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Barron's The Trader: The Mouse That Didn't Roar
(From BARRON'S)
By Jay Palmer
A burnt bagel and
some stray baby powder gave nervous traders an excuse to
knock stocks lower ahead of the long holiday weekend. Sure, there was
some less
than delightful economic news. But, asked to explain the selloff in
the week's
last session, some traders pointed to two news reports, one that the
Senate
building in Washington had been evacuated following a fire alarm (seems
an
intern had burnt her breakfast) and the second that some "mysterious
white
powder" had beendiscovered at a New Jersey post office. The offending
substance
later tested negative for any poison.
So the week ended more or less as it began, on a bear note. But between
those
two down days, the market rose enough to take the Dow Jones Industrial
Average
and the S&P 500 to new 52-week highs and to leave both up on the
week, albeit
only slightly. At Friday's close, the Dow stood at 10,627.85, up 0.62%
on the
previous Friday's 10,593.03. The S&P 500 rose 0.55%, to 1,145.81
from 1,142.76,
while the Nasdaq dropped 0.51%, to 2,053.56 from 2,064.01.
Though stocks started gaining ground Tuesday, the big advance came Wednesday.
One factor was Federal Reserve Chairman Alan Greenspan's annual testimony
on
monetary policy to the House Financial Services Committee. The good
news: It
contained no surprises, such as the hints of higher rates that triggered
a
selloff after the Jan. 28 policy statement.
In fact, given the way investors switched into buy mode, Greenspan might
as
well have been tailoring his remarks for the market. He used the term
"patient"
in a reference to raising rates and added that "prospects are good
for sustained
expansion of the U.S. economy." A caution that the "real federal-funds
rate will
eventually need to rise" raised little concern.
A further factor in the Wednesday advance was a $66 billion hostile
bid from
cable giant Comcast for Disney (see page 36), an offer that not only
popped
Disney stock and put the House of the Mouse in play but also added luster
to
investment- banking stocks on the assumption that a new era of big corporate
deals is upon us.
The logic behind the deal, combining content with distribution, is much
the
same as that behind Time Warner's merger with AOL, and Disney's own
takeover of
CapCities/ABC, neither of which worked out too well. Comcast clearly
hopes to
execute differently, but that didn't stop Disney from rebuffing its
suitor. As
speculation continues over the possibility of a rival white (or maybe
black)
knight entering the fray at, presumably, a higher price, Disney stockholders
disenchanted by the company's ho-hum performance seized the moment to
take
profits, knocking the stock down to 26.92 from over 28 the previous
day and
about 24 ahead of the bid. Comcast came under pressure, too, ending
the week at
30.06, more than 11% below its Tuesday close.
But neither Greenspan nor Disney could keep stocks hopping, given the
wan
economic news. January retail sales were off 0.3%; new unemployment
claims for
the week ending Feb. 7 unexpectedly rose by 6,000. And the nation's
trade
deficit came in at a-worse-than-expected $42.5 billion, while the University
of
Michigan Consumer Sentiment Index for February ended up far below market
expectations, at 93.1 versus a consensus target of 103.3.
A shaky end to a once-promising week.
Much has been written over the years about the impact -- or lack thereof
-- on
a company's stock price when that firm is added to or deleted from the
Standard
& Poor's 500 index. After all, an estimated 10% to 12% of all equity
investment
dollars are indexed, more to the S&P 500 than any other measure.
A new study by Marc Goedhart and Regis Huc, both employees of McKinsey,
the
giant management-consulting firm, suggest that there certainly is an
impact, but
only a short-lived one. The pair looked at the performance of 103 U.S.
stocks
added to the S&P 500 since December 1999 and 41 U.S. companies booted
from the
benchmark index over the same period (excluding those exiled because
of mergers
or takeovers).
The study specifically set out to measure the "abnormal" impact
by comparing
actual changes after the S&P announcement with the underlying trend
that existed
before that. For instance, if a stock had been outperforming the broad
market by
5%, a 5% gain would be used as the base line to measure the impact.
Their findings: Companies being eliminated from the index, which during
this
period include troubled operations such as HealthSouth, Kmart and Polaroid,
saw
their stocks fall, on average, by 17% from the day of the announcement
of the
change until the date on which it took place. But 40 days later, the
stocks had
made up all of that ground. The same applied on the plus side. Here,
stocks of
such firms as eBay, Electronic Arts and United Parcel Service jumped,
on
average, 5% on the news, only to give up that gain over the next 40
days.
"The market is smart and, given time, gets things right,"
says Goedhart.
"Ultimately, the price of a stock is determined not by whether
or not it is in
an index, but by its long-term prospects."
But this analysis is challenged by some who insist there is a greater
impact
-- though perhaps not necessarily in the period covered by the study,
which
included the dying days of the tech boom and subsequent crash.
"Academic studies are just plain wrong on this score," says
Leo Guzman,
president of an institutional brokerage firm doing basket trades for
index
managers. "There is no question that there is an effect, both beneficial
and
negative, and that it does last. Being in or out of an index like the
500
changes liquidity and volume. You might have to take a longer view but
the
impact is there."
Dell computer's fourth-quarter earnings on Thursday were everything
the market
expected, and more, although by the stock's initial downward move in
after-hours
trading, that wasn't quickly apparent.
But the stock moved up in Friday's regular trading session, after investors
mulled the news and found it good. The Texas-based computer maker made
29 cents
a share, versus the consensus target of 28 cents and a year-earlier
23 cents.
Increased corporate information-technology spending resulted in strong
sales of
servers and data-storage equipment, hinting that corporate demand is
finally
again moving higher after three years of slump. Clearly, although
Hewlett-Packard and Dell are locked in battle for the title of No. 1
PC seller,
Dell remains the driving force in the industry with margins that are
the envy of
all and a direct sales model that continues to deliver.
All of which leads us to examine just where this leaves Gateway, which
was
once bigger than Dell but which has fallen on hard times, with its stock
tumbling from over 80 in late 1999 to under 5 now. Investors clearly
don't rate
highly the loss-making company's chances of making a comeback. And they
are
probably right, if one looks only at the PC direct-sales channel.
But since 2001, the company also has been selling consumer electronics,
including LCD TVs, digital cameras, camcorders, MP3 players and the
like -- and
starting in 2002, it came out with a line of expensive (and high-margin)
Gateway-branded plasma-screen TVs. Up to now, these products have moved
through
the direct Internet and phone channels, as well as through Gateway's
stores.
This consumer-electronics business delivered $268 million -- 31% --
of the
company's $875 million in fourth-quarter '03 revenue.
But now Gateway has done something that really might be very clever:
agreeing
to buy eMachines, a retailer of low-end PCs that nearly went belly-up
in the
tech crash but which later prospered by distributing computers through
such
third-party retailers as Best Buy and Circuit City. In effect, Gateway
has
increased its bricks-and-mortar points of distribution for both PCs
and
electronics from 190 Gateway stores to more than 7,000 outlets.
Of course, the big electronics chains might balk at selling the same
product
offered in Gateway stores. But the conflict could be minimized if Gateway
closes
its own chain, as some suspect it may, or limits sales there to some
high-end
products but continues to sell over the Internet. Moreover, eMachines'
CEO,
Wayne Inouye, will become the boss of Gateway. And as a former senior
vice
president for electronics sales at Best Buy, he surely knows how to
smooth
ruffled retail feathers.
In support of the Gateway comeback is the growing belief that the direct-sales
channel exemplified by Dell might not offer quite as much growth as
does
Gateway's new two-tiered strategy. In a new study, IDC analyst Weili
Su argues
that "innovation in the consumer electronics market is outpacing
the knowledge
and capabilities of the average consumer," escalating the need
for face-to-face
hand-holding during sales and post-sales service.
Digital convergence is on the verge of becoming a reality, offering
the
potential to tie together wirelessly everything in the home from computers
to
TVs to burglar alarms and heating controls. But making everything work
together
can be daunting. "This is a case of technology outpacing the comfort
zone of the
consumer," says Su. She argues that Gateway is one of the companies
best-positioned to benefit from the trend. At the very least, if Su's
right,
this might make Gateway a takeover target for Dell, HP or even Sony.
In the auto business, January is normally the slowest sales month, so
too much
shouldn't not be read into last month's numbers. Still, they weren't
good. While
light-vehicle sales jumped 3.2%, to a seasonally adjusted annual selling
rate of
16.8 million vehicles, up from 16.2 million a year ago, it should have
been
better. After all, the 2003 period had borne the impact of pre-Iraq
war jitters,
and economic growth and consumer confidence have both risen in the past
six
months.
What's more, even
that small gain didn't flow to Detroit. True, General Motors
boosted sales by 1.8%, but only by keeping incentives high. At Ford,
the same
generous incentive strategy delivered a 5.6% sales drop, despite strong
demand
for the new F-150 truck. The big winner, no surprise, was Toyota, with
a 20%
jump in sales.
All of which suggests that 2004 is going to be another bloody year.
The big
auto players will be launching more than 60 new models, the highest
number in
years, which implies a continued high level of price incentives. That,
in turn,
means more cost-cutting -- and more pressure on auto suppliers.
That brings us to the nation's two top makers of aluminum wheels, Superior
Industries and Hayes Lemmerz. Though they are in the same business,
they have
very different histories, stock performances and market valuations --
so
different, that one is likely out of whack.
The loss-making Hayes, which emerged from bankruptcy last year, has
seen its
stock soar to 18 from 11 in the past seven months, But it still trades
at a mere
0.25 times 2003 sales. Shares of the profitable Superior, in contrast,
have slid
from about 41 to 36 in the same span. Yet even after this drop, Superior
sells
at a price-earnings ratio of 13 -- not cheap for an auto supplier --
and at
about 1.3 times 2003 sales, a valuation that some argue reflects its
superior
profit margins, long among the highest of any auto supplier.
But the company is now becoming the target of short-sellers, partly
because it
recently lowered expectations for first-quarter 2004 earnings. But the
big
negative is the looming threat from China. The Asian giant now can produce
seven
million alloy wheels a year; by 2010, it plans to have the capacity
to build 20
million annually. That could triple its current 5% share of the North
American
market. And it could give GM and Ford another cudgel to beat down prices
and
margins.
The world wine glut that Barron's predicted more than a half-decade
ago has
worsened. After large wine-grape yields in 2002, reports from California
suggest
that 2003 was another bumper year, and wine grapes are plentiful in
Chile,
Argentina and Australia. Premium wine makers, who once thought their
names would
allow them to cling to high margins, are coming to terms with the reality
of
excess supply.
Few of the really prestigious brands have cut prices, since to do so
would
damage their products' snob appeal. Rather, they've been bottling less
and
taking the excess and selling it under new labels priced far more modestly.
Result: Buyers are paying $15 for wines that once would have commanded
$35.
Where does this leave the only remaining U.S. publicly traded winemaker
of any
size, Constellation Brands? The company, whose stock has risen from
22 last
April to 35 now, gets about 70% of its revenue and 60% of its operating
profit
from wine -- and the remainder from importing and distributing beers
such as
Mexico's Corona.
As a buyer of wholesale wine, the company will obviously benefit from
lower
prices. But as a seller of low-priced jug wines, it has to be hurt by
increased
high- quality competition. Finally, as the owner of Australia's largest
wine
maker, it will be hurt by the high Aussie dollar. In sum, with a P/E
of 13,
based on its projected fiscal 2004 net of $2.70 a share, the prospects
for
Constellation's shares hardly seem worth drinking to.
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