-Term Value

Posted on 2:38 AM by Unknown | No comments

The management of BB&T (NYSE:BBT) once enjoyed a pretty sterling reputation for their performance, but a variety of missteps seem to be accumulating. Couple that with “industry standard” mediocre performance, and I can understand why BB&T shares have gone almost nowhere over the past year and are, in fact, one of the worst performers of the peer group. For investors willing to play the long game, though, I do believe that meaningful value remains in these shares at today's price.

SEE: Equity Valuation In Good Times And Bad

Sluggish First Quarter Results
BB&T reported operating revenue growth of 4% for the first quarter, with revenue down 5% on a sequential basis. Net interest income was weak, falling 1% and 4% respectively, but not all that different than what U.S. Bancorp (NYSE:USB) and Wells Fargo (NYSE:WFC) reported earlier. BB&T did see comparatively low earning asset growth, while the net interest margin erosion (down 17bp from last year) wasn't too bad and the company's absolute NIM still compares favorably at 3.76%.

Fee income rose 11% and fell 7% (on an adjusted basis), as the company's mortgage banking revenue was even weaker than expected. Service charge income was also soft, while insurance was better than expected with 1% sequential growth.

Given the performance of U.S. Bancorp and PNC Financial (NYSE:PNC) in cutting costs this quarter, I was a little disappointing with BB&T's on-target performance (down 3% sequentially). All the same pre-provision net revenue did fall 8% (adjusted), the worst in the peer growth that have reported so far.

SEE: Analyzing A Bank’s Financial Statements

Loans – No Growth Today, But Growth Tomorrow?
BB&T's lending activity was pretty sluggish this quarter, as has been the case for most banks. Lending was pretty much flat with the fourth quarter on an end-of-period basis, with weakness in commercial and residential mortgage lending. On a more positive note, management did say that March was the best month in company history of loan originations, and they were more optimistic about lending growth through the balance of the year.

It's also worth mentioning that BB&T reported somewhat mixed credit metrics. The company's non-performing asset and net charge-off ratios are good, and continuing to improve, but the company's loan loss provision expense was not as good as we've seen from many other banks this quarter.

Do A Series Of Small Matters Add Up?
One of my concerns about BB&T is whether the company loses what has generally been a very strong reputation on the Street as a well-run bank. Over the last year or so there have been a string of slip-ups that were not all that problematic on an individual basis, and perhaps not fully in management's control, but nevertheless may be adding up in terms of sentiment.

The bank had to redo its merger with BankAtlantic because of how the company initially wanted to treat BankAtlantic's trust preferred shareholders. Then the company failed its recent CCAR evaluation despite having some of the strongest capital ratios in the group. Then there are other matters like the company's tax squabble with the IRS (the source of a large reported EPS adjustment this quarter). I could go on, but the point is that this is a stock where shareholders would certainly like to hear (and arguably need) a string of positive announcements as a change of pace.

SEE: Why Consumer Confidence Matters

The Bottom Line
I remain quite positive on BB&T shares, though I have to acknowledge that my view of the company's long-run profitability (as measured by return on equity) is more bullish than most sell-side analysts. I'm looking for a long-term ROE of 12%, and that supports a fair value of about $39 today. Go with a more Street consensus number of 10% and the target drops to about $32 – which, I'll note, is still above today's level.

With strong capital, good deposit share, and a management that seems to successfully manage “prudent aggression”, I think BB&T is a good bank stock to hold for the long term. I fully expect M&A to figure significantly in the company's future, and I do believe that it will work out its CCAR issues. I also believe, though, that the bank is facing more competition than ever before, with banks like Wells Fargo, PNC, and Fifth Third (Nasdaq:FITB) all directly targeting its core Southeast operating area. While I believe the stock's positives outweigh those challenges, investors shouldn't be fooled into thinking this is a “money for nothing” type of opportunity.

At the time of writing, Stephen D. Simpson owned shares of BB&T.

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Intel – A Bond's Downside And A Stock's Upside?

Posted on 2:35 AM by Unknown | No comments

Intel (Nasdaq:INTC) still has a long road ahead of it to regain the love of tech investors who believe that the core PC market is in permanent decline and that rivals like Qualcomm (Nasdaq:QCOM) and ARM Holdings (Nasdaq:ARMH) are still too far ahead in the expanding mobile market.

The concerns about Intel – revenue growth potential, cost structure, capital spending needs – are valid, but should also be viewed in context. Even though Intel is currently converting revenue to free cash flow (FCF) at a historically poor rate, it's generating more than enough to pay its dividend and fund ongoing buybacks. I wonder, then, if investors should approach Intel from the viewpoint that the downside scenario sees Intel grinding along with a bond-like total return, but with the potential upside of a more equity-like return if the company's efforts in mobile and foundry pay off.

First Quarter Results Only Decent On A Relative Basis
I sometimes wonder if investors get so obsessed with a company's performance vis a vis sell-side analysts that they sometimes forget to step back and look at results on their own merits. To that end, while Intel did meet the sell-side targets for top and bottom-line performance, the results really weren't what I'd call good.

Revenue fell almost 3% from the year-ago level and nearly 7% from the fourth quarter. Performance was pretty much evenly bad across the board, as all the major units had mid-to-high single-digit revenue declines on a sequential basis. That said, relative to the overall PC market, Intel's PC chip business did appear to outperform.

Margins were not particularly good. Gross margin fell almost eight points from the year-ago level and two points from the prior quarter, as inventory write-offs and lower utilization hurt. Operating income fell by nearly one-third, and the nearly 10-point drop in operating margin (three and a half points, sequentially) was one point steeper than expected. While Intel only missed its average EPS estimate by one cent, that was due to a lower-than-expected tax rate.

SEE: How To Decode A Company’s Earnings Reports

Plenty Of Challenges Left In Mobile
Clearly the biggest talking point on Intel remains its ability (or inability) to transition from dominating the PC chip space to becoming a major player in the mobile market. Some argue that it's just a matter of time, that Intel was slow to recognize the transition, but that the company's R&D and manufacturing capabilities will eventually close the gap with the likes of Qualcomm, Broadcom (Nasdaq:BRCM), and ARM's licensed technology.

Maybe that's true. Certainly Intel has a manufacturing advantage that its most direct mobile rivals (other than Samsung) do not. But I wouldn't underestimate the challenges. Intel has been flummoxed in trying to match ARM's power efficiency, though recent Intel chips have been better. I also wouldn't underestimate the reticence that some mobile players may have about letting Intel back into the game – everybody saw how Intel and Microsoft (Nasdaq:MSFT) dominated the PC market, and I don't think Samsung, Apple (Nasdaq:AAPL), LG, and the others want a replay (though you could argue ARM's design market share is just old wine in a new bottle).

Adapt Or Die
Barring a major leap forward that puts Qualcomm and/or ARM on its heels, Intel has to accept that the road forward is quite a bit different than the one that brought it here. As chip companies go, Intel hasn't been all that great recently at generating cash flow, and I'm not sure the Street is sold on the company's foundry aspirations (though I view it more as a means of subsidizing the cost of staying on the bleeding edge of manufacturing capabilities). At a minimum, investors should expect a steady drumbeat of criticism and heckling regarding the company's cost structure unless/until the mobile market share improves.

SEE: A Primer On Investing In The Tech Industry

The Bottom Line
Intel is in a tricky spot from a valuation perspective. Free cash flow margin is quite low now, and if the company cannot improve it beyond the mid-teens it's hard to argue that the stock is really exciting from a capital gains perspective. Even an eventual return back to the 10-year average free cash flow margin of 20% only suggests a fair value in the neighborhood of $25 unless the company can reignite revenue growth.

Here's how I view Intel today – it's a hybrid bond with stock-like upside. If Intel “is what it is”, I think the company will continue to generate significant cash flow and pay a hefty dividend. To me, that suggests a bond-like downside. If, however, the company can reignite growth through a stronger push into mobile (and/or more success in the data center), that bond-like floor will also see a meaningful capital appreciation kicker that should result in appealing total returns.

At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

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Is Pepsi's Turnaround For Real?

Posted on 2:32 AM by Unknown | No comments

Pepsico (NYSE:PEP) announced first quarter earnings April 18. Better than expected, its stock jumped more than 3% on the news. The soda pop and snack food conglomerate is in the midst of a revitalization that's getting a lot of attention from investors. With its stock up 20% year-to-date, I question whether its good performance will continue. Read on and I'll look at the pros and cons of Pepsi's latest results.

Earnings - The Good
Pepsico originally set a goal of $1.5 billion in annual productivity savings between 2012 and 2014. By the end of 2012 it had taken enough positive steps to double its goal to $3 billion by 2015. As a result of these productivity savings, its Q1 core constant currency operating profit increased 9% year-over-year with its core operating margin up 80 basis points to 14.3%. It's definitely a big positive.

SEE: Parched For Profit? Try Beverage Stocks

In terms of volume, snacks have been the big winner with 4% organic growth in the quarter versus a 1% increase for beverages. Its PepsiCo Americas Foods (PAF) business unit, its biggest, grew organic revenue by 6% in the quarter led by a 14% increase in its Latin America Foods segment. PepsiCo Americas Beverages (PAB) unit generated organic revenue that was flat. Its Europe and AMEA (Africa, Middle East, and Asia) business units, which combine snacks and beverages, both had healthy growth with 4% and 15% organic revenue growth, respectively.

Until PepsiCo makes further inroads outside the Western Hemisphere, its two business units in the Americas (PAF&PAB) are the key to its success. In the first quarter their revenues were 76% of its overall global business and 87% of operating profit. Its two biggest units combined achieved revenue growth in the quarter increase of 2.4% to $9.54 billion with a 4.6% increase in operating profits. Meanwhile, Coca-Cola's (NYSE:KO) first quarter revenue in the Western Hemisphere (Latin and North America) grew by 1.6% on a constant currency basis to $6.2 billion with operating income (constant currency) basically flat at $1.25 billion. On a comparable basis, PepsiCo's business in the Western Hemisphere grew more than Coke's both in terms of revenue and operating profit. However, Coke's operating margin was better at 20.2%, 590 basis points higher than PepsiCo.

SEE: 3 Great Business Battles

While some of the cost savings will be reinvested in its business, the remainder will likely go towards additional share repurchases. In its 2013 outlook Pepsico projected it will make $3 billion in share repurchases this year, slightly less than in 2012. In addition, it will pay out $3.4 billion in dividends returning a total of $6.4 billion to shareholders. Its capital allocation is definitely tilted toward rewarding investors.

Earnings - The Bad
Because its Americas business is such a huge piece of its overall revenue, it would be nice if it delivered significantly higher operating margins. Trailing Coke by almost 30%, it's leaving a lot of money on the table. Shareholders better hope its $3 billion in cost cuts are permanent because if they're not, Coke's stock is going to continue outperforming PepsiCo's.

Wells Fargo analyst Bonnie Herzog pointed out April 18 that the PepsiCo Americas Beverage unit saw volume shrink by 3% in the first quarter. Only price increases helped limit the damage. Herzog stated, "A 1% global volume growth in beverages reflects continued underperformance versus Coca-Cola." At the end of the day, Coke's global volume in beverages was four times higher than PepsiCo's. Worse still, Coca-Cola Americas' volume growth was 200% higher at 3%. PepsiCo Americas Beverages really brought down its Western Hemisphere numbers.

Lastly, and this has little to do with PepsiCo's financial performance in the quarter, is its valuation. Virtually anyone writing about PepsiCo agrees its stock is very frothy at 17 times its 2014 earnings. Considering its operating margins are much lower than Coca-Cola, Dr. Pepper Snapple (NYSE:DPS) and Monster Beverage (Nasdaq:MNST), its stock price is probably about 15% too high.

SEE: Equity Valuation In Good Times And Bad

Verdict
In my opinion, Pepsico never seems to know whether it's a beverage or snack food company. In recent years the idea of a split has come into play because several other key players have done precisely that; the most notable being Kraft, which split into two last October. With the beverage business growing in emerging markets, I think it makes a good deal of sense to split the businesses.

If PepsiCo were to split the two businesses I could see the current valuation. But since that's unlikely to happen, I'd wait to buy in the high 60s.

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Joh. A Benckiser Looks To Corner The Coffee Market

Posted on 2:30 AM by Unknown | No comments

D.E. Master Blenders 1753 (OTC:DEMBF), the former Sara Lee spinoff is going private after less than a year. Joh. A Benckiser Sarl (JAB) is paying a huge price for the European coffee maker. What does this mean for the rest of the world's coffee manufacturers? Is Green Mountain next? I'll have a look at some of the ways investors can make money from Benckiser's move to corner the coffee market.

Bart Becht
That name probably doesn't ring a bell, but it will soon enough. Becht was CEO of Reckitt Benckiser (OTC:RBGLY) for 12 years until the well regarded (and well paid!) executive surprised the European business community by stepping down from the top job in September 2011. Tired of being the full-time CEO of a public company, Becht instead decided he wanted to spend more time investing in private companies. However, the speculation is Reckitt-Benckiser's board wouldn't support his desire to purchase Colgate-Palmolive (NYSE:CL) so Becht took his ball and went home, and now he's back.

Coffee Consolidation
Well, he actually returned to the spotlight in January 2012, joining JAB, the holding company for Germany's Reiman family, as Chairman and an 8% partner. JAB's main holdings prior to its coffee buying spree were a 10.5% investment in Reckitt Benckiser (French's mustard), 80% of Coty Inc. (Chloe, Sally Hansen) and 100% of Labelux Group (Jimmy Choo, Bally). Owning some serious brands, it could have carried on as is and no one could blame them. Instead, Becht went to work buying up the coffee world.

JAB's first coffee acquisition was a 12.2% stake in D.E. Master Blenders 1753, which it picked up in July 2012. The next investment was Peet's Coffee, which it acquired for $1 billion on October 26, 2012. In January it completed the $340 million purchase of the Caribou Coffee Company. In less than a year Becht had made three moves that had JAB seriously into the beans. Who knew that its biggest move was yet to come?

On April 12 JAB announced that it was acquiring D.E. Master Blenders 1753 for approximately $10 billion including $3.9 billion in debt. Becht made it abundantly obvious that this was only the beginning stating: "DEMB has fantastic brands in Western Europe, Brazil and Australia, but that's clearly not the world … We have a lot of the world to conquer, and clearly acquisitions will be part of that strategy." However, Becht did say that they wouldn't be combining the retail store business (Caribou, Peet's) with the coffee roaster business so my guess is its next acquisition will be a coffee roaster located in the U.S. or Canada.

SEE: Key Players In Mergers And Acquisitions

How To Play This?
JAB is a private company so there isn't a direct way to benefit from Becht's orchestrations. The next possibility is to consider a pure-play coffee roaster that's publicly traded: Green Mountain Coffee Roasters (Nasdaq:GMCR) is the only real option and it would likely fetch an enterprise value of 15 times EBITDA, approximately the same as JAB is paying for D.E. Master Blenders 1753. That would put the price tag at about $12 billion including debt. Given the amount of equity it's putting into the D.E. Master Blenders deal, it's possible that it could pull it off. But I wouldn't bet on it happening in the next six months. JAB first has to digest its current deal.

A good alternative would be to buy the First Trust Consumer Staples AlphaDEX Fund (ARCA:FXG), an ETF with 38 holdings including Green Mountain Coffee Roasters at a weighting of 4.73%. In addition to Green Mountain it holds 3.77% of its portfolio in Mondelez International (Nasdaq:MDLZ), the makers of Maxwell House, the second largest coffee roaster in the world with 11% market share behind only Nestle. If Becht buys either of these you win and if he doesn't, you get a diversified portfolio of consumer staples stocks.

SEE: Analyzing An Acquisition Announcement

Bottom Line
Call it a hunch but I think Becht's next target could be Mother Parkers, a Toronto-based company and the fourth largest coffee roaster in North America. Its annual revenues are approximately $600 million and while small in comparison to D.E. Master Blenders 1753's $4 billion, they've been making a lot of noise recently with its RealCup single-serving capsules. Available on Amazon.com and in most grocery store chains in the U.S., it's the perfect under-the-radar acquisition.

There's only one problem--it's privately held.

At the time of writing, Will Ashworth did not own shares in any of the companies mentioned in this article.

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Investors Seem To Be Overrating Bank Of America

Posted on 2:27 AM by Unknown | No comments

Few large bank stocks have come close to the market performance of Bank of America (NYSE:BAC) over the past year. While some of that appreciation may have been due to investors accepting that BoA is still a going concern in banking, the reality is that the bank still has a lot of work left to do, and the current banking environment is not exactly hospitable. With legal risks still pretty high and near-term growth opportunities looking more modest, Bank of America seems pretty fairly valued today.

SEE: Equity Valuation In Good Times And Bad

Good And Bad News In Q1
Bank of America did miss expectations for the first quarter, and the company did come in short of its expense reduction targets. Even so, it wasn't a terrible quarter for this still-troubled bank.

Net interest income performance was actually better than expected (down 2% annually and up 3% sequentially), as the bank posted a small increase in average earning assets. Net interest margin did decline 14bp on a market-adjusted basis (while increasingly slightly on a sequential basis), but the adjusted figure of 2.4% is still quite low relative to other large banks like Citigroup (NYSE:C), Wells Fargo (NYSE:WFC), and U.S. Bancorp (NYSE:USB) (though the sizable capital markets business at Bank of America makes the latter two comps a bit unfair).

Fee income was not as strong, though. While non-interest income did increase 24% from the fourth quarter, the bank missed on investment banking/trading revenue. Other line items like cards, service charges, and mortgage banking were down sequentially, but more in line with analyst expectations.

Bank of America also missed on expenses, as core expenses increased about 4% on a sequential basis. Coupled with weak trading revenue, this lead to a roughly five-cent miss at the bank equivalent to an operating income line.

SEE: Analyzing A Bank’s Financial Statements

Mixed Trends In Business And Share
Bank of America did report a pretty gaudy figure for mortgage originations, with growth of 57% relative to last year and 11% compared to the fourth quarter. Keep in mind, though, that Bank of America's share of the mortgage business has cratered since the crisis, with rivals like U.S. Bancorp picking up the slack.

What's more, overall loan growth was all but non-existent on a sequential end-of-quarter basis. Even with the jump in mortgage originations, consumer lending was weak overall, while commercial lending was a bit stronger than we've seen from banks like Comerica (NYSE:CMA) and U.S. Bancorp (and more or less in line with Wells Fargo).

Curiously, Bank of America is one of the few banks so far that has reported a sequential decline in deposits. While banks are not exactly clamoring for new deposits (why bother when loan demand and securities yields are both so poor?), that's unusual so far in this reporting season. I'm inclined to believe this has more to do with letting go of expensive deposits than real share loss, and I believe Bank of America is still the largest bank in the U.S. by deposit share (in the neighborhood of 12%).

SEE: The Industry Handbook: The Banking Industry

I do wonder, though, what the future holds. Bank of America's CEO has been pretty aggressive in projecting significant cost reductions across the business, and I wonder how that will square with the bank's huge branch footprint. While trying to encourage customers to adopt cost-saving moves like paperless statements and technology-assisted deposits will help, there is the risk of losing deposits to smaller banks that can maintain familiar service levels. It's also worth asking how Bank of America will combat increasing competition in the card space and non-mortgage lending spaces, as almost every major peer (Wells Fargo, Citi, U.S. Bancorp, etc. is talking about bulking up these businesses).

The Bottom Line
With this quarter's results in hand, I feel a bit more confident about the bank's core banking operations, but a bit less confident about the always-volatile investment banking/trading businesses. Moreover, I think this quarter highlights that the march towards a more cost-efficient bank is not going to be a steady one.

I still don't see a tremendous amount of value in these shares. I admit that my long-term target return on equity of 8% could prove low if management can hit all of its targets, but I'd also point out that my 8% target is higher than a large percentage of the sell-side targets. In any case, I think U.S. Bancorp and Wells Fargo offer more upside from today's levels than Bank of America. I do agree that there's still a “getting back to business as usual” trade with Bank of America, but I think the process will be longer and more challenging than bulls believe, and I think the easy money is likely in hand with most of the market's problem-child banks.

At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

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Does A Tough Patch Really Matter To McDonald's Shareholders?

Posted on 2:25 AM by Unknown | No comments

Excellent earnings consistency and a long history of dividend payments will buy a lot of patience and support from investors. Consequently, I find it hard to imagine that even this disappointing patch of weak same-store sales will really dent McDonald's (NYSE:MCD) all that much. Though I'm not very fond of the multiples being paid for consumer stocks these days and won't be looking to add McDonald's to my own portfolio, I don't expect a mass exodus from these shares unless the market as a whole takes a tumble.

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Q1 Results Thin On Growth
Sell-side analysts weren't expecting great things from from McDonald's this quarter, but the company's performance was soft all the same. Revenue rose just 1%, as revenue from company-owned stores was flat and revenue from franchised stores increased 2%. Relative to what we've heard from Yum! Brands (NYSE:YUM) recently, it wasn't so surprising that McDonald's saw weakness across the globe – revenue from the U.S. was down 1%, while Europe and the APMEA region were up 2%.

With such a large footprint of stores, comp-store growth pretty much guides McDonald's performance. To that end, a 1% decline in comps was disappointing, as both the U.S. and Europe saw a small decline, and results for the month of March were weak.

McDonald's is also struggling to generate margin leverage in this environment. Reported operating income was flat with the year-ago level, and the company reported more than one point of company-operated store operating margin erosion largely due to higher payroll and occupancy costs.

SEE: Understanding The Income Statement

Ongoing Innovation Should Keep Traffic Flowing
McDonald's is unusual in the quick service restaurant (QSR) space for its pace of menu innovation. McDonald's is always working on something new and the company is quick to yank products that aren't earning their keep. To that end, the company is looking to launch new breakfast products and support an expanded line of wrap products – a group of food offerings that some McDonald's executives have reportedly referred to as “Subway-busters”.

Of course, success in the QSR space isn't just about innovative and exclusive products. If it were, Sonic (Nasdaq:SONC) should do better than it does. While it probably won't be long before Burger King (NYSE:BKW) tries to match McDonald's with follow-on products, McDonald's continues to look for ways to keep costs down and margins up, and the ability to offer such a strong value menu without compromising margins has proven to be a powerful factor in the company's significant market share growth in recent years.

Is Service A Real Problem?
McDonald's investors have likely noticed more media attention recently on declining customer satisfaction with service levels at McDonald's. While I'd be sorely tempted to remind the complainers that you get what you pay for and that expectations should be different between QSRs like McDonald's and hybrid concepts like Panera (Nasdaq:PNRA) and Chipotle (NYSE:CMG), management is taking the issue seriously.

While skeptics (like me) will argue that there's only so much service you can expect for the wages McDonald's pays, the reality is that the unemployment situation in the U.S. probably means that McDonald's could find motivated new employees if they need to go that route. That said, it's worth following this story in the coming quarters, as it's not often that low prices and high services travel together.

SEE: 5 Must-Have Metrics For Value Investors

The Bottom Line
As I said in the intro, I don't see all that much value in McDonald's today and I do worry that investors may be too complacent if they expect McDonald's to match the volume and margin improvements that the company has managed over the last five years into the next five years. While there is long-term potential for market penetration and better margins in the international operations, I want to emphasize the “long-term” part of that statement – restaurants like McDonald's, YUM's KFC, and Subway are relative luxuries in many parts of the world, and it will take years for that to change.

Given McDonald's below-market risk (in terms of earnings volatility, at least), there's no particular reason that the stock should be priced for market-matching performance. That said, I do worry that investors have piled into consumer stocks a little too heavily, and I think McDonald's at today's prices isn't all that compelling unless you're content with mid-single digit returns.

At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.

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Is Controversy About Robot-Assisted Surgery Showing In Intuitive Surgical's Numbers?

Posted on 2:23 AM by Unknown | No comments

There has always been controversy around Intuitive Surgical (Nasdaq:ISRG) and its daVinci robotic surgical system. In recent months this controversy has reignited over allegations that device malfunctions/adverse events are increasing and that the system is little more than an expensive, unnecessary toy in procedures like minimally invasive hysterectomy. Making matters worse, this has long been an expensive stock where success has been predicated on double-digit growth in minimally invasive surgery and Intuitive's share in the market.

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First Quarter Results Strong, But Not Where They Count Most
Intuitive Surgical's first quarter is a pretty good example of why or how simply looking at a company's income statement and comparing it to First Call estimates may not give an investor the full picture of what's going on. While Intuitive's financials were quite strong, there were non-financial data points that were more troubling.

Revenue rose more than 23% this quarter, as system sales increased 24% on a 17% increase in units sold and an increase in per-robot selling prices. Instrument and accessory revenue rose almost 26% on a nearly 20% adjusted increase in procedures and a 6% higher average selling price. Service revenue was the only weak area, but I'd use the word “weak” advisedly given the 17% increase in revenue.

Intuitive continues to run a very profitable business. Gross margin did decline nearly one point on an annual and sequential comparison, but this was largely as expected. Operating income increased 30%, though, and came in well ahead of expectation due to both higher-than-expected revenue and lower-than-expected SG&A spending.

SEE: Understanding The Income Statement

Procedure Volumes On A Roller Coaster
The key driver for investor sentiment in Intuitive (and fellow, but different, robot player MAKO Surgical (Nasdaq:MAKO)) is procedure volume. While the reported 18% growth in procedures (and 20% on an adjusted basis) looks good, it was lower than most analysts and investors were expecting and investors won't like the acknowledgment from Intuitive management that the controversy about robot-assisted hysterectomy (“dvH”) seems to be impacting procedure growth.

On a positive note, procedure volume increased 18% despite an 11% decline in U.S. prostatectomy procedures (“dvP”) as the company continues to absorb the impact of a change in treatment protocols. What's more, international procedure volume increased 14% even despite the much-discussed reimbursement pressures that are hitting multiple overseas markets.

From where I sit, I think Intuitive investors need to accept a certain degree of “predictable unpredictability” when it comes to quarter to quarter procedure volume numbers. While I do think there is some competitive risk that single-port surgical tools from Johnson & Johnson (NYSE:JNJ), Covidien (NYSE:COV), and Stryker (NYSE:SYK) could capture some share (particularly since they're about 30% cheaper), most of Intuitive's volume is in procedures that the large majority of users believe cannot be performed without the robot.

I also think investors will see a repeat of the dvP and dvH controversies over and over again. Intuitive is still early in its launch of tools targeting gall bladder removal (a large market), but I suspect there will eventually be papers out decrying the expense of daVinci-assisted cholecystectomy and the similar of results with other minimally invasive procedures – just as we've seen in dvP and dvP procedures. Ultimately, though, I do believe that there is a legitimate use for this device in helping surgeons perform procedures on a minimally invasive basis that would otherwise be too difficult or dangerous, and that benefit is worth a premium price (though perhaps not as much of a premium as Intuitive currently charges).

The Bottom Line
The controversy and worry over Intuitive has put the stock in an unusual place – it actually looks cheap for once relative to my expectations. To be sure, my growth rates are aggressive as I am looking for long-term revenue growth of 12% and free cash flow growth of 13% to 14%. That sort of growth would appear to be worth about $550 per share, and it's worth noting that it was only a short time ago that the market was discounting a much higher (and likely too aggressive) rate of growth.

SEE: 5 Must-Have Metrics For Value Investors

It is probably unfair to say that the daVinci system is a two-trick pony, but the reality is that the company has really concentrated on building the business around dvP and dvH thus far. That leaves a pretty promising runway of growth if and when management can develop the devices and support the training efforts to push adoption in the numerous other procedures where the robot could be useful. That said, investors need to appreciate what they're getting into – Intuitive Surgical looks undervalued today and appears to have a strong future ahead of it, but quarterly volatility in procedure growth and never-ending controversy about the utility (and cost-benefit) of the system will keep these shares swinging within a wider-than-normal range.

At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.

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Three Ways To Short Gold

Posted on 2:20 AM by Unknown | No comments

Gold’s recent sell-off has been nothing less than spectacular. Over the last week or so, prices for the precious metal have plunged nearly 12%, and touched lows not seen in the last two years. This certainly has stung many gold-bug portfolios, and it definitely came as a surprise. Since 2001, gold prices have surged more than 600% as sovereign bond risk and rock-bottom interest rates have taken hold.

However, the recent improving financial landscape and macroeconomic picture over the next few years seems to have taken the wind out of gold’s sails. Given the improving environment and investors preference for stocks, the golden play over the next few months could actually be to short the precious metal.

SEE: What Is Wrong With Gold?

Lowered Price Targets
Gold prices’ bull-run lasted about a decade -from 2001 to 2011- when prices hit a peak of $1,900 per ounce. Since reaching that historic mark, however, gold has fallen about 22%, and there is no sign of an end to the carnage.

Much of gold’s appeal stemmed from all the global macroeconomic problems facing the world. After all, the precious metal is seen as a "port in a storm" and all the debt, austerity and slowing developed market growth can certainly be seen as an approaching hurricane. So it's no wonder why investors have embraced gold and funds like the SPDR Gold Shares (ARCA:GLD), stocks of mining companies and even gold coins have crept into a variety of retail investors' portfolios.

However, it seems like a lot of those negatives haven’t come to fruition.

Recent bullish employment numbers, rising consumer confidence and lower inflationary pressures have all been gold's undoing. Additionally, the strength in the U.S. dollar and treasury bonds as the "best house in the bad neighborhood" have caused gold to see price declines. Since reaching its peak per ounce price, the U.S. dollar index (USDX) has appreciated almost 50% against gold over the past 2 years. Even Europe’s recent debt woes and the issues in Cyprus barely budged gold prices.

Then there is the coming end to the Federal Reserve’s quantitative easing programs. The Fed has basically telegraphed that it plans to slowdown the pace of its $85 billion worth of scheduled asset purchases in the second half of the year. Some analysts have even speculated that the Fed will end the program early. This, plus weak gold demand from nations like India and China, along with increasing appetite for equities over commodities has many now believing that gold’s record bull market has finally ended.

As such, a variety of investment banks have reduced their forecasts for gold prices over the next few years. Goldman Sachs (NYSE:GS) reduced its target to just $1270 per ounce by the end of 2014, while Societe Generale expects it to average $1500. There has even been some class from analysts that gold will break a thousand dollars and settle at $800 per ounce.

SEE: What Drives The Price Of Gold?

Time To Go Short
Given the headwinds facing gold, investors may want to short the precious metal. Shares of the two biggest funds in the sector- The SPDR Gold and iShares Gold Trust (ARCA:IAU) –are available to borrow. However, an easier way could be by using one of the dedicated short gold exchange traded funds (ETFs) now available.

The biggest of which is the ProShares Ultra Short Gold (ARCA:GLL). The ETF is designed to deliver twice the daily inverse return of gold bullion prices. With more than $100 million in assets and with nearly a 330,000 shares trading hands daily, the fund is the most popular choice of investors looking to short gold. So far it’s up about 26% this year as gold has fallen.

For those investors not wanting the leverage that comes with GLL, the PowerShares DB Gold Short ETN (ARCA:DGZ) can provide the same effects. However, the gains- and potential losses- will be muted.

With production costs rising, the miners of the precious metal have been forced to deal with shrinking profit margins. That fact has been exacerbated by the falling gold price. As such shares of gold producers like Barrick (NYSE:ABX) and Newmont (NYSE:NEM) have imploded over the last few weeks. To that end, shorting the various mining stocks could also make sense. The Direxion Daily Gold Miners Bear 3X Shares (ARCA:DUST) provides a leveraged way to short the popular Market Vectors Gold Miners ETF (ARCA:GDX). Like GLL, DUST has surged as the price of gold has dwindled.

SEE: The Midas Touch For Gold Investors

Bottom Line
With the improving global macroeconomic picture taking some of the luster away from gold, investor enthusiasm for the precious metal has been falling by the wayside. For portfolios, that could mean it's time to get short the metal. The previous ETFs along with the VelocityShares 3x Inverse Gold (ARCA:DGLD) make it easy for investors to do just that.

At the time of writing, Aaron Levitt did not own shares in any of the companies or funds mentioned in this article.

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Weak PC Growth And Slow Mobile Penetration Weighing On Microsoft

Posted on 2:18 AM by Unknown | No comments

It really is too bad that the conversation on Microsoft (Nasdaq:MSFT) always seems to be dominated by what the company isn't. Bearish analysts and investors hammer the company for its heavy reliance on PCs and fault the company for letting Apple (Nasdaq:AAPL) and Google (Nasdaq:GOOG) build such a large lead in mobile operating systems, while also complaining about the company's relatively weak online business and below-average entertainment profitability.

Those are legitimate criticisms, but only to a point. It is not as though smartphones and tablets have replaced PCs in the office environment, nor are they likely to anytime soon. What's more, Microsoft has a bigger (and faster-growing) presence in enterprise software than is usually appreciated. Last- and by no means least, Microsoft remains an exceptionally profitable company that generates exceptionally large amounts of cash every year.

SEE: Microsoft Vs. Apple

Fiscal Third Quarter Pretty Good Relative To The Market
Given the steady drumbeat of negative news on enterprise and consumer IT spending, I think Microsoft had a pretty solid quarter.

Revenue was slightly below expectation, but up 18% over last year and up about 11% on an adjusted basis. Windows revenue rose 23% as reported, though performance was closer to “flat” after excluding recognized deferrals and down about 9% after excluding Surface revenue. Servers and Tools was up 10%, though, and while that number is below the consensus guess (by about 2%) it was still quite a bit better than the performance at IBM (NYSE:IBM) and Oracle (Nasdaq:ORCL) this quarter.

Microsoft also disappointed a bit with Business revenue, with revenue growth of 9%. Online revenue was up 18%, though, on 22% ad revenue growth and share growth for Bing. Last and not least, Entertainment and Device revenue jumped 57% on very strong Xbox 360 platform growth.

Where Microsoft really delivered this quarter was on its expense control and profit margins. Gross margin did fall about 70bp from last year, but came in more than a point higher than analysts projected. Likewise, operating income rose 19% as reported, with operating margin up 60bp and almost two points better than the average sell-side target.

SEE: A Look At Corporate Profit Margins

Can Microsoft Change The Tone On Win8 And Mobile?
Windows 8 has been on the market for a little while now, and the reviews have not been very good. While there are certainly some fans of the new operating system, most reviews (particularly those not using touch-enabled systems) have been harshly critical. In fact, while it looks like the underlying performance of Windows revenue was better than the reported decline in first quarter PC shipments (down about 14%), more than a few commentators have blamed Windows 8 for the poor pace of PC sales.

On the mobile front, Microsoft continues to make slow progress at best. Nokia (NYSE:NOK) is doing a little better with the Windows-powered Lumia smartphones, but there is nothing in the numbers to suggest that Apple, Google, or Samsung have much to worry about.

Neither of these developments are good for sentiment on the stock, but I'm not sure they're serious long-term problems. Microsoft is preparing an update to Windows (codenamed “Blue”) that would seem to address at least some of the major Win8 complaints, and that should be out later this year. On the mobile front, Microsoft has more than enough time (and cash) to play a long-term game, and I wouldn't rule the company out at this point.

SEE: Microsoft: By The Numbers

The Bottom Line
Even though Microsoft's revenue growth has bounced back into the double digits, nobody expects this to continue – most analysts are calling for mid/high-mid single-digit revenue growth at best for Microsoft over the next few years. Coupled with worries about the demise of the PC and poor strategic/competitive positioning in mobile, Microsoft's improved margins and strong cash flow just don't resonate with what most tech investors want in a stock.

Consequently, I see Microsoft as a value stock, but one that does carry risk of being a value trap. Microsoft has a huge amount of cash, but barring a major increase in the dividend there will always be the nagging question of whether management can/will reinvest it successfully. On a more positive note, even meager free cash flow (FCF) growth in the neighborhood of 1% to 2% is enough to merit a fair value well above $40. For investors with the patience to play the long game, I think Microsoft offers pretty limited downside and at least a fighting chance for respectable long-term performance.

At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

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Stick With “Bond-Like Stocks”

Posted on 2:16 AM by Unknown | No comments

With the recent rout in various commodities and global growth concerns now creeping back into the headlines, investors are understandably getting nervous. After all, it was only a few years ago that the Great Recession took hold. With that in mind, U.S. Treasuries have once again become the asset class du jour as investors flocked to funds like the iShares Barclays 7-10 Year Treasury ETF (NYSE:IEF).

However, with yields on fixed income investments such as bonds, CD's and money market funds painfully low, they offer now real solace to investors looking for any sort of return. Luckily, investment bank Barclays (NYSE:BCS) has some other advice for investors to weather any approaching storm- dividend stocks.

Dividends, Dividends, Dividends
According to a new research note from the British bank, stocks that pay steady and rising dividends are the place to be as worries about the health of the global economy begin to take hold. Barclay’s notes that “stocks in the sweet spot of monetary policy- high quality, high dividend yield, low volatility- are supporting the broader market.” A group of four sectors- including healthcare, utilities, energy and financials- are each outperforming the S&P 500 by a wide margin month over month. The bulk of that outperformance has come from the group’s dividend payments.

SEE: Why Dividends Matter

There’s certainly a method to Barclay’s madness.

Dividends can help smooth out returns as these payments can help cushion the downside in falling markets. Reinvesting those payments can help enhance returns when the market rights itself. According to data compiled by Ned Davis Research, over the last 36 years, dividend stocks have outperformed the rest of the S&P 500 by 2.5% annually. More importantly, they outperformed non-payers by nearly 8% each year.

Blue chip stocks with strong corporate balance sheets and cash flow are already paying much more than treasuries. Yet, companies with a history of raising payouts are especially warranted. Unlike a bond which pays a fixed rate, with stocks you could potentially get a higher dividend year after year. Yields on the 10-year Treasury bond recently fell below 2%. When accounting for inflation, that equates to a less than 0% yield.

Overall, Barclay’s predicts that these “Bond-like Stocks” will continue to outperform over the longer haul and over the next few months as global growth concerns could come to fruition.

SEE: Banking On Blue Chip Stocks

Finding Those Bond-Like Stocks
With market volatility rising, now could be the best time for investors to add strong dividend payers to a portfolio. One of the best choices could be the Vanguard Dividend Appreciation ETF (ARCA:VIG). The fund is an index of stocks that have raised dividends over the last 10 straight years. The fund’s holdings- such as Coca-Cola (NYSE:KO) and Chevron (NYSE:CVX) -are exactly the kind of companies that Barclays is talking about. These large-cap names with strong global footprints are most likely to provide sustained growth during troubled times. VIG has a rock bottom expense ratio and currently yields 2.17%.

Another broad buy could be iShares Dow Jones Select Dividend Index (ARCA:DVY). The fund tracks a basket of dividend stocks. However, the iShares fund is bit more concentrated at 101 holdings and focuses more on current yield rather than dividend growth. As such the ETF produces a 3.93% dividend. Expenses are higher for the fund at 0.40%. Similarly, investors looking for more global muscle from their dividend investments could use the iShares Dow Jones International Select Dividend Index (ARCA:IDV). This ETF follows an analogous index to DVY, but shifts that focus to firms located outside the U.S.

Finally, one of Barclay’s biggest recommendations for investors looking for bond-like stocks is in the utilities sector. Even in times of uncertainty, consumers, businesses and municipalities still need to power their operations and cool their homes. Water still needs to flow and electricity hums through power lines. That makes firms like American Electric Power (NYSE:AEP), Consolidated Edison (NYSE:ED) and DTE Energy (NYSE:DTE) powerful dividend payers through thick and thin.

SEE: Trust In Utilities

The Bottom Line
With concerns about the global economies health, investors are once again facing a quandary- how to balance portfolio growth with safety. Luckily, they have a powerful tool at their disposal. By betting on large-cap stocks that pay healthy growing dividends, portfolios should be able to navigate whatever the market throws at them.

At the time of writing, Aaron Levitt did not own shares in any companies or funds mentioned in this article.

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Fairway Group Gets The Green

Posted on 2:13 AM by Unknown | No comments

Grocery store chain Fairway Group (Nasdaq:FWM) sold 16.7 million shares at $13 in its IPO debut April 16. In its first day of trading shares gained 33.5%. Year-to-date it's the second best performing IPO next to ExOne (Nasdaq:XONE), which gained 47.3% in its coming out party. The question for those who weren't able to pick up shares at $13 is whether you should still be buying north of $17. Read on and I'll give you an answer.

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History
Nathan and Leo Glickberg created the first Fairway Market in 1954 at 74th St. and Broadway in New York's Upper West Side. Leo's son Howie joined the grocery store in 1974 with a plan to grow it beyond one location. By 2006, Glickberg and his two partners had four stores open and business was booming. While the partners were ready to retire Glickberg wanted to keep expanding. In need of capital, he held discussions with potential investors. Out of this came an offer from Sterling Investment Partners, a Westport, Connecticut, private equity firm. Paying approximately $150 million for majority control, the partners went to work adding stores. Today it has 12 high-volume locations with two more expected in 2013.

Caveat Emptor
This deal was brought to you by a private equity firm. Its only goal is to maximize profits for their investors often by applying significant leverage to ratchet up returns over a relatively short period of time. They're also not immune to using superlatives when discussing their investments. Co-founder and managing partner Charles Santoro said this about Fairway: "With the opening of the four additional stores, Fairway is expected to expand its annual revenue to $1 billion." Sterling felt that eight stores would generate an average of $125 million in revenue per store. As of the end of 2012 it had $483 million in revenue from 12 stores over a 39-week period. Annualized that's $53.7 million per store or less than half its projection. Granted it bought right before the "great" recession, but you'll want to be careful about any PR coming from Sterling Partners. At this point it just wants to realize its investment.

Valuation
If you assume that the underwriters will exercise their option to buy 2.05 million additional shares from some of the existing shareholders, Fairway Market's market cap prior to trading was $563 million and $752 million by the close of its first day as a public company. With total debt of $255 million at the end of 2012 and $29 million in cash, its enterprise value is $977 million while its adjusted EBITDA on an annualized basis is $45.1 million. Put it all together and you've got an enterprise value that's 21.7 times EBITDA.

SEE: 5 Must-Have Metrics For Value Investors

Both Whole Foods Market (Nasdaq:WFM) and The Fresh Market (Nasdaq:TFM) have EV/EBITDA multiples that are 37% lower than Fairway Market. Yet The Fresh Market's EBITDA margin is 410 basis points higher while Whole Foods' isn't too shabby at 9.2%, higher again by 220 basis points. When The Fresh Market went public in November 2010, its stock closed up 46% in its first day of trading. Eventually the excitement wore off after hitting an all-time high of $65.69 in August 2012. Since then it's dropped 40% as of April 17. This for a company that had far more revenue and profits than Fairway Market when it went public and significantly less debt.

Capital Expenditures
One area where Fairway Market wipes the floor with its peers is its average net sales per gross square foot. In 2012 on an annualized basis they were $1,114 while The Fresh Market's in 2010 when it went public was $481 or slightly less than half. However, The Fresh Market spends about $210 per square foot when opening new stores compared to $310 for Fairway Market. The Fresh Market expects a new store to payback within four years; Fairway Market expects payback in 2.6 years on average. So, while the payback is 35% faster, the outlay (and risk exposure) is almost four times as great. Add to this the fact that it's not making money despite generating industry-leading revenues per square foot and you have to wonder if it will ever be profitable.

Should You Buy?
There's no doubt Fairway Market have some of the most productive grocery stores in the nation. It's a store I'd probably shop at if I lived in the New York City area. The company estimates it can operate up to 90 stores in the Northeast and 300 across the country. That's 14.4 million square feet of grocery store at an approximate cost of $4.5 billion. To date, with the store opening costs and interest expense associated with its expansion, it's been unable to generate a profit. Until it stops building stores, this situation will never change.

SEE: Earning Forcasts: A Primer

By the time the company pays outs dividends to the pre-IPO shareholders (primarily Sterling) along with various payments typical of private equity deals it will have just $64.7 million to invest in its business. That's the equivalent of four stores. If it's planning to go all the way to 300, it's a drop in the bucket. The pre-IPO investors contributed about $159 million in equity. After the dividend payments, etc., they will have a net investment of $65 million while their shares will be worth $484 million as of April 17. That's an annualized return of 39.7% over the last six years.

Frankly, if you want a grocery store investment, go out and buy Whole Foods, The Fresh Market, Safeway (NYSE:SWY) or Kroger (NYSE:KR). They're alstronger financially and cheaper to own at this point. I'd wait for at least a year to see if Fairway Market can figure out how to make money. Until then, the downside risk is too great in my opinion.

Shop at its stores--but don't buy its stock.

At the time of writing, Will Ashworth did not own any shares in any company mentioned in this article.

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CSX Adapting To New Realities

Posted on 2:10 AM by Unknown | No comments

It wasn't long ago at all that the rails seemed to have things pretty much all going their way. Better management was producing better margins, pricing advantages over trucking were leading to good intermodal growth, and a recovering economy was supporting higher traffic and strong pricing. Then came a structural shift in electricity generation and a serious drought that hammered both coal and agricultural volumes.

To its credit, eastern rail operator CSX (NYSE:CSX) is rolling with the punches. The company is largely through the worst of the volume reset caused by declining coal demand, and while management has stretched out its margin improvement targets, there's still a pretty good case to be made for solid operating performance over the next few years. Unfortunately, the market has been quick to anticipate this and the shares don't look like a tremendous bargain today.

SEE: A Primer On The Railroad Sector

Q1 Not Quite As Good As It Seems, But Okay All The Same
With most banks citing economic uncertainty as a leading cause of stagnant loan demand and many industrial companies talking about weak demand, this wasn't set up to be a great quarter for CSX. Even so, it turned out to be an okay quarter and management continued to deliver margin improvements.
Revenue fell slightly this quarter, as the company couldn't completely recapture a 1.5% volume decline with better pricing. Intermodal remained a source of relative strength, with revenue up almost 4%, but at less than 15% of revenue it can only help just so much. Merchandise revenue rose more than 2% on good pricing (up more than 3%), while coal was down nearly 13% on a greater than 10% decline in volume.
Operating income improved about 2% from the year-ago level and nearly 9% from the prior quarter, as the company saw a big benefit from lower material and supply costs. The company's operating ratio (basically in the inverse of operating margin) improved by 70bp to 70.4. While CSX's reported EPS did benefit from liquidated damages and the MSO benefit, the company still managed a small beat (relative to the average estimate) on the operating line on an adjusted basis.

Life After Coal
It may be hasty to completely write off coal for the major rails, but it looks like 2013 is shaping up to be another poor year, as natural gas prices still make it a more cost-effective fuel source and coal export volumes to Europe remain weak. While CSX does have some exposure to Illinois Basin and Powder River Basin coal, the historically core Appalachian coal business may be permanently impaired due to the higher production costs.
In the short term, there's not a lot CSX can do about this. While the transportation of shale oil to Eastern refineries does offer some growth potential, CSX isn't going to benefit from shale-by-rail nearly as much as Berkshire Hathaway's (NYSE:BRK.A) Burlington Northern, Kansas City Southern (NYSE:KSU), or even Norfolk Southern (NYSE:NSC). Likewise, while CSX continues to invest in opportunities in intermodal (including the National Gateway project), it's all but impossible to replace a large (nearly 20% of volume) and profitable business quickly.

Still A Long-Run Economic Play
Even with the disruption in the coal business, CSX (and other Class 1 railroads like Union Pacific (NYSE:UNP), Norfolk Southern, BNSF, and Kansas City Southern) is still a leveraged play on the health of the U.S. economy. Taking business away from trucking (largely through intermodal) certainly sweetens the pot a bit, but ultimately revenue growth here will rest on the underlying growth in the economy.

Over the long term, then, I'm not too worried about CSX's revenue performance. The bigger worry is with margins and cash flow conversion. Losing all of this coal volume has forced management to stretch out its target date for the ambitious goal of a 65% operating ratio, and average cash conversion over the past few years has been significantly higher than the long-term average. I do believe the rail industry has made some significant changes that should allow these improvements to stick, but I don't believe investors should completely ignore the risk that this is a peak scenario and that mean reversion could kick in again in a few years' time.
More: CSX Corp. Slips To Underperform

The Bottom Line
I'm relatively ambivalent on most rail stocks today, as I believe investors may be a little too casual about the risks to U.S. economic growth and/or too confident in the possibilities for ongoing margin improvement. To that end, CSX already trades basically in line with historically normal EV/EBITDA, and a cash flow analysis suggests mid-single digit appreciation potential. Rail stocks make sense for investors who think the economy will stage a big second-half rebound, but in terms of likely total return there seem to be higher-potential ideas out there today.

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Broad Weakness Makes It Harder To Like St. Jude Today

Posted on 2:08 AM by Unknown | No comments

I've been relatively optimistic about St. Jude Medical's (NYSE:STJ) long-term prospects as the company navigates its current multi-year lull in growth. The company has a legitimate presence in important markets like cardiac rhythm management, atrial fibrillation, neurostimulation, and heart valve replacement, plus a pipeline that could reignite growth. With all of that said, it's still getting harder to ignore the realities of just how growth-challenged the company is in the here and now. Although I do believe the long-term expectations for St. Jude are increasingly beatable, this could be a frustrating stock to own for a little while yet.

SEE: A Checklist For Successful Medical Technology Investment

Broad, But Relatively Shallow, Shortfalls in Q1
St. Jude's first quarter was definitely a mixed bag. Relative to Wall Street expectations, the company posted only small misses on the top line and the operating income line, while below-the-line results actually led to a one-cent outperformance. On the other hand, almost every business category was soft.

Revenue was down about 3% on a constant currency basis this quarter. In the cardiac rhythm management business, sales fell 7% on an 11% decline in pacemaker sales and a 4% decline in ICDs. While it's still early, I'd suspect those results will be better than those of Boston Scientific (NYSE:BSX) and worse than Medtronic (NYSE:MDT), but I do believe St. Jude is losing pacemaker share.

Sales in cardiology were flat and neuromodulation was down 3%. Outside of the transcatheter heart valves sold by Medtronic and Edwards Lifesciences (NYSE:EW), these results are pretty consistent with both industry groups. Atrial fibrilation sales (ablation, mostly) were up only 7%, an unimpressive performance relative to the low-teens growth at Johnson & Johnson (NYSE:JNJ).

Where St. Jude did perform better was on the margin lines. Gross margin fell more than a point from the year-ago level, but came in about a half-point better than expected. Operating income was a similar, albeit somewhat weaker, story. Operating income declined 6%, but St. Jude's operating margin (which fell a half-point) was about 20bp better than the Street average (suggesting some loss of leverage through SG&A and R&D).

SEE: A Look At Corporate Profit Margins

It Could Get A Little Darker Before The Dawn
While St. Jude management seemed cautiously optimistic, management guidance always needs to be taken with a grain of salt. In the case of St. Jude especially, there are reasons to worry both about the overall health of the cardiac rhythm management business as well as the company's market share as the controversy over the company's Durata leads continues to play out.

Longer term, though, I think there are some reasons for optimism. New products like a line of value-priced pacemakers and the Nanostim leadless pacer could rebuild some momentum in CRM. I'm also more optimistic than many sell-side analysts about the firm's potential in transcatheter heart valves and renal denervation. Likewise, I think St. Jude is making solid moves in atrial fibrillation, where new catheter introductions and the MediGuide platform could help the company compete against large rivals like Medtronic and Johnson & Johnson, as well as smaller players like AtriCure (Nasdaq:ATRC).

That said, St. Jude has shown recently that it's unwise to count the pipeline eggs before they hatch. Data for the company's PFO and left atrial appendage products weren't great, and it's harder now to argue for blockbuster potential in those products. The same could prove true in heart valves and renal denervation, where there will be ample competition in these growing markets.

SEE: Equity Valuation In Good Times And Bad

The Bottom Line
I think it's generally a bad idea to make drastic whipsaw changes to estimates, but I have revised my expectations on St. Jude a little lower. I'm now looking for long-term revenue growth of about 3% and long-term free cash flow (FCF) growth of 4%. Those numbers could well prove conservative if the pipeline pans out, but by the same token the near-term growth outlook could worsen dramatically if there's a recall tied to Durata.

Those growth estimates lead to a fair value target near $43 for St. Jude today. That's still below today's price, and it's well worth noting that I think I'm erring on the side of conservatism with those growth projections. Still, even in the somewhat overheated world of med-tech, investors can find alternatives that are both cheaper on a long-term basis and stronger in the near term.

At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

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The “Healthy” Play In Contract Research Organizations

Posted on 2:05 AM by Unknown | 1 comment

Big pharmaceutical companies like Merck (NYSE:MRK) are facing a major hurdle- it takes a lot of work and money in order to get a new drug to market. From beginning research to running clinical trials, creating new therapies is a daunting task. That task becomes even more daunting as robust cash flows from blockbuster drugs begin to dry up as they go off patent.

In order to save on expenses and costs, biotech and drug manufacturers have started outsourcing various steps in the process to independent lab firms. Growth in these contract research organizations (CROs) has been staggering as more and more healthcare firms begin to use their services.

For investors, the CROs offer a unique play on the drug industry.

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Dwindling Internal Spending, More Outsourcing

With more than $106.9 billion worth of annual branded drugs sales coming off patent, from now until 2020, Big Pharma needs to reinvent its pipeline. However, R&D budgets are failing to keep with rising expenses. According to analysts at investment bank Jeffries, R&D spending by large pharmaceutical firms only rose by tiny 1.2% in 2011. Scary still was the 1.1% contraction last year as drug manufacturers wrestled with Obamacare changes. The bank expects drug makers to increase their spending by only 0.7% in 2013.

Yet it still takes a lot of work to get new drugs to market.

That’s where the CROs come in. These labs are hired by drug developers and medical device makers to offer research services such as overseeing preclinical and clinical testing of healthcare products during various stages of development. Given the mandates to reduce R&D costs while decreasing the time it takes to launch new drugs, business at the CROs is booming. Jefferies expects to see a 6% rise in outsourcing spending this year to reach nearly $26 billion.

The long term picture is rosy as well.

The industry has started to adopt a strategic partnership model that will ultimately benefit both pharmaceutical firms and CROs. This has allowed major drug makers to pair up with leading CROs as long-term partners in research and development. As such, healthcare intelligence company GBI Research estimates that the CRO industry will grow at a compound annual growth rate (CAGR) of 12.8% and reach $56 billion in size by 2018.

SEE: 5 Must-Have Metrics For Value Investors

Adding The CRO Winners
Given the potential growth in the industry, investors may want to make a play for the contract research players. With stagnant R&D budgets and rising costs, the CROs are in a sweet spot to profit as various biotech and drug makers tap them to run more and more clinical trials. While some broad-based healthcare funds- like the First Trust Health Care AlphaDEX (NYSE:FXH) –do provide exposure to some CROs such as Covance (NYSE:CVD). That exposure is muted. For investors, individual picks are best.

And one of the best could be Ireland-based ICON (Nasdaq:ICLR). The firm wears the crown at signing long term deals with some of the world's largest drug makers. Back in 2011, ICON- along with rival Parexel (Nasdaq:PRXL) -signed a five-year deal with healthcare giant Pfizer (NYSE:PFE) to conduct clinical trials. Later that year, ICON was selected by Bristol-Myers Squibb (NYSE:BMY) as its preferred provider for pharmacology studies. Those partnerships have expanded the firm’s backlog by 20% and increased earnings by an astounding 92% in 2012.

Another interesting choice could be Albany Molecular Research (Nasdaq:AMRI). The small-cap firm recently reversed a year-ago loss by posting a larger profit than analyst expectations. Perhaps more importantly, the firm’s small size could make it an attractive buy-out target now that it is profitable.

Private equity buyers have shown a certain enthusiasm for CROs of late and started to gobble them up at premiums. Private equity firm, the Carlyle Group (NYSE:CG) purchased Pharmaceutical Product Development for $3.9 billion back in 2011, while Bain Capital recently did a recapitalization of industry leader Quintiles from the private equity arm of JPMorgan Chase (NYSE:JPM). Albany could be on the radar on some other firm.

SEE: What Is Private Equity?

The Bottom Line
The pharmaceutical industry is under pressure to do more with less. That means it will be farming out many of is mundane clinical trial and lab work. This outsourcing will be a big win for the contract research organizations like Charles River Laboratories (NYSE:CRL) and its investors.

At the time of writing, Aaron Levitt did not own any shares in any company mentioned in this article.

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Nokia Still Straddling Fault Lines

Posted on 2:03 AM by Unknown | No comments

Nokia Still Straddling Fault Lines
by Stephen D. Simpson, CFA

Roughly 18 months into his tenure as the CEO of Nokia (NYSE:NOK), Stephen Elop hasn't yet proven much of anything about the future of this former mobile device leader. The company has done a better-than-expected job of cutting costs and its Nokia Siemens Networks joint venture is looking a lot better, but the company continues to lose mobile device share at an alarming rate. While the company's ongoing existence as a going concern is arguably not an issue, there's a great deal more to do before the company can be considered a real turnaround stock.

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A Step Back In The First Quarter
While Nokia's stock is still well above its mid-2012 desperation lows, the first quarter results mark a meaningful step back for the company. That the company continues to cede market share isn't so surprising, but the magnitude of the decline continues to surprise in a bad way.

Revenue fell 20% this quarter and 27% when compared to the fourth quarter, a result that was about 10% below the average sell-side estimate. The decline was led by the company's device business, where revenue fell 32% and 25% respectively. Nokia Siemens (NSN) was also surprisingly weak, though, with revenue down 5% and 30%.

Normally investors might cheer the progress that Nokia has made with its cost-cutting efforts. Adjusted gross margin improved almost four points, with year-on-year improvements in both devices (up 70bp) and NSN (up 740bp). Operating income was likewise better, as the company reversed a year-ago loss and posted an adjusted operating profit of 181 million euros.

SEE: Understanding The Income Statement

Mobile Is Still In Deep Trouble
Nokia may well still have an impressive-looking share of the global mobile phone market, but that position is eroding at a worrisome rate. Making matters worse, the company's efforts to shore up its smartphone business are still coming in short.

Overall units fell 25% this quarter (down 28% sequentially), with mobile phone units down 21% and 30%. Smartphone units were down 49% and 8%, though the company did see 27% sequential growth in the Lumia platform (which is supported by Microsoft (Nasdaq:MSFT)). Numbers like that are doing nothing to quell worries that Nokia is just hopelessly behind Apple (Nasdaq:AAPL) and Samsung in advanced devices and that the company is living on borrowed time.

I'm not sure I quite agree. While it's true that Lumia has not changed the world, the reality is that Microsoft has only had mixed success with its Surface tablet, and that likely means the company will be reticent to launch an independent phone effort. What's more, Microsoft's current management is showing no signs that it is willing to cede the mobile operating system market to Apple and Google (Nasdaq:GOOG), so I think Microsoft will continue to support Nokia as much as possible.

That said, I do see at least one big problem between these partners. Nokia's past success and current strength in distribution would seem to argue for focuses on the value segment of the smartphone market (particularly in emerging markets), but I suspect that that's pretty much the opposite of what Microsoft wants.

SEE: 5 Must-Have Metrics For Value Investors

What Is To Become Of NSN?
There are more than enough uncertainties with the mobile device business, but the NSN joint venture is also a big unknown in its own right. This business has turned itself around pretty effectively and is once again a credible threat to the likes of Ericsson (Nasdaq:ERIC) and Huawei. What's more, with the carrier spending market essentially going to sleep over the last 12-18 months, it's not like they missed out on much.

The question is what happens from here. Siemens (NYSE:SI) wants out, and nobody really knows if the companies will pursue an IPO, if Nokia will try to buy out Siemens, and/or whether another company like Alcatel Lucent (NYSE:ALU) could emerge as a strategic and financial partner. Splitting the two businesses may make some sense, but it's NSN that's largely helping things stay above the waterline for now.

The Bottom Line
I freely admit that long-range discounted cash flow models are an exercise of guesswork to some extent even in the best of cases. In the case of Nokia, though, a DCF analysis just feels like a dressed-up version of peering into a crystal ball given all of the unknowns regarding product launches and the fate of NSN.

All of that said, a scenario analysis suggests a floor value of around $2.50 today, with substantial upside if you believe that Nokia can sort out its mobile business and become a viable next-tier player behind Apple and Samsung. With so many unknowns, though, buying these shares today is pretty much a speculation that Nokia's cash, distribution system, and brand name can ultimately underpin better results over the next year or two.

At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.

View the original article here

IBM Makes It Official – Tech Has Some Troubles

Posted on 2:00 AM by Unknown | No comments

Although I doubt there were many investors still holding serious hope that the first quarter of 2013 was going to end up being a good one for tech companies, IBM (NYSE:IBM) likely snuffed out those hopes with an uncommonly weak quarter. With Big Blue missing for the first time in eight years, and missing across the board, it's pretty clear that business conditions have slowed markedly. Management remains optimistic that business will recover with a strong second half, but even with the big post-earnings decline these shares are not exactly cheap.

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Q1 Weak Across The Top Line
IT spending seems to have hit the rocks in the first quarter, and that showed up across all of IBM's business units.

Revenue fell 5% as reported and 3% on a constant currency basis, as IBM missed the average sell-side guess by almost 5%. The company's largest business unit, services, saw revenue down 4% as reported, with a 2% constant currency decline in Global Tech and flat results in Global Business. Software did a little better, with revenue up 1% on a constant currency basis (down 1% reported), but still missed estimates. Last and definitely least, hardware revenue was down 13% excluding a divestiture.

The news didn't get much better in the profit lines. IBM reported a one-point increase in adjusted (non-GAAP) gross margin, and did slightly beat estimates, but adjusted operating income fell 1% and the company missed the sell-side margin target by more than a point. It's worth noting too that this is the first quarterly miss from IBM since the first quarter of 2005.

SEE: Understanding The Income Statement

Can Everybody Screw Up At Once?
The stereotype on Wall Street is that management teams are loathe to admit any fault, usually trying to pass the buck for poor performance on to “market conditions” or “macroeconomic factors”. Curiously, the opposite seems to be true this quarter in the software market. Management at Oracle (Nasdaq:ORCL), TIBCO (Nasdaq:TIBX), Red Hat (NYSE:RHT) and now IBM all cited “sales execution” issues for weak results this quarter, as deals slipped out of the quarter. I have a hard time buying that, and it seems to me that universal sales slippage may in fact be a sign that customers are nervous about the economy and looking to delay major spending decisions until they see business picking up.

Hardware Looking Scary
IBM isn't a perfect bellwether for tech hardware, but these results should still have investors on edge. The company's weak server performance can't be encouraging for other weak hands like Hewlett-Packard (NYSE:HPQ) or Dell (Nasdaq:DELL). Likewise, IBM's 10% decline in storage may point to more share gains for NetApp (Nasdaq:NTAP) and EMC (NYSE:EMC), but I'd argue that it also suggests weak quarters may be on the way for them as well.

On a more positive note, IBM seems to be continuing its policy of evolving with the times and jettisoning low-potential hardware lines. Specifically, management is looking to sell its x86 server business, and it sounds like Lenovo (Nasdaq:LNVGY) may be the company that buys it. Whether that's a good move for Lenovo is a subject for another day, but it's hard not to respect IBM's willingness to punt businesses with weak future prospects when so many other companies cling stubbornly to their legacy operations.

Are Better Days Ahead In Services?
If there was a positive note in IBM's quarter, it was perhaps the datum point that services signings jumped 44% this quarter to almost $17 billion. That's consistent with the results seen at Accenture (NYSE:ACN) and suggests that IBM is still in a good competitive position relative to the likes of Infosys (Nasdaq:INFY), Cognizant (Nasdaq:CTSH) and so on. It's worth mentioning again, though, that IBM is deliberately looking to turn away less desirable business in an effort to improve margins and returns, so the signings/revenue progression could still be a little lumpy (in addition to the “natural” lumpiness resulting from the economic environment).

SEE: A Primer On Investing In The Tech Industry

The Bottom Line
Even with IBM's stock down hard on this disappointing earnings report, it's not close to value territory for me. I believe that the company can continue to grow its free cash flow at a long-term rate close to 5%, but I wouldn't pay more than $180 for that growth right now. What's more, on a relative basis Oracle, Microsoft (Nasdaq:MSFT), and Cisco (Nasdaq:CSCO) all look cheaper than IBM today, leading me to wonder if investors are a little too enamored of buzzwords like “cloud” and “Big Data” when it comes to IBM.

At the time of writing, Stephen D. Simpson owned shares of EMC.

View the original article here

GE's Guidance Wasn't Great, But Expectations Seem Low

Posted on 1:57 AM by Unknown | No comments

Many investors are desperately hanging on to the idea that the economy will spring back in the second half and validate the multiples in the market. When companies like General Electric (NYSE:GE) report earnings and give guidance that makes that second-half recovery look shakier, the stocks pay the price. While I understand short-term investors selling GE on disappointment over the company's outlook, the stock still seems too cheap from a long-term cash flow perspective.

Not Much Joy In The First Quarter
Probably the best that can be said about GE's performance in the first quarter is that investors weren't expecting a great set of numbers.
Revenue was flat as reported, with a 6% decline in industrial earnings (and a 20% sequential decline). While transport was strong (due in large part to an acquisition) and aviation was respectable, power and water saw a big decline (down 26%) on weak gas and wind turbine shipments. Healthcare, oil/gas, and home/business all flat-lined relative to last year.

GE Capital also continues to recover. Revenue rose 1% and beat expectations as growth in real estate, energy finance, and aircraft leasing offset declines in the commercial lending business.

SEE: Conglomerates: Cash Cows Or Corporate Chaos?

GE's profits were disappointing. Gross margin did improve slightly from last year, but industrial profits fell 11% for the quarter. Power and water was the big disappointment, as the margin declined more than three points, but healthcare and oil/gas were disappointing as well from a profit and margin standpoint. Given the weak volumes in these markets at present, these results aren't entirely surprising and I don't think GE is underperforming its peers.

Orders Look Alright, But What Will The Margins Look Like?
While GE management was more conservative with its guidance than the Street wanted, the company's order book looked pretty respectable. Orders were up 6% overall, while equipment orders improved 10% on big increases in oil/gas and aviation.
These numbers seem to make sense. Boeing (NYSE:BA) is trying to step up its production and trends in aftermarket aviation seem to be stabilizing. That should be a positive for GE, Honeywell (NYSE:HON), and United Technologies (NYSE:UTX). Likewise, while the energy sector is not healthy (and a recent decline in oil prices won't help), most equipment and service companies like National Oilwell Varco (NYSE:NOV) seem cautiously optimistic about 2013.
The big question, though, is what the margins on this business will look like. GE has done a good job of building its market share in markets like wind power, but industry-wide volume pressures could make it challenging for GE to outperform on margins in the short run.

The Bottom Line
If you're patient, I believe this is a good time to consider GE shares. The company's efforts to clean up and turnaround GE Capital seem to be working and I believe the company remains committed to an overall operating philosophy of “be the best, or be gone” with respect to its core end markets. Markets like aviation, power, healthcare, and oil/gas are all cyclical, but the long-term growth outlook for each of these markets is pretty strong.
Right now, it looks like the Street is betting that GE cannot/will not grow in line with global GDP. At a long-term free cash flow growth rate of 3% and a long-term ROE of 10% for GE Capital, fair value on GE would see to lie above $27 per share, while the stock trades for less than $22 as of this writing. While GE is not the kind of stock that is likely to double your money in six months, I believe patient long-term holders could do well buying GE at these levels, even if there are risks to the second half outlook and broader stock market.

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Nokia Still Straddling Fault Lines

IBM Makes It Official – Tech Has Some Troubles

GE's Guidance Wasn't Great, But Expectations Seem Low

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