Don’t Sweat TRW Automotive’s Sell-Off

Posted on November 16, 2010 by steve@ascenderellc.com

The worst decliner in our model long portfolio today was TRW Automotive (TRW), down 5.69%, due in part to the decline in the market and more likely due in part to its recent announcement to commence a 10 million share secondary offering.  According to Bloomberg, parts of the management team and Blackstone are the sellers.  The company stated it will receive zero proceeds and that impact to share count will be negligible.

Secondary offerings tend to “coincidentally” come right before peaks in stock prices, especially cyclicals, so it is no wonder that investors are spooked.  But we would note that the company itself is not raising money, which sometimes can signal that shares are overvalued.  In addition, we would note that we are just days away from the General Motors initial public offering, which could potentially be one of the biggest IPOs in history.  It makes sense that a large investor may possibly be reducing positions in one auto-related stock and reallocating some to GM.  We have no way of knowing if this is in fact what is going on, but it is something we would do.

TRW scores the highest possible score in four key factors we use to help choose stocks for our model portfolios: 1) Relative Value; 2) Operating Momentum; 3) Analyst Revision; and 4) Fundamental Quality.  TRW is currently one of only four companies out of more than 3000 that score this high in our ranking update.

A secondary offering is never good news, but a nearly 6% sell-off even in a bad market for fundamentally one of the best companies in any sector seems a bit overdone.

 

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RPC Inc the Most Intriguing Idea this Week

Posted on November 14, 2010 by steve@ascenderellc.com

RPC Inc. (RES) is a $2.6b market cap oil and gas services company that offers technical and support services to other oil and gas companies.  It operates in two segments, Technical Services and Support Services.  Technical Services include pressure pumping, coiled tubing, snubbing, nitrogen pumping, well control consulting and firefighting.  The Support Services segment offers equipment and services, including drill pipe and related tools; pipe handling, inspection, and storage services; and oilfield training services.  The stock is up more than 50% over the last three months, driven by an almost 50% surge in revenue growth and a doubling in EBITDA over last year.  The energy sector in general has been on fire lately, and barring any worsening global energy and materials correction in the short term, it seems likely that RES has a good change of continuing to outperform.  Only four sell side analysts cover this company that we are aware of.  A 3-for-2 stock split is scheduled to go in effect on December 10.  The stock closed at $25.90 on November 12, down 2.19% for the day on 530,000 shares traded.

East West Bancorp, Inc (EWBC) is not new on our list, but it is a small cap bank stock ($2.6b market cap) that has consistently held high across-the-board rankings in recent weeks.  On October 25, the company reported better than expected earnings for its latest quarter and raised guidance for its next quarter.  ROE is improving, non conforming loans are declining and it trades at 1.3x tangible book value, which is a discount to a mean of 1.85x of ten other small-cap regional banks we quickly took a look at.  13 sell side analysts cover this company and their mean target is $20.  Good relative value versus improving fundamentals make a compelling case for this idea.  Investor relations page.

Replace Your Loser with Limited Brands (LTD)
On occasion we come across a potentially interesting short-term rebalancing idea.  This week it is Limited Brands (LTD), which reports after the close on Wednesday, November 17 with a conference call scheduled for the next morning.  Everyone is already expecting a good quarter and raised guidance from LTD, it is only a question of how much.  Normally such a situation would not interest us because such heightened expectations are usually fully priced into the stock.  However, we note that Fossil, Inc. (FOSL) was facing much the same situation when it reported last week but still ended up closing up nearly 6% the day of its positive report.  While LTD is 2.5x the size of FOSL in terms of market cap, and additionally LTD pays a dividend and carries net debt, they have closely ranked quantitative profiles.  It might be worthwhile for portfolio managers looking to rebalance out of a losing stock idea and replace it with LTD for the short-term.

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    Fossil Inc. Showing Strong Momentum but Unlikely the Next Chipotle or Netflix

    Posted on November 9, 2010 by steve@ascenderellc.com

    Fossil Inc. (FOSL) reported a very strong quarter and raised guidance today.  While the stock hit our price target, the strong operating momentum and likely still too-low forward earnings estimates may provide a particularly good opportunity for some discretion with regards to its sale.  At the same time, we want to remain disciplined and capture gains, so will use the recently attained price target as an initial stop loss level.

    FOSL was part of a portfolio of stocks that was sold on October 22 and repurchased on November 1.  Ongoing excessive turnover in a stock that we might want to hold in a portfolio for several months can counterproductive, so we want to take some time and review the idea here.

    We allow for the consideration for overriding our models to allow for capturing potential high-flyers like Netflix (NFLX), Apple (AAPL) or Chipotle (CMG).  These stocks once traded at GARP-type multiples but were sold off in a back test as they hit price targets or moved into growth territory.  It would be quite disappointing to sell off a stock just prior to a 200% run.  Since as of yet we have no systematic way of identifying the next NFLX, AAPL or CMG with any kind of certainty (imagine the possibilities), it is best to analyze the position as long as it stays above its new stop loss position.

    Despite a recent history of earnings beats and raises, we think it is unlikely that FOSL  is the next power-momentum stock.  Such stocks appeal to a wide consumer base and have a product that does not need to be refreshed with 100% appeal every fashion season.  But its at least worth taking the time to consider for an additional day or two.

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    High-Quality Continues to Beat S&P 500 Performance

    Posted on November 4, 2010 by steve@ascenderellc.com

    Model Portfolio Daily Update:  November 4, 2010

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    Of Note:
    A huge rally today with the S&P 500 starting with what appears to have been at least a 10 point gap up that kept getting stronger as the day progressed.  The S&P finished up 23.10 points or 1.93%, while our model long portfolios finished up 2.74%.  (This was the kind of market action that we feared on Monday, which is why we executed our real basket trades early that day, thereby creating significant negative slippage versus our theoretical models when the market instead closed 5 points down from the opening gap up).

    Our best stocks today included Freeport McMoran (FCX) up 7.00% benefitting from the inflationary trade and Macy’s (M) up 6.63% benefitting from better than expected same store monthly sales, a better than expected 3Q10 results and raised guidance, stating that it “ended the month with a strong trend going into the holiday selling season.”  Two of our model portfolio stocks already are showing double digit returns for the month, including Williams-Sonoma Inc. (WSM) and TRW Automotive Holdings Corp. (TRW).

    8 of our “high-quality” 23 stocks lagged the S&P 500 today; hopefully this provides an opportunity for continued upside as investors start selling winners and look for other high-quality stocks to move into.  Anecdotally speaking only, this is what appeared to occur last month.  Our worst stock today came from United Continental Airlines (UAL), down 3.70% and now down 4.06% MTD even though the airline indices finished slightly up based on no headlines that we can see.

    Our long models have only finished at or above this 2.74% on 51 out of last 1473 trading days going back to 12/31/2004.  Not that this is statistically significant, but 32 out of those 51 days were positive the following day.

    Or, track a long-only model based on actual trade data.

    About this report
    This daily update is a supplement to a monthly report dated October 31, 2010 that details the model portfolio strategies of Ascendere Associates LLC (“Ascendere”).  The daily update alerts readers to portfolio changes, provides updated rolling price targets and stops, and reports daily returns and updates to month-to-date and year-to-date returns.  None of the information in this report is representative of any investment management service we offer.  A long-only model based on actual trade data is available via a separate service.  Please see our disclosures and disclaimers at the back of this report.

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    Executing Real Trades Relative to a Theoretical Model Involves High Risk of Slippage Costs

    Posted on November 1, 2010 by steve@ascenderellc.com

    Ascendere Model Portfolio Daily Update:  November 1, 2010

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    Of Note:

    Fundamentals are sharply improving and valuations remain compelling
    As of October 31, 2010, 24 stocks made it our Core and Opportunistic Model Long Portfolios, and 11 made it our Core and Opportunistic Model Short Portfolios.  This compares to 19 stocks on the long side (adjusted to 18 a day later) and 19 stocks on the short side the previous month.  The sharp change in the number of stocks in each portfolio reflects a surge in improving fundamentals and relative valuations of stocks.  The continued momentum in improving company specific fundamentals makes us optimistic that the current rally may actually be extended beyond election results on November 2 and an expected enactment of quantitative easing policies following the FOMC meeting on November 3.  That is not to say we have clarity either way.  But in our opinion, it is a good idea to continue to follow the models, which assume we are invested again.

    Theoretical models are difficult to execute in reality; high risk of slippage
    Our model long portfolios, which exclude costs of any kind and are not reflective of any real portfolio, were up 0.13% versus the S&P 500 return of 0.09%.  However, rebalancing the portfolios today in actuality would have had a wide range of returns relative to the S&P 500 today.  This is because the S&P 500 (and stocks in general) opened with a gap up, rose about 10 points higher subsequently declined by 15 points to close to negative 5 points at one point, only to finish only 1 point up on the day.  Real basket trades executed today may already be lagging the S&P 500 by a full percentage point.  This is the risk of slippage in executing real trades versus a theoretical model that we have emphasized on numerous occasions.

    To mitigate this risk, it may make better sense to execute VWAP trades — volume weighted average price — which is an execution service offered by some brokerage firms that guarantees an weighted volume average price over a specified time frame in advance.  While an investor may be guaranteed the average price over a specified time, he is losing his ability to use discretion.  We are also possibly considering executing trades one or two days prior to the first day of any month.  It seems like the first trading day of any month is more volatile than usual, but we are going to have to backtest to get a better idea.  Whatever method of executing a theoretical model in reality, it may be a wash over the long term.  For example, on October 1 we probably saved ourselves at least 50 basis points by using discretionary timing to execute a basket trade, and today on November 1 we probably lost almost 100 basis points.  For our models based on real trades, we will allow ourselves a few more months of discretionary execution and reassess our position then before moving to a VWAP execution style.

    Actions Taken for November to Date:
    Model portfolios were rebalanced following the 10/31/2010 close.


    This daily update is a supplement to a monthly report dated October 31, 2010 that details the model portfolio strategies of Ascendere Associates LLC (“Ascendere”).  The daily update alerts readers to portfolio changes, provides updated rolling price targets and stops, and reports daily returns and updates to month-to-date and year-to-date returns.  None of the information in this report is representative of any investment management service we offer.  Please see our disclosures and disclaimers at the back of this report.

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    RenaissanceRe Holdings Ltd. is Worth a Look

    Posted on October 26, 2010 by steve@ascenderellc.com

    RenaissanceRe Holdings Ltd. (RNR) is a “global provider of reinsurance and insurance to cover the risk of natural and man-made catastrophes.”  This $3.8b market cap company is trading at 1.05x tangible book value and 7.6x the consensus calendar-year 2011 EPS estimate of $7.95, and is yielding 1.6%.

    RNR reports 3Q10 results on Thursday morning, October 28, 2010.  The company states in its 2009 annual report that the most important metric by which it measures shareholder value is tangible book value per share plus the change in accumulated dividends.  This company has a history of raising dividends each year by $0.04 per share; its latest annualized dividend is $1.00, up from $0.96 in 2009.  The stock has traded between 0.81x to 2.11x tangible book over the last 7 years, and in 2008 and 2009 traded at an average tangible book value of 1.21x and 1.19x.

    RNR stock got our attention because it is only two of the 18 new adds that scored the best possible score in 3 out of 4 factors, and the second highest score for a fourth.  Based on forward looking estimates, it looks like operating momentum may have peaked in the June 2010 quarter, but given its rising stock price though still low P/BV multiple and rising analyst revision momentum, we wonder if analyst revisions will continue.  Perhaps earnings estimates are too low because of overly-high estimates for the cost of Gulf of Mexico cleanup?  This is one stock that deserves further study.

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    A Republican-based Congress Would Benefit Many in Aerospace and Defense — Except Boeing Co.

    Posted on October 26, 2010 by steve@ascenderellc.com

    This is a guest article provided to Ascendere Associates LLC by a “Source close to the Hill.”

    Aerospace and Defense is still a stock pickers’ sector, but post-election, you’ll see the most interesting variables found here. Secretary of Defense Robert Gates is leaving and he’s a budget hawk. His professional background is also in intelligence not defense. So with a more industry-friendly SECDEF, some defense programs may find a way to get off the chopping block and get funded.

    A lot depends on Gates’ replacement who will be confirmed by more Republicans in the Senate. Along with a defense-industry bull as Secretary of Defense, the new SECDEF may bring his own people to trump the Office of the Secretary of Defense Acquisition, Technology, and Logistics (OSD AT&L). The current AT&L post is held by Ashton Carter, who is a former Harvard academic, clearly not from the defense world. OSD AT&L is where many of the policy decisions are made on major defense acquisition programs and Congressional Members from the “Gunbelt” would like to see more arms projects green-lighted. Under-Secretary Carter may feel the heat from Republicans and other defense hawks.

    Look for growth in foreign arms sales to counteract White House cuts in the defense budget. The Administration has already approved large deals with Taiwan ($6 billion in F-16s and Patriot air defense systems in January) and most recently with Saudi Arabia. Big boys Lockheed Martin (LMT), Boeing (BA), and Raytheon (RTN) enjoyed a $60 billion windfall while the Saudis received F-15s along with Apache Longbow and Blackhawk helicopters.

    If the GOP takes the House, Rep. Buck McKeon (R-CA) is due to get the gavel in House Armed Services. He’s a straight, squeaky-clean, and no-nonsense guy so expect fiscal prudence. However, he’s also from the California Gunbelt and will fight for his turf. If Carly Fiorina wins the Senate in California and gets rid of mega-dove Barbara Boxer (D-CA), Fiorina would very likely join Senate Armed Services and California defense and IT-related defense stocks could get a bump, especially those located in Long Beach and San Diego.

    Perhaps the biggest surprise on the House Armed Services Committee is Chairman Ike Skelton (D-MO) fighting for his political life. Polling shows his race as a dead heat. Unbelievably, Armed Services Democrat number two in seniority, Rep. John Spratt (D-SC), could also lose. This would leave the Democrats with very little bench strength on the committee. With these potential losses and this year’s death of Rep. John Murtha who was  the reigning defense appropriations Godfather for decades, Democrats have seen a lot of their in-fighting ability against the Republicans evaporate.

    If the GOP wins the Senate, Sen. John McCain (R-AZ) takes the gavel in Senate Armed Services.  This looks like a definite short play on Boeing. McCain hates Boeing with a cold, steely passion and watches every move they make. First, Boeing has completely failed its mission on the virtual border fence. After four years and $850 billion, the fence is still not complete and it still doesn’t work. McCain has been slowly trying to pound nails in Boeing’s coffin since at least 2002, when the Arizona senator helped bust the defense giant on an illegal tanker leasing deal. McCain has even been known to request flying on Airbus aircraft to symbolically stick it to Boeing.

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    Carlyle Group Should Purchase InterDigital Instead

    Posted on October 25, 2010 by steve@ascenderellc.com

    Bloomberg reported this morning that the leveraged buyout firm Carlyle Group is in talks to purchase CommScope (CTV), a fiber-optic cable maker based in North Carolina, for $31.50 cash per share or about $3b.  The deal values CTV at about 13.9x calendar 2011E consensus EPS and 7.7x EV/LTM EBITDA.  At Friday’s close, CTV’s market cap was about $2.2b and it was trading at 10.2x 2011E consensus EPS and 6.1x EV/LTM EBITDA.  As table below illustrates, CTV was showing fairly decent Relative Value in the Technology sector, but ranked poorly on every other keep metric, including Operating Momentum, Analyst Revisions Momentum and Fundamental Quality.

    Could Carlyle have made a better choice?  A preliminary analysis indicates yes.

    InterDigital (IDCC), a wireless technology company, looks like it would have been the much better acquisition.  IDCC is trading at a discount to CTV, with a 2011E P/E of 10.1 and EV/LTM EBITDA of 3.5x.  In addition, the company has virtually no debt and $486m in cash.  Backing out net cash of $11/share, the stock is only trading at 6.4x 2011E EPS.

    This is an absurdly low valuation for a stock that that holds a 5 out of 5 score on our key ranking factors.  At a 13.9x 2011 PE, IDCC could fetch $41 per share; adjusting for its net cash position and using the same multiple, a valuation of $52 could be justified.

    Obviously more than a few minutes of analysis needs to be done, but the initial valuation parameters do look compelling.

    Netezza’s Compatriots — Where are they today?
    In a similar M&A screening exercise we conducted last month on September 20, we found five Technology sector stocks that were more attractive than Netezza (NZ), which International Business Machines (IBM) announced it intended to purchase for $1.7b.

    Since September 20, these five stocks –AVX Corp. (AVX), Vishay Intertechnology (VSH), Veeco Instruments (VECO), Trina Solar (TSL) and TriQuint Semiconductor (TQNT) — have appreciated an average of 8.75%, above the Nasdaq Composite return of 5.24%, and ranging -1.35% to 22.76%.

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    American Express Corp, Currently One of the Best Financial Sector Stock Ideas

    Posted on October 24, 2010 by steve@ascenderellc.com

    Every week, we include in our weekly ranking report a list of the highest quality and lowest quality stocks as defined by four key factors: 1) Relative Value; 2) Operating Momentum; 3) Analyst Revision Momentum; and 4) Fundamental Quality.  At the end of each month, we take roughly 1/3 of the stocks on this list to construct our various long/short and long-only model portfolios, which are rebalanced monthly.

    This week, 62 stocks make the “high-quality” list, with 18 additions and 18 deletions. Rankings will fluctuate more widely than usual as financial results continue to be reported, but for now American Express (AXP) looks to be one of the most attractive “high-quality” stocks in the Financial sector this week.

    American Express Company is a “go-to” stock in the Financials sector, the same way that Freeport McMoran (FCX) is a go-to stock in Materials.  When portfolio managers speak of financials, they always want to know about AXP.  We have not been able to say anything good about American Express for a long time, but this may be changing.  AXP, a $47b market cap company, is trading at 3.2x book value, 11.0x times the calendar 2011 consensus EPS estimate of $3.55, with an annualized dividend of $0.72 and yield of 1.8%.

    The stock sold off 3% this past Friday following its 3Q10 report the night before.  Revenue and earnings beat consensus, helped in part by rising card usage, lower defaults, and a release of bad debt reserves. That sounds like positive developments to us, but a number of analysts expressed concern about higher expenses and increasing risk of a decline in its merchant discount rate and ongoing pressure related to the Credit Card Accountability, Responsibility and Disclosure Act.

    The risks in the details are real, but perhaps they are embedded enough in current valuations, likely ongoing analyst revision momentum and relatively low but still likely positive operating momentum.  By focusing on the big picture relative to other Financial sector stocks, AXP as of today deserves a look as both a short-term and long-term holding idea.

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    Maybe CREE’s Shortfall Wasn’t Really a Surprise

    Posted on October 19, 2010 by steve@ascenderellc.com

    This daily update is a supplement to a monthly report dated September 30, 2010 that details the model portfolio strategies of Ascendere Associates LLC (“Ascendere”). Today’s detailed report is available here.  Daily-Ascendere-2010-10-19

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    Of Note:
    The market sold off today based on a combination of less than perfect quarterly reports from Apple Inc. (AAPL) and International Business Machines Corp. (IBM), a rate hike by the People’s Bank of China, and reports that PIMCO, BlackRock and the Federal Reserve Bank of New York are seeking to put back $47b in bad loans by Bank of America’s (BAC) Countrywide Financial. CNN has a good overview of today’s market action.

    The S&P 500 was down 1.59% while the long positions in our Core and Opportunistic Long Model Portfolios were down 2.19%, led by a 4.47% loss in Aixtron AG (AIXG) and a 4.23% loss in LG Display Co., Ltd. (LPL).

    AIXG — Barclay’s initiated coverage of AIXG today with a Neutral rating, apparently struggling “to see meaningful upside on CY11 and normalized estimates.” Piper Jaffrey reiterated its Underweight stance on AIXG and lowered its price target to reflect concern of end-demand. (See this good overview of the LED market from the Street.com today.)

    LPL — Meanwhile, Bank of America/Merrill Lynch reduced LCD TV growth forecasts for the industry and reduced estimates for LPL, citing weak demand and higher than normal inventory.

    (LZ — we note somewhat belatedly that over the weekend, LZ was mentioned in the latest issue of Barron’s as having been cited as a possible LBO candidate by UBS.)

    Our models show AIXG having high asset turnover and good working capital management and fast growing ROIC, with consensus revenue and EBITDA estimates having moved up more than 6% from a month ago. LPL appears to show good asset utilization and ROIC improvement, with consensus revenue and EBITDA estimates having moved up more than 4% over the last month.

    We would note that a LED semiconductor company Cree Inc. (CREE) just reported a quarter that was a little light on revenue and lower guidance next quarter. According to an analyst at Noble Financial Group in the above cited Street.com article, compared to LED semiconductor equipment companies like AIXG, “…Cree is far more exposed to short-term pressure because it has more competitors and its backlog is not as large.” Unlike AIXG, CREE ranked poorly on 3 out of the 4 key factors we measure — see the tables below. So perhaps this earnings report from CREE is generally in keeping with quantitative investor expectations, which might mean there is little additional fallout on the LED equipment makers. We will see how this translates in tomorrow’s price action.

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