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Why profit taking in Shanghai turned into panic selling

posted on July 27, 2015 at 1:35 pm

It’s no surprise that China’s Shanghai and Shenzhen stock markets fell over night. After a huge rally on government moves to support share prices, traders—especially traders outside Mainland China–widely expected profit taking. The Shanghai Composite, for example, had climbed 16.1% from July 8 to July 24. That’s so far, so fast that selling seemed inevitable.

But the size of the drop is more than expected. The one-day collapse—8.5% in Shanghai, 7% in Shenzhen, and 7.4% on the ChiNext index—is the biggest one-day retreat since the days of the financial crisis in 2007. Almost 2,250 stocks fell on Monday in Shanghai against just 77 stocks showing gains. More than 1,500 shares in Shanghai and Shenzhen fell by their 10% daily limit.

What seems to have pushed the markets from profit taking to panic?

Rumors that the Chinese government was about to reduce cash support for equity markets. Some traders apparently decided that the China government had targeted 3,800 (or was it a nice round 4,000?) on the Shanghai Composite as sufficient to permit a reduction in government cash available for margin loans. The Shanghai index hit 3970 on July 13 and 4124 on July 23.

A huge increase in pork prices, the most sensitive element in inflation at the consumer level, reinforced fears that the government was about to reduce cash flows into stocks. Between March 20 and July 17, pork prices had surged by more than 20% on a big decrease in hog supply. That had led some analysts to conclude that the People’s Bank of China would look to rein in increases in the money supply in order to prevent inflation, now under control with a 1.3% year over year increase in consumer prices in the first half of 2015, from rising to dangerous levels.

There may also be fundamental—as opposed to speculation about monetary policy—reasons for the drop. Disappointing data on profits at China’s industrial companies sent mainland markets down more than 2% at the open. Industrial profits fell 0.3% year over year in June, the government reported on Monday. That comes after a reported 0.6% gain in industrial profits in May. While that reported increase in industrial profits in May initially buoyed mainland markets, later more skeptical analysis has argued that the increase in May was a result of stock market investments by Chinese companies. Chinese companies routinely invest in stocks and the National Bureau of Statistics has acknowledged that investment gains played a big part in the reported rebound in corporate profits.

Overseas investors have also played a big part, first in arresting the rally off the July 13 bottom and then in casting doubt on the sustainability of government support for stocks. Overseas investors have sold $7.6 billion in shares of Shanghai listed companies since July 6, using the Shanghai/Hong Kong exchange link. Overseas investors pay more attention to measures of valuation than China’s domestic investors and much of the recent selling by overseas investors has been a result of worry about sky-high multiples in Shanghai and Shenzhen.

Also on the international front the International Monetary Fund has, apparently, told the Chinese government that extensive market interventions should be temporary measures and that markets should be allowed to clear through normal market mechanisms, such as price declines. At many times I don’t think Beijing would much care what the IMF recommends but the Chinese government is in the midst of a major effort to win approval for the yuan as a global currency. Reports are that the Chinse government has assured the IMF that market interventions are indeed temporary.

That’s not exactly what traders in Shanghai and Shenzhen who are hoping for more government cash want to hear.

Update Visa

posted on July 24, 2015 at 2:45 pm
supermarket checkout

Updated July 24, 2015.  On July 23 Visa (V) reported fiscal year third quarter earnings of 62 cents a share (excluding one-time items), beating the Wall Street consensus of 58 cents a share. At $3.52 billion revenue for the period was up 11.4% year over year and ahead of Wall Street projections by $160 million.

Shares of Visa climbed 7.1% for the day.

Today, July 24, shares are up again—4.04% as of 2 p.m. New York time—on news that Visa is talking with Visa Europe, which split off from Visa in September 2007, about purchasing its former unit. Visa Europe accounts for 52% of the European credit card market by volume.

As of today, July 24, I’m raising my target price on Visa in my Jubak’s Picks portfolio to $82 a share by December 2015 from the prior target of $78. Shares of Visa are up almost 17% since I added them to this portfolio at $63.65 on November 15, 2014.

Visa’s earnings beat on July 23 was the result of a combination of an increase in transaction volumes and an increase in the fees that Visa collects for the use of its branded cards and transaction system. Nothing like a dominant market position to make a price increase possible. Visa accounts for 50% of all global credit card transactions and 75% of all debit card transactions. Visa makes its money from fees on Visa branded cards and from fees on transactions that pass through the Visa network.

The worry that hangs over Visa in the long-term is that some digital upstart will put together an electronic payment system that will eat into the use of credit cards. That fear receded a good bit when Apple (AAPL) decided that its Apple Pay electronic payment system would work with Visa, MasterCard (MA) and American Express (AXP) rather than compete with those transaction companies.

In its conference call after earnings Visa raised its guidance for earnings growth rate in the fiscal year that ends in September to the mid-teens from the previous low to mid-teens rate.

Lessons from Qualcomm’s earnings debacle for the company, smartphones, and the technology sector

posted on July 24, 2015 at 1:27 am

Let me be honest.

When I recommended selling Qualcomm (QCOM) out of my Jubak’s Picks portfolio on April 2, I wasn’t imagining anything like yesterday’s earnings debacle.

The stock closed at $67.97 on April 2 and I recommended taking profits because valuation looked stressed considering the number of competitors that were putting pressure on margins in Qualcomm’s smartphone chip business. The stock jumped to obey my sell by climbing slightly for the next month or two until it hit $69.86 on June 3. Shares then crept gradually lower until yesterday’s earnings report sent them down to $61.78, a drop of 3.75%.

It’s actually amazing to me that the stock didn’t fall further. For the quarter ended June 30, Qualcomm reported earnings of $1.2 billion, down from $2.2 billion in the year-earlier quarter. Revenue fell 14%. Chip shipments were flat year over year.

And then Qualcomm said things would be worse next quarter, the fourth quarter of Qualcomm’s fiscal year. For the quarter that ends in September Qualcomm projected earnings of 51 cents to 76 cents a share on revenue of $4.7 billion to $5.7 billion. The Wall Street consensus had seen the company earning 95 cents a share on sales of $6.13 billion.

Qualcomm’s quarter and its projections for next quarter highlight a problem across the technology sector. Very few technology companies are making very much money. And those that are can expect to see everybody including my Aunt Tilly chasing them. Qualcomm had averaged better than 20% annual sales growth since 2010 because of its dominance of the market for high-end chips that connect phones to the fastest data networks using the LTE standard. But that dominance has been under attack from companies such as Taiwan’s MediaTek, Korea’s Samsung, Arm Holdings (ARMH), and Intel (INTC). In fact in the first three months of the year Samsung and MediaTek grabbed 19% of the market. The loss of a huge order from Samsung’s smartphone business to Samsung’s chip unit was a major contributor to the end of a 19-quarter string of year over year sales growth at Qualcomm.

I don’t see the dynamic that turned this quarter into such a disappointment for Qualcomm turning around quickly. Qualcomm is predicting rather modest compounded annual growth of mid- to high-single digits in the 3G and 4G-device market over the next five years with average selling price (ASP) of the chips that go into those phones staying flat. That seems optimistic to me given that competition has been driving ASPs lower over the last couple of years, but the view is pessimistic enough to explain why so much of Qualcomm’s reaction to this quarter has focused on cost cutting–$600 million in fiscal 2016 and then an additional $1.1 billion in annual reductions.

The other part of Qualcomm’s response to the challenge of this quarter is to announce that it will be looking to address new markets with management citing networking, mobile computing, Internet of Things, and automotive as adding up to a $10 billion addressable opportunity now with growth to $20 billion by 2020.

I think you can readily see the problem with targeting those opportunities. Lots of competitors are going after the same markets—Cisco and Google (GOOG) in the Internet of Things, for example. Intel is willing to pour billions and then more billions into mobile computing. Apple and Google have both targeted the automotive opportunity.

That doesn’t mean it’s not worth going after these opportunities, but it is important to think about those opportunities in the context of the current pattern in the technology sector of one or two companies dominating a market and collecting all the profits from that market.  Qualcomm cited in its conference call the growing concentration in its own sector. That’s a development that should be familiar to technology investors from the examples of Microsoft (MSFT), Intel, and Cisco Systems (CSCO). According to Qualcomm just two companies—Apple (AAPL) and Samsung account of 85% of the premium smart phone segment. The two companies account for an even bigger percentage of the profits in the smartphone sector: Apple accounts for 92% of profits in the smartphone sector, according to Canaccord Genuity, with Samsung pulling in 15%. The rest of the sector shows a loss—which is how Apple and Samsung can add up to more than 100%.

Looking at these numbers and trends I have to wonder if Qualcomm wouldn’t do a better job for shareholders if it eschewed the short-term solutions being urged on it by activist shareholders and instead concentrated on building an unassailable position in 5G technologies based on its clear lead in 4G technologies. That would produce some short-term pain, undoubtedly, since 5G technology is emerging only slowly. (From a long-term perspective it’s the lag in 5G adoption that accounts for much of Qualcomm’s current disappointment.)

And looking at the Qualcomm story I have to wonder if the pattern of concentrating all the profits in a sector in just a few companies doesn’t go a long way to explaining the number of young technology companies that are concentrating on growing revenue and market share as fast as they can—with the hope that someday that will result in the kind of market dominance that has made Apple such an amazingly profitable company.

Of course, it is a whole lot easier in the current technology market to build a strategy around growing revenue as fast as possible and letting profits take care of themselves somewhere down the road. At least that way a CEO doesn’t flag a profit opportunity and attract lots of competitors.

Would you like chips with that dip?

posted on July 23, 2015 at 1:06 am

Yesterday disappointing quarterly results from Apple (AAPL), Microsoft (MSFT), and Yahoo (YHOO) took down those stocks. Apple, for example, reported a 38% increase in earnings year over year but fell 8% in after hours trading, wiping $66 billion off the stock’s market capitalization, as Wall Street analysts and investors decided that a mere 38% increase in revenue was a sign that growth was slowing at the company.

Today, the damage has spread to technology stocks in general—the iShares PHLX Semiconductor ETF (SOXX), for example, was down 2.52% as of 2:30 p.m. New York time, and the technology-heavy NASDAQ index was lower by 0.62%–and to shares of technology suppliers, and in particular Apple suppliers.

ARM Holdings (ARMH), down 4.6%, NXP Semiconductor (NXPI) down 2.6%, and Synaptics (SYNA) down 5.52% are among the hardest hit.

It hasn’t helped that Linear Technology (LLTC), a big name in analog chips, missed estimates for the quarter, supplied weak guidance for the next quarter, and noted that it had seen bookings slow “considerably” near the end of the quarter.

I think that the wider sell off is an over-reaction. Apple’s revenue “disappointment” was to announce just $49.6 billion in revenue when analysts had forecast $49.4 billion.

Yep, that’s right, Apple “disappointed” by only reporting revenues slightly above the official consensus projection for the quarter.

I don’t think the technology sector is out of the danger zone yet. Qualcomm (QCOM), a company with that has an Apple-like growth problem since it dominates its market, reports today after the close. I’d worry about another “disappointment.”

Two of the technology stocks that I’d most like to pick up on a sell off in the sector—NXP Semiconductors (NXPI) and Synaptics (SYNA)–report earnings on July 29 and July 30, respectively. And they’re both subject to a big drop on an Apple-like “disappointment. (That’s especially true for NXP, which trades at a trailing 12-month price to earnings ratio of 61. Synaptics trades with a PE of just 18.)

I’d wait on the earnings reports see if the market gives me good entry point for these stocks on near term fears in the sector.

Buy Cummins

posted on July 21, 2015 at 12:26 am

The perfect dividend stock is one that pays a high current yield—let’s fantasize and imagine a yield of 5%–and that is also raising its annual dividend payments at a rate that will produce a future yield (on your purchase price) way above that initial 5%.

Such perfection is rare. Most of the time investors have to pick one–either current yield or future yield. And our choice between the two alternatives should be influenced by the state of the financial world. For example, when interest rates and inflation are stable, a current high yield might be preferable because the value of that dividend isn’t being eroded by rising interest rates or inflation. On the other hand, when either interest rates or inflation are headed upwards, a future dividend that was growing at a faster rate than market interest rates or than inflation has extra value since it’s a way that a dividend income stock, in comparison to the fixed payouts from a bond, can, maybe, keep up or surpass interest rates and/or inflation.

On the eve of the first increase in the Fed funds interest benchmark interest rate since 2006, I think the edge goes to dividend stocks showing a strong pattern of strong increases in dividend payouts.

And that’s why the 25% dividend increase voted by Cummins (CMI) on July 14 caught my eye. That increase pushed the current yield to slightly over 3%. (The yield was 3.02% at the close on July 20.)  And it promises, if the company continues its recent (nine-years and counting) history of 25% annual dividend increases, to give you a yield of 9.2% on your original purchase price (of $128.97 at the July 20 close) at the end of five years. (By the way, the recently declared quarterly dividend of $0.975 is payable on September 1 to shareholders of record on August 21.

I’m adding shares of Cummins to my Dividend Income Portfolio as of today July 21.

The big question, of course, is whether the company will be able to continue to increase its dividend payout at anything like the recent rate.

On a purely financial basis the odds look good. The payout ratio over the trailing 12 months has climbed to a still reasonable 31.8% from 20.18% in 2012 so the company has room to increase its dividend. (Payout ratios above 70% or so aren’t easily sustainable for a company that is still investing in its business and in developing new products, as Cummins is.) The company isn’t carrying a lot of debt—the debt to equity ratio is a low 22%–so Cummins doesn’t face that drag on its ability to pay a higher dividend.

Cummins’ market, though, does present a challenge right now. In its last quarterly earnings report Cummins guided to a revenue increase of just 2% to 4% for 2015 as weaknesses in the Chinese and Brazilian market for trucks (and thus for the diesel engines that Cummins makes) continue. Heavy and medium truck sales in China are forecast to fall 15% in 2015 and in Brazil by 28%.

But margins are forecast, by Standard & Poor’s, to climb in 2015 and 2016 on continued cost cutting and improvements in capacity utilization. S&P projects operating earnings per share of $9.96 in 2015 and $11.38 in 2016, up from $9.13 in 2014.

The wild card in these projections is the state of the North American market for heavy and medium duty trucks. Some competitors have pointed to their belief that the demand for trucks in that market has hit a cyclical peak. That’s certainly a danger to revenue at Cummins although the company has a history of adding market share when the market slows that reduces the likelihood that any cyclical decline in market-wide sales would take a big bite out of Cummins’ revenue.

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