Saturday, December 31, 2011

2012 U.S. Economic Outlook

Of course a wise person will hedge his or her bets ...

In 2011 the U.S. economy took everything that nature and venal politicians could throw at it and still managed to grow overall. It could have been a banner year, but the tsunami in Japan, the politics of Washington, high oil prices due to Libya, the Euro crisis, and finally flooding in Thailand all took a toll.

I think the most likely scenario for the U.S. economy in 2012 is moderately strong growth. I don't think turmoil in Europe will hurt the profits of very many American companies; the worst effects will come from converting the Euro to dollars for multinationals, if they have substantial European sales and the dollar continues to strengthen. Keep in mind that the alarmist view of Europe may not pan out, in which case a rising Euro could have the opposite effect.

2011 was also the year in which almost every professional economist in the U.S. predicted a new recession, which did not happen, despite the best efforts of Congress. Where do they find these guys?

In fact, I would hazard that strong U.S. economic growth is now more likely than another recession, in 2012. Demand is out there: consumer demand for autos and housing, which are big economic drivers, is strong. Credit is a constraining factor, but there is still plenty of stimulus from the Fed and the deficit.

We are clearly in the virtuous cycle where demand leads to more employment and profits, which in turn creates more demand. It might even give bankers and other major capitalists enough confidence to invest in expansion. I'm not advocating going back to bubble days, but there is as much danger in being too cautious as there is in pretending there is no such thing as a risky investment or loan.

That should mean the stock market is heading up, but stocks are bought by by individuals, one decision at a time. Companies with the best track records for generating profits are already attracting investors. It is hard to find an overvalued stock today, although I could name a few. Undervalued stocks are plentiful, just pick a flavor, do thorough research, and avoid the wooden nickels.

Will the bond market fall? It should, but it won't as long as enough people are willing to accept almost no returns on their capital, as long as the capital is preserved and reasonably liquid. Once the bond market starts falling, if the economy is getting strong, watch out. Get out quick, while the getting is still good.

The gold bubble seems to have popped. I never liked gold as an asset (See The Gold Bubble [November 18, 2009]), but enough fools bidding on a Beanie Baby can make it seem valuable, until the auction fever dies. Gold has no intrinsic value. It just sits there, useless. Its price depends on the whims of jewelry consumers and irrational investors.

It would be helpful if the price of petroleum came down, but oil prices are geopolitical, for the most part set where the dictator of Saudi Arabia wants them set.

Inflation is dead in the U.S. for the moment, but high prices for agricultural commodities are giving some state economies a good boost. Wages will remain dead in the water until more unemployed workers are soaked up, so I don't intend to worry about inflation until 2013.

The main fly in the ointment is potential political suicide. Most investors know that the national deficit needs to be brought under control. The best way to do that is to freeze or even reduce federal expenditures, then allow for economic growth to increase tax revenues to the point the budget is balanced, and then start reducing the deficit. Counter-cyclical federal budgets were a major key to U.S. economic success ever since the Great Depression. Deficit spending during booms is as stupid as cutbacks during recessions. In no case does a train wreck in Washington help the situation.

Investors and the nation (and its government) need a long term outlook. It will take years to get to a balanced budget, and perhaps decades to significantly reduce the national debt. That takes planning and discipline. The Communist Party of China could accomplish that. Could we do it? Sure, we could. Will we? Only if long term, public-spirited investors insist on it.

Here's an outside opinion: the U.S. could become the driver of the global economy again in 2012, for the first time since 2006. We are still a big, rich, creative, and occasionally hard-working nation. Our natural direction is up.

Monday, December 12, 2011

Cantel Medical Record Quarter

Cantel Medical (CMN) had a record fiscal Q1 2012 ending October 31, 2011, driven by organic growth and acquisitions.

Cantel Medical has been a good stock to hold so far in 2011, closing today at $26.91, up 18% from $22.81 a year ago, with a 52 week high of $28.50 and a 52 week low of $19.02. Not a bad showing in this tough market.

Cantel Medical is a smallish company (market capitalization today ended at $483 million) specializing in infection control through sterilization and disposables. Infection control is more cost effective than treatment for infection, which has become a much larger problem because of the evolution of multiple-antibiotic resistant bacteria.

Cantel is not a well-known name, even in hospitals, partly because it operates through named divisions. Minntech makes and markets endoscope and dialysis equipment sterilizers. Crosstex is the disposables business, working mostly in the dental market, but also moving into the general medical market. It makes face masks, sterilization patches, and other single-use items. Mar Cor makes machines to purify water, often for specialized medical needs. A smaller division is Saf-T-Pak, which produces specialty packaging for transporting specimens, and related materials.

For the latest fiscal quarter, Q1, Cantel reported revenue at $93.3 million, up 8% sequentially from $86.0 million, and up 29% from $72.0 million in the year-earlier quarter. GAAP net income was $6.2 million, up 32% sequentially from $4.7 million, and up 24% from $5.0 million year-earlier. GAAP EPS was $0.35, up 30% sequentially from $0.27 and up 21% from $0.29 year-earlier.

The latest acquisition was of Byrne Medical, announced August 2, 2011. Byrne manufactures products that act as replacements in gastrointestinal endoscopy procedures, eliminating the need for sterilization before reuse. The price of $100 million for a company with trailing annual revenues of $38.6 million seemed high on a revenue basis, but trailing annual pre-tax profits were $8.6 million. Cantel expects to increase gross margins in the business, which had a historical growth rate of over 20%. Byrne Medical had a 30% y/y increase in sales to $11.5 million in Q1 and is already accretive to earnings and cash flow.

Cantel has been fueling its growth with acquisitions. As a result, it ended the quarter with $116.5 million in debt, as against a cash balance of $19.6 million. If you, like me, have been burned occasionally by the poor acquisition strategies of other companies, you might not take this as a recommendation. However, for the few years I have followed Cantel they have done very well with acquisitions. They don't pay too much and sometimes acquire a division of a company they want, rather than the whole company. Then they cross-sell the new products with their established sales force. They have made it work well so far.

Meanwhile, the water purification business also keeps growing. The disposables business should ramp up when (or if) the unemployment rate tweaks down. People have been avoiding doctor and dental visits for economic reasons. When they have the dough to head back in for a checkup, the run rate will pick up again, meaning more use of infection prevention disposables.

So, in summary, the overall anti-infection story is a good one. Cantel is a pure infection play, and it has top-notch management. Should you be cautious because the stock is up 18% y/y? My guess is that the stock is currently priced about right for the short term, although the stock could make another run for its 52 week highs, if the overall market firms up. The trailing P/E ratio at the end of today was 22 (per NASDAQ), which is reasonable for a company with a strong track record of growth. In the longer run I expect continuing profit growth will compell a higher stock price. Cantel Medical should be attractive to long-term investors looking for diversification in the healthcare space.

As a kicker, the dividend was recently raised to $0.14 per year, paid semi-annually.

For more details on quarter results, see my Cantel Medical Q4 fiscal 2011 analyst call summary.

Disclosure: I am long Cantel and will not change my position in the next 2 weeks.

Keep Diversified!

Friday, December 9, 2011

Applied Materials See Cycle Bottom

Applied Materials (AMAT), the semiconductor capital equipment maker, had a very difficult fourth quarter of fiscal 2011 ending October 30th. The stock is trading trading today around $11.20 per share, less than 8 times earnings and not that much above its 52 week low of $9.70 touched on October 4.

Yet revenue for the fiscal year set a record. Applied Materials and other semiconductor equipment makers tend to be very cyclical because demand for new equipment is only strong when semiconductor end use is ramping. It looked like calendar 2011 would continue to be part of a strong up cycle that started in 2010, but global economic turmoil and weak consumer electronics end demand has made chip makers and the foundries that serve fabless chip makers reluctant to increase capacity.

Sales continue because even during slow periods there are advantages to moving to new process technologies that put more transistors on any given area of chip surface. Applied Materials also derives considerable revenue from related services. Its services division contributed $629 million in revenue in the quarter.

Total Q4 revenue was $2.18 billion, down 22% sequentially from $2.79 billion and down 25% from $2.89 billion in the year-earlier quarter. GAAP net income was $456 million, down 4% sequentially from $476 million and down 3% from $468 million year-earlier. GAP EPS (earnings per share) were $0.34, down 6% sequentially from $0.36 and down 3% from $0.35 year-earlier.

Non-GAAP net income was $271 million, down sequentially from $467 million and also down from $476 million year-earlier. EPS $0.21. The vastly lower non-GAAP than GAAP earnings were mostly due to a $203 adjustment to the prior-year's income tax filings.

Despite the poor quarter, cash flow from operations was near $700, or about $425 million excluding the income tax refund. Cash and equivalents were over $7 billion.

The stock pays a dividend of $8 per quarter per share. Management reiterated that they are committed to increasing the dividend, but stock buy backs are the preferred method of returning profits to shareholders. The acquisition of Varian Semiconductor will put a temporary crimp in cash, but is a good long-term move.

Which brings us back to the question of where we are in the cycle. To some extent that depends on the global economy. It is also sector-specific, as capacity utilization and end demand growth differ for sectors like RAM, Flash memory, application-specific chips and display technology.

Applied Materials management has had decades of experience with these cycles. They expect the first half of their fiscal year 2012 to be difficult. In particular Q1 fiscal 2012 (ending January 30th) guidance was for revenues down sequentially another 5% to 15%. However, they believe they are already past the bottom of the order cycle. Because we are talking about capital equipment, when the order cycle starts trending upward it can be six months before actual revenues start trending back up.

Flash and mobile processor capacity utilization are already high, so any further increase in demand should generate equipment orders. However, RAM capacity is plentiful, so we probably won't see a big uptick in revenues until demand catches up to capacity in that segment, probably later in 2012.

Despite unevenness, we are still in a global economic ramp with billions of consumers set to acquire smartphones in the next 3 years (600 million in China alone). Everyone wants devices that do more with less power, and the only way to get that is with new semiconductor manufacturing capabilities. It does not matter who wins the smartphone race; everyone needs the kind of semiconductor manufacturing solutions Applied Materials provides.

For more details about Q4 results, including questions by analysts, see my Applied Materials Q4 2011 Analyst Call summary.

Disclaimer: I have a long position in Applied Materials (AMAT), with a long term view. I have no plans to change my position anytime soon.

See also:

And keep diversified!

Monday, December 5, 2011


Back in February I warned that "at $25.48 [per share], you might want to consider that it could take NVIDIA [NVDA] a couple of years of outstanding growth to justify this price."

Maybe it is just the stock market and macroeconomic turmoil, but NVDA closed today at $15.48.
What I think about the pricing of a stock is only loosely linked to what I think of a company. As to engineering and execution, I have long believed NVIDIA is one of the best technology companies in the world. As the long-term leader in computer graphics chips (GPUs), however, it is now at a crossroads where the old rules no longer seem to apply. It is a time of both tremendous opportunity and tremendous danger, which makes predicting future profit streams mainly guesswork.

NVIDIA reported fiscal Q3 results and held its analyst conference call on November 10, 2011. Note the quarter ended October 30, so its not a calendar quarter and chips going into consumer products for the holidays pretty much had to be out the door by the end of the quarter. Q4, ending January 30th, is historically a slower quarter for NVIDIA. Note also that rivals AMD and Intel had quarters ending September 30.

Revenues were $1.07 billion, up 5% sequentially from $1.02 billion and up 26% from $840 million in the year-earlier quarter. Net income was $178.3 million, up 18% sequentially from $151.6 million and up 110% from $84.9 million year-earlier. EPS (earnings per share) were $0.29, up 16% sequentially from $0.25 and up 93% from $0.15 year-earlier.

That is pretty strong growth over the past year. However, from a licensing deal and litigation settlement with Intel, NVIDIA got roughly $60 million in royalties it did not get a year earlier (the royalties run about another 5 years). That had some impact on revenue and a huge impact on net income and EPS. It is real money, but it did not come from chips sales.

At this point NVIDIA has two games going. One is in its classic discrete GPU chips, which are now also used as math and application acceleration co-processors. Its only real rival in that market is AMD.

The other is combining its graphics engine with ARM chip designs for mobile devices. That results in a chip called Tegra. The first version was interesting but did not generate much revenue. Tegra II sold a lot better, and has powered a number of smartphones and tablets. Tegra III, or Kal-El, became available in the quarter, so a few devices are available now and it will be widely available in 2012. NVIDIA management did not break out Tegra revenue for the quarter.

The NVIDIA vision is not just to dominate the smart phone and tablet markets. Future versions of Tegra are supposed to be powerful enough to go into notebooks, desktops, and even servers.

The problem with being in the ARM market is that anyone can license the ARM design. Graphics and cell phone connectivity chips and designs are available as well. NVIDIA seems tight with Google, but any ARM-based design can run the Android software.

Competitors each have some advantages. Apple, of course, is the perceived frontrunner. There is no guarantee that the iPhone is ultimately going to be defeated by Android-based phones or less likely competitors.

When it comes to ARM based chips for tablets and phones, each competitor brings some serious advantages to the court. Qualcomm has far more extensive experience in cell phone chips than NVIDIA does; so does Texas Instruments. Among a host of other contenders, Marvell (MRVL) should be noted, since they generate a lot of cash each quarter and have a lead in China, a much bigger market to fight over than the U.S. market. Then there are the Koreans, and Japanese, and numerous small innovators.

Another problem for NVIDIA is the lack of a x86 CPU chip design. AMD and Intel both are incorporating graphics into their base designs, eliminating the need for NVIDIA's GPU chips for most users. This already appears to be hurting them in the notebook segment. It will take some time and at least a couple of die shrinks before the pure GPU chip dies (except in specialty markets), but that time is coming at a fairly predictable clip.

So far profit margins have been good at the leading edge of smartphone and tablet processors, but at some point pricing could become more competitive.

2012 is likely to be a make or break year for NVIDIA. If they are able to dominate the Android phone market they might become the dominant semiconductor company, a position Intel has had for a couple of decades now. Myself, I am not willing to make that bet, but I'll keep a close watch. However, I do believe NVIDIA's price is now pretty reasonable, everything taken into account.

See also my Q3 NVIDIA analyst call summary.

Disclaimer: I have no position in NVIDIA and will not take a position for at least 2 weeks following the publication date of this article.

Keep Diversified!