Yesterday FDA approved the AMGN's Vectibix as a late stage colorectal cancer treatment. This marks the company's first attempt to capture a piece of fast growing oncology drug market. Ahead of the anticipated announcement, the stock made an advance from low $68 to mid $72. Frankly, I expected a larger jump in the share price upon FDA approval. However, investors seems to be a little disappointed by the pricing of the drug, which is about $8000 per month and roughly 20% lower than the competitor drug made by Imclone. I believe that AMGN has priced Vectibix very competitively to win the market share fast and potentially cover all the patients under the Medicare D program which has toughened up its efforts to cut cost.
Vectibix is an antibody which works by blocking a protein called epidermal growth factor that helps tumors grow. While Genentech's drug Avastin combats cancer cells by choking blood flow to malignant tumors, it does not shrink the already existing tumors. Once the cancer cells have grown and spread to other parts of the body, Avastin alone is not sufficient. Vectibix helps to block further growth of the tumor and even shrink it in some instances. As such, it can be a powerful cancer antibody that is very effective by itself or along with DNA's Avastin. Vectibix is initially approved for the late stage colorectal cancer with an estimated potential of generating 700 to 800 mil in revenue. However, it is also being currently evaluated for treatment of early stage colorectal cancer along with Avastin. Trial data for early stage treatment can be available as early as Jan of 2007. In case of positive trial outcome, Vectibix then becomes a multi-billion dollar revenue generator for AMGN. I expect AMGN to continue to pursue Vectibix in other cancer applications such as prostate, breast, lung, brain, and gastrointestinal.
I would like to remind you Vectibix is merely a beginning in the oncology market for AMGN. There will be continued flow of news on the trial outcome for AMGN 706, AMGN 162, and AMGN 531 in mid to late stage developmental efforts and any positive outcome may continue to excite the investors as AMGN makes strong efforts in the cancer related market.
One remaining overhang that is still concerning the investors is the litigation against Roche which is trying to enter AMGN's highly profitable EPO market. This litigation is moving along swiftly and we may hear soon on the status of the litigation as early as late Oct. Smithbarney views the chance for AMGN to defend its patents in EPO franchise against Roche favorably due to its extensive patent portfolio. AMGN has to show Roche infringes on any of the single patent items to thwart the Roche's advance into the US EPO market. As such, I think the litigation issue may be resolved quickly in favor of AMGN.
Biotech sector is heading into seasonally strong period of winter. I expect over the next three months, many medical and oncology conferences will highlight the positive trial data for AMGN's existing oncology product pipeline. As uncertainty over the patent litigation resolves and as the biotech sector sees influx of the money rotated away from the commodity and energy sector, I see AMGN heading higher from the current level. Due to its low valuation, I believe AMGN has relatively low downside risk and from the risk to award point of view, it is a definite buy. I believe that those investors who stay patient with the stock will be rewarded handsomely in the future. I will be a buyer at the current level at $72 and a change.
Thursday, September 28, 2006
Tuesday, September 19, 2006
Is story of high energy and commodity price continuing?
The oil and commodity prices have dipped since reaching peak value in May of this year. Since the big correction in May, oil and many commodity names crept higher towards their highs in set in May, only to see another sharp correction this month. Jim Rogers, a famous commodity bull, cites the commodity bull market is far from being over. According to him, the typical bull cycle in the commodity market lasts 10 to 15 years. We are only into sixth years of commodity bull cycle. Hence the game is in only 4 or 5th inning and there are still plenty of innings left to be played. In addition, many famous oil experts contend that oil price will head back up to $80, if not $100. I tend to disagree with them. Although oil and commodity can snap back to higher prices from the current level, I think it is now a trading play at best. In my opinion, the price of the oil and many metal commodities will be confined to the trading range, causing stocks in these markets to behave in a similar manner. In the meanwhile, more supply of the oil and commodity can come online from the record exploration and mining activities. And eventually a few years from now, we may see a significant pullback in the price of commodity and oil depending on the extent of the global economic slowdown.
It is all about the supply and demand.
The way in which commodity boom and bust cycle occurs is simple; it is all about the supply and demand. In a strange way, boom starts because of the bust and bust starts because of the boom. Here goes the story. Due to certain economic events, demand of the commodity and oil goes down. The lower price of the oil and the commodities follows. Because of the lower prices, there is no incentive for capital investment in the mining and oil exploration. Due to lack of the investment in the commodity and oil infrastructure, the economy is unable to respond to the pickup in the demand. Then, an upturn in the economy occurs. The price is raised as the demand outstrips the supply. As the price of the oil and commodity rises, there is more incentive to increase oil exploration and mining activities. This results in a heavy infrastructure investment to increase the supply. In the meanwhile, high prices of oil and commodity curbs the consumption rate as economy look for the alternative solutions. Increased supply resulting from more exploration and mining activities and decreased demand due to alternate solutions or economic downturn bring down the oil and commodity prices. Falling prices accelerate as the economy contracts, creating the bust cycle. Then the capital investment in the oil and commodity industry is sharply cut, setting the economy nicely for another oil and commodity upturn.
But there is more to simple supply and demand picture for current boom cycle.
The start of the current boom cycle in the energy and commodity coincides with the burst of the tech bubble in 2000. In 2000, oil was priced at slightly less than $28 a barrel. The oil has risen to near $80 a month ago. The precious and basic metals including gold, silver, copper, zinc, Al, titanium, ect has seen a meteoric rise and their associated stocks has risen just as much (1000% in many cases).
Fed popped the tech bubble with mean doses of interest rate hike in early 2000. Burst of the tech bubble actually killed the economy, creating uncomfortably high unemployment rate. Then the world economy got another jolt from the terrorist incident on Sept 11th, 2002. Fed then took the rate to all time low just above 1%. The US government also cut the tax rate to revive the nation's economy. The rest of the world also brought their national interest rate to align it more closely to the US economy. As a result, the world economy lowered the interest rate to an unprecedented level.
The low interest rate resulted in the worldwide boom of the construction market. As it was so cheap to own the house, the demand for the housing went up. People took more liquidity out of their homes to buy more homes. And soon speculation in the housing market was rampant. Condos and town homes in Las Vegas and dessert Arizona was "hot" thing which was unimaginable a few years ago.
The lowest interest rate globally pumped in record amount of the speculative money into the world financial markets. Much speculative money in the Asian markets and from the hedgie fund in the US went into the energy and commodity trading. When the energy and commodity prices soared due to increasing demand from China, India and other emerging market countries, the speculators got more speculative and further drove up the energy and commodity names. Finally, natural disasters such as hurricane Katrina and political uncertainties hanging over Iran, Iraq, North Korea, India, Venezuela, and Nigeria started to influence commodity and energy prices. Perception is that there is no buffer left between the demand and supply and the disruption of any production source will lead to large imbalance between the supply and demand, creating more and more price appreciation. You have to note that these political uncertainties and natural disasters are of nothing new. But as these markets heat up and get more speculative, people pay more and more attention to trade the stocks. This is why it is talked about more, reminiscent of the speculative top.
Will the story continue?
Over the last decade, the US and the world economy has achieved stunning improvement in increasing productivity. Despite the higher oil and commodity prices, the economy was able to absorb the cost of the higher commodity and energy prices without seeing significant uptick in the inflationary pressure. Higher productivity allowed the economy to expand and consume more and more oil and commodity. And consumers saw no tangible increase in the price of the goods. However, corporate America has been very lazy in investing in technology infrastructure upgrade during last 5 years and the productivity number is now showing signs of leveling off (last 3 months). While core CPI and PPI remained tame early this year, CPI and PPI numbers are finally falling outside the Fed comfort zone of 0.2% increase in last three months. Flatlining productivity is now no longer able to offset increasing energy and commodity prices. This implies further increase in the commodity and energy price is likely to result in higher PPI and CPI number going forward. From this point on, Fed is likely to fight higher energy and commodity prices with the additional hike of the interest rate. Bernanke has been keen on fighting the inflation and he cites rising commodity and energy cost as one of the primary risks for the higher inflation. Consequently, any further uptick of the oil and commodity prices is likely to encounter higher interest rate as Fed attempts to cool hot energy and commodity market. This trend will limit further upside for the oil and commodity market.
Another factor that also does not bode well for the oil and commodity sector is the trend for the higher interest rate globally. While the US is about to end one of the longest rate hike in the US history, the rest of the world especially those in the emerging market is likely to further raise interest rate near term. Over last three months, India, Japan, ECB (European Central Bank), Korea, China, Australia, England, ect has been raising interest rates to fight inflation. China especially is seeing greater risk as its economy is spinning out of the control. China is expected to hike interest rate and end its floating currency policy which will result in slower export business and more timid growth of the economy. This may be essential for China to avoid hard landing of the economy after 2008 Olympic. Japan is finally terminating 0% interest rate policy as the economy gains firmer traction. Japan may implement additional interest rate hike if energy and commodity prices stays persistently high to avoid the inflation risk. Korea has been raising rates already several times this year to slow down the real estate market which has attained the status of bubble. ECB pledges to fight higher energy and commodity prices that cause higher inflation. Rising interest rate globally is expected to dampen the economic activities and will lead to reduced demand for the oil and commodities. More importantly, higher interest rate sucks out the liquidity and speculation that may have supported a huge run in the energy and commodity market. I think wall street will see more risks with the energy and commodity names and as they flock out of these issues, selling pressure will build as some hedgies are heavily leveraged in the energy and commodity markets.
How the commodity and oil stocks may go down?
The correction in these stocks may occur in two phases. First, dissipation of the speculative premium may occur. Oil and commodity names have much risks premium built into the stock price, associated with the political uncertainties in the Middle East, Latin America, Russia, and Africa. Also oils stocks bet on the supply disruption due to natural disasters such as hurricane. Any concerns over the bad weather and political turmoil abroad wanes, we are likely to see these premiums disappear, pushing these stocks lower. However, demand for the oil and commodity will not go down over night. In fact, energy and commodity demand story from China and India is real so the stock could see support and see buying interest once correction of the speculative premium occurs. However, rising interest rate and slowing economies in the US and abroad is likely to put a ceiling on the extent of the rally. Consequently, oil and commodity stocks could be caught in the trading range for sometime. But bullish upward trend may be over for these stocks. I think the price corrections we are seeing currently in these issues are the dissipation of the speculative premiums, not the faltering demand of the oil and commodity.
On a longer term, we may see more supplies of the oil and metal commodities come online stemming from the torrid exploration and mining activities. In addition, emergence of the alternative energy source could reduce the oil demand going forward. I expect the US and world economy will achieve slower growth rate as interest rate near 0% become fainted memory. Reduced demand along with the more supply will ultimately bring out the bust cycle. But that may be still two to three years from now.
It is all about the supply and demand.
The way in which commodity boom and bust cycle occurs is simple; it is all about the supply and demand. In a strange way, boom starts because of the bust and bust starts because of the boom. Here goes the story. Due to certain economic events, demand of the commodity and oil goes down. The lower price of the oil and the commodities follows. Because of the lower prices, there is no incentive for capital investment in the mining and oil exploration. Due to lack of the investment in the commodity and oil infrastructure, the economy is unable to respond to the pickup in the demand. Then, an upturn in the economy occurs. The price is raised as the demand outstrips the supply. As the price of the oil and commodity rises, there is more incentive to increase oil exploration and mining activities. This results in a heavy infrastructure investment to increase the supply. In the meanwhile, high prices of oil and commodity curbs the consumption rate as economy look for the alternative solutions. Increased supply resulting from more exploration and mining activities and decreased demand due to alternate solutions or economic downturn bring down the oil and commodity prices. Falling prices accelerate as the economy contracts, creating the bust cycle. Then the capital investment in the oil and commodity industry is sharply cut, setting the economy nicely for another oil and commodity upturn.
But there is more to simple supply and demand picture for current boom cycle.
The start of the current boom cycle in the energy and commodity coincides with the burst of the tech bubble in 2000. In 2000, oil was priced at slightly less than $28 a barrel. The oil has risen to near $80 a month ago. The precious and basic metals including gold, silver, copper, zinc, Al, titanium, ect has seen a meteoric rise and their associated stocks has risen just as much (1000% in many cases).
Fed popped the tech bubble with mean doses of interest rate hike in early 2000. Burst of the tech bubble actually killed the economy, creating uncomfortably high unemployment rate. Then the world economy got another jolt from the terrorist incident on Sept 11th, 2002. Fed then took the rate to all time low just above 1%. The US government also cut the tax rate to revive the nation's economy. The rest of the world also brought their national interest rate to align it more closely to the US economy. As a result, the world economy lowered the interest rate to an unprecedented level.
The low interest rate resulted in the worldwide boom of the construction market. As it was so cheap to own the house, the demand for the housing went up. People took more liquidity out of their homes to buy more homes. And soon speculation in the housing market was rampant. Condos and town homes in Las Vegas and dessert Arizona was "hot" thing which was unimaginable a few years ago.
The lowest interest rate globally pumped in record amount of the speculative money into the world financial markets. Much speculative money in the Asian markets and from the hedgie fund in the US went into the energy and commodity trading. When the energy and commodity prices soared due to increasing demand from China, India and other emerging market countries, the speculators got more speculative and further drove up the energy and commodity names. Finally, natural disasters such as hurricane Katrina and political uncertainties hanging over Iran, Iraq, North Korea, India, Venezuela, and Nigeria started to influence commodity and energy prices. Perception is that there is no buffer left between the demand and supply and the disruption of any production source will lead to large imbalance between the supply and demand, creating more and more price appreciation. You have to note that these political uncertainties and natural disasters are of nothing new. But as these markets heat up and get more speculative, people pay more and more attention to trade the stocks. This is why it is talked about more, reminiscent of the speculative top.
Will the story continue?
Over the last decade, the US and the world economy has achieved stunning improvement in increasing productivity. Despite the higher oil and commodity prices, the economy was able to absorb the cost of the higher commodity and energy prices without seeing significant uptick in the inflationary pressure. Higher productivity allowed the economy to expand and consume more and more oil and commodity. And consumers saw no tangible increase in the price of the goods. However, corporate America has been very lazy in investing in technology infrastructure upgrade during last 5 years and the productivity number is now showing signs of leveling off (last 3 months). While core CPI and PPI remained tame early this year, CPI and PPI numbers are finally falling outside the Fed comfort zone of 0.2% increase in last three months. Flatlining productivity is now no longer able to offset increasing energy and commodity prices. This implies further increase in the commodity and energy price is likely to result in higher PPI and CPI number going forward. From this point on, Fed is likely to fight higher energy and commodity prices with the additional hike of the interest rate. Bernanke has been keen on fighting the inflation and he cites rising commodity and energy cost as one of the primary risks for the higher inflation. Consequently, any further uptick of the oil and commodity prices is likely to encounter higher interest rate as Fed attempts to cool hot energy and commodity market. This trend will limit further upside for the oil and commodity market.
Another factor that also does not bode well for the oil and commodity sector is the trend for the higher interest rate globally. While the US is about to end one of the longest rate hike in the US history, the rest of the world especially those in the emerging market is likely to further raise interest rate near term. Over last three months, India, Japan, ECB (European Central Bank), Korea, China, Australia, England, ect has been raising interest rates to fight inflation. China especially is seeing greater risk as its economy is spinning out of the control. China is expected to hike interest rate and end its floating currency policy which will result in slower export business and more timid growth of the economy. This may be essential for China to avoid hard landing of the economy after 2008 Olympic. Japan is finally terminating 0% interest rate policy as the economy gains firmer traction. Japan may implement additional interest rate hike if energy and commodity prices stays persistently high to avoid the inflation risk. Korea has been raising rates already several times this year to slow down the real estate market which has attained the status of bubble. ECB pledges to fight higher energy and commodity prices that cause higher inflation. Rising interest rate globally is expected to dampen the economic activities and will lead to reduced demand for the oil and commodities. More importantly, higher interest rate sucks out the liquidity and speculation that may have supported a huge run in the energy and commodity market. I think wall street will see more risks with the energy and commodity names and as they flock out of these issues, selling pressure will build as some hedgies are heavily leveraged in the energy and commodity markets.
How the commodity and oil stocks may go down?
The correction in these stocks may occur in two phases. First, dissipation of the speculative premium may occur. Oil and commodity names have much risks premium built into the stock price, associated with the political uncertainties in the Middle East, Latin America, Russia, and Africa. Also oils stocks bet on the supply disruption due to natural disasters such as hurricane. Any concerns over the bad weather and political turmoil abroad wanes, we are likely to see these premiums disappear, pushing these stocks lower. However, demand for the oil and commodity will not go down over night. In fact, energy and commodity demand story from China and India is real so the stock could see support and see buying interest once correction of the speculative premium occurs. However, rising interest rate and slowing economies in the US and abroad is likely to put a ceiling on the extent of the rally. Consequently, oil and commodity stocks could be caught in the trading range for sometime. But bullish upward trend may be over for these stocks. I think the price corrections we are seeing currently in these issues are the dissipation of the speculative premiums, not the faltering demand of the oil and commodity.
On a longer term, we may see more supplies of the oil and metal commodities come online stemming from the torrid exploration and mining activities. In addition, emergence of the alternative energy source could reduce the oil demand going forward. I expect the US and world economy will achieve slower growth rate as interest rate near 0% become fainted memory. Reduced demand along with the more supply will ultimately bring out the bust cycle. But that may be still two to three years from now.
Thursday, September 14, 2006
CPI (Consumer Price Index) will set the tone for the market
CPI number, which measures the inflationary pressure on the consumer front, is released pre-market tomorrow. This number is likely to impact tomorrow trading and beyond in a significant way. The consensus number for the core CPI number is 0.2% increase, excluding the food and energy component. CPI gauges the cost component for the housing rentals (which has seen steady rise), service, as well as the overall price that consumers are seeing for the finished goods. Given that the energy and commodity price has remained persistently high last month prior to this month's correction, we may see core number higher than 0.2% expected. Consequently, I see greater downside risk for the market tomorrow. On the other hand, Fed has been focused on controlling energy and commodity price via higher interest rate. To a certain extent, this has finally occurred this month. As previous Fed's interest rate hikes are yet to be reflected in the economy and moderating oil and commodity alleviates pressure on the inflation, Fed is still likely to stay paused even if the core rate comes in at slightly above the consensus number. In conclusion, I think Fed will stay on the sideline if the core rate comes in at 0.3% or below, while number greater than 0.4% could make Fed think again about hiking the rate further.
From my perspective, at 0.2%, we will have a nice rally. 0.2% ensures that Fed is done and if oil and commodity really tanks, Fed may actually cut rates further as cheaper oil and commodity can have effect of deflation on the consumer front. Also such sentiment may help investors feel better about the consumer spending going forward. Thus, I see further rally in the financials, consumer retailers, battered housing, transportation, techs, and biotechs. Oil and commodity could too rally due to improved confidence that the economy will not enter into recession and hence the demand will not abate rapidly. We could see money rotated out of the defensive names as the investors will likely to take higher risk.
At 0.3%, the market will gyrate back and forth. This number is not high enough to trigger fear but uncomfortable enough for the investors to stay away from being aggressive. As Fed has indicated clearly that it needs lower energy and commodity price to curb inflation, this number may continue to pressure commodity and oil issues.
If CPI comes in above 0.3%, we may be in for a more pain. This will trigger fear that Fed is further raising rates and the faltering economy could weaken significantly and enter into recession. Other than extremely defensive names such as consumer staples and healthcare stocks, you could be broad selling in techs, high PE biotechs, oil and commodity (recession never bodes well oil and commodity), retailers, home builders (you can buy homes with rising rates?), transportation, ect.
I know that this is very difficult environment for the individual investors. And it definitely pays to be diversified (owning both defensive and offensive names) to reduce the risk. Pay closer attention to the economic indicators and make the proper bet on the direction on the economy. Although swings in the stock market can unnerve you, the most profit is made by making the correct guess in an uncertain environment.
From my perspective, at 0.2%, we will have a nice rally. 0.2% ensures that Fed is done and if oil and commodity really tanks, Fed may actually cut rates further as cheaper oil and commodity can have effect of deflation on the consumer front. Also such sentiment may help investors feel better about the consumer spending going forward. Thus, I see further rally in the financials, consumer retailers, battered housing, transportation, techs, and biotechs. Oil and commodity could too rally due to improved confidence that the economy will not enter into recession and hence the demand will not abate rapidly. We could see money rotated out of the defensive names as the investors will likely to take higher risk.
At 0.3%, the market will gyrate back and forth. This number is not high enough to trigger fear but uncomfortable enough for the investors to stay away from being aggressive. As Fed has indicated clearly that it needs lower energy and commodity price to curb inflation, this number may continue to pressure commodity and oil issues.
If CPI comes in above 0.3%, we may be in for a more pain. This will trigger fear that Fed is further raising rates and the faltering economy could weaken significantly and enter into recession. Other than extremely defensive names such as consumer staples and healthcare stocks, you could be broad selling in techs, high PE biotechs, oil and commodity (recession never bodes well oil and commodity), retailers, home builders (you can buy homes with rising rates?), transportation, ect.
I know that this is very difficult environment for the individual investors. And it definitely pays to be diversified (owning both defensive and offensive names) to reduce the risk. Pay closer attention to the economic indicators and make the proper bet on the direction on the economy. Although swings in the stock market can unnerve you, the most profit is made by making the correct guess in an uncertain environment.
Wednesday, September 13, 2006
Look for signs of money rotation
Today, Nasdaq is looking quite nicely. In my opinion, money that is coming out of energy and commodity sector is being rotated into the tech and other beaten down consumer related sectors. In my opinion, there will continue to be outflux of money from the commodity and energy. Most of these money will sit as cash on the sideline until the economy gains firmer traction. However, hedgies and fund managers will look for other opportunities outside the energy and commodity sector.
I think the stocks that we cover in the filthy rich index is poised well to benefit from these trend. Financial stocks have seen some selling pressure lately. The brokerage has been hit hard amid concern over decreasing M&A activities and difficult trading environment. This morning GS reported the earning; although results were down from the previous two hot Q's. it continues to beat the consensus bottom number. Financials amid difficult real estate loan and investing banking environment had lowered expection heading into the earning season. I believe they will come in as expected and are set up nicely for the relief rally. Also, with falling energy price, I just don't see why Fed will raise the rates again. Fed will stand paused and banks and other financials' market multiple may expand.
I also like tech and biotech sector. They have been beaten down. Money are rotated and as people realize that recession will not happen, money rotated from very defensive names and faltering oil and commodity is likely to fuel rally in tech and biotech sector. With MSFT vista possibly generating next PC upgrade cycle, I like tech sectors from here.
Stay consistent with your view. Do not get frustrated by daily market movement. Study the market fundamentals and individual stock names. Jim Cramers is right in that you need to be very diligent in studying what you are investing in order to make money.
I think the stocks that we cover in the filthy rich index is poised well to benefit from these trend. Financial stocks have seen some selling pressure lately. The brokerage has been hit hard amid concern over decreasing M&A activities and difficult trading environment. This morning GS reported the earning; although results were down from the previous two hot Q's. it continues to beat the consensus bottom number. Financials amid difficult real estate loan and investing banking environment had lowered expection heading into the earning season. I believe they will come in as expected and are set up nicely for the relief rally. Also, with falling energy price, I just don't see why Fed will raise the rates again. Fed will stand paused and banks and other financials' market multiple may expand.
I also like tech and biotech sector. They have been beaten down. Money are rotated and as people realize that recession will not happen, money rotated from very defensive names and faltering oil and commodity is likely to fuel rally in tech and biotech sector. With MSFT vista possibly generating next PC upgrade cycle, I like tech sectors from here.
Stay consistent with your view. Do not get frustrated by daily market movement. Study the market fundamentals and individual stock names. Jim Cramers is right in that you need to be very diligent in studying what you are investing in order to make money.
Added Al and X to my commodity short list
I have added X (US Steel) and Al (Alcan) to my short list. So far, I have ATI, N, PD, Al, and X on my commodity list. I am only shorting small number of shares on these names as an initial position. With N, I made have made the mistake as the company could be taken over with higher premium. So if you are interested in shorting commodity names, wait on N before I can look into the company fundamentals. If I can get some time, I will outline how the oil and commodity boom and bust cycle occurs and why this may be a good time to become negative on these issues. Also, as I have promised, I will go over the state of the semiconductor equipment industry and outline why these stocks may be very close to bottom and are getting ready for the next upcycle. My two best pick in the semi-equipment is LRCX and NVLS with NVLS being the top pick.
Monday, September 11, 2006
Going short on metal commodity names
I have decided to go on short on some metal commodity names. Oils have tanked and I see more downside for the oil. Fed Beige book shows slowing economic momentum in the 5 out of 12 districts. It also noted slowing housing and manufacturing sector. Globally interest rates are rising. Inflation in China is concerning many people. China is expected to strengthen Yuan and hike interest rates in the future to slow down the economic expansion. Korea has implemented rate hike several times this year and construction activities in Korea has slowed. US housing market are going to be in deep slump this year. Everyone knows the price of the house is falling. No one is willing to step up and buy the house when the price is falling even for the interested buyers. As the housing market enters seasonally the slowest time of the year (winter), you will see some ugly housing number in the US. This means reduced construction and consumption of the basic materials.
Commodity bulls maintain we may be only half way through the commodity bull cycle. However, there clearly has been much speculation in the commodity market. As the US large cap and other tech issues have lagged the market, hedgies have taken a lot of risks in investing in the emerging markets and jump on the bandwagon of India and China expansion. They all got in and touted the oil and commodity names during last 3 to 4 years. These stocks have soared, some as much as 1000%. Look at any commodity companies and you will see some incredible charts.
Commodity still may be in bull cycle. But the stock price may have outrun the fundamentals as these stocks have high speculation premium. I believe with the recent price fall in the oil, slowing economy in the US and abroad, and prospect of rising interest rate in the emerging markets, the liquidity may not be no longer there to support high commodity stock value as the speculation premium disappears.
I locked in my profit with CTRP in my trading portfolio and with the proceeds, shorted PD, N, and ATI. PD (Phelps Dodge) is the copper commodity names. N (INCO) is the nickel commodity play and ATI (Allegany) is the specialty commodity company such as titanium. Let us see how my trades turn out.
Commodity bulls maintain we may be only half way through the commodity bull cycle. However, there clearly has been much speculation in the commodity market. As the US large cap and other tech issues have lagged the market, hedgies have taken a lot of risks in investing in the emerging markets and jump on the bandwagon of India and China expansion. They all got in and touted the oil and commodity names during last 3 to 4 years. These stocks have soared, some as much as 1000%. Look at any commodity companies and you will see some incredible charts.
Commodity still may be in bull cycle. But the stock price may have outrun the fundamentals as these stocks have high speculation premium. I believe with the recent price fall in the oil, slowing economy in the US and abroad, and prospect of rising interest rate in the emerging markets, the liquidity may not be no longer there to support high commodity stock value as the speculation premium disappears.
I locked in my profit with CTRP in my trading portfolio and with the proceeds, shorted PD, N, and ATI. PD (Phelps Dodge) is the copper commodity names. N (INCO) is the nickel commodity play and ATI (Allegany) is the specialty commodity company such as titanium. Let us see how my trades turn out.
Thursday, September 07, 2006
choppy market but stick with your long term outlook
The market is nervous as we head into seasonally challenging months of September and October. Last two days, two economic indicators are bothering the traders. One is productivity data which seems to be tapering off. Higher productivity is perceived as favorable as increased productivity acts to offset the higher energy and commodity prices and help economy to fight inflationary pressure. Another issue is rising wage, which tends to spur spending, causing inflation.
On the other hand, Fed Beige Book report shows slowing economic momentum in five out of 12 US district. The report cites slowing manufacturing and housing sector. This morning, home builders, KB homes and Beazar homes, pre-announces earning shortfall, noting rising home inventory and very tenuous housing market. These factors are worrying traders that the economy is slowing too much and earning from the US corporations is going to slow.
So again people are looking at the water glass as half empty: economy is slowing and inflation is still out there. Fed will raise again, slowing down the economy even further and killing the corporate earning in the process. In this type of choppy market, traders and hedgies rotate the sectors around according to the daily economic picture. If you are following this, you will more or less end up losing money. I believe that you need to have a long term view and stick with your strategy.
So what is my current belief on the market? I continue to believe that inflation will moderate due to slowing economy. Fed cites cooling housing sector and moderating energy price as mitigating factors for the inflationary pressure in their last meeting. Have you noticed that oil prices are now in $67 range? Barring another nasty hurricane, we are headed even lower with the oil price. I see oil trading below $60 by the early winter. This may save the consumer from tightening up too much for the critical holiday season. I believe that the economy is slowing but not entering into the recession. Slowing housing cools the construction activity and as the demand for the construction materials eases, basic metals and oil price see further downside. Stabilizing energy price and commodity will finally help Fed to terminate interest rate hike. If the economy is slowing enough, then we may actually see rate cut sometime next year.
Yes. We may see earning results not as good as previous Q’s as the economy is currently contracting. So I want you to for now stay with financials in which we may see some support to the downside by the prospect of Fed’s rate cut. Also biotech’s could be good as earning will not depend on the interest rate. If the US companies see slight decelerating earning momentum, investors may look abroad for more robust growth. As such, I think you should get some exposure to China whose economy is showing greater than 10% GDP growth (I will mention more about china later). Finally, techs are out of favor but I continue to look for a bargain in tech sector. Everything goes around in cycle and techs will be in vogue again if Fed pumps more liquidity into the market with rate cut next year.
In this spirit, I will talk about NVLS in my next stock message and show why I this tech stock for the long term.
On the other hand, Fed Beige Book report shows slowing economic momentum in five out of 12 US district. The report cites slowing manufacturing and housing sector. This morning, home builders, KB homes and Beazar homes, pre-announces earning shortfall, noting rising home inventory and very tenuous housing market. These factors are worrying traders that the economy is slowing too much and earning from the US corporations is going to slow.
So again people are looking at the water glass as half empty: economy is slowing and inflation is still out there. Fed will raise again, slowing down the economy even further and killing the corporate earning in the process. In this type of choppy market, traders and hedgies rotate the sectors around according to the daily economic picture. If you are following this, you will more or less end up losing money. I believe that you need to have a long term view and stick with your strategy.
So what is my current belief on the market? I continue to believe that inflation will moderate due to slowing economy. Fed cites cooling housing sector and moderating energy price as mitigating factors for the inflationary pressure in their last meeting. Have you noticed that oil prices are now in $67 range? Barring another nasty hurricane, we are headed even lower with the oil price. I see oil trading below $60 by the early winter. This may save the consumer from tightening up too much for the critical holiday season. I believe that the economy is slowing but not entering into the recession. Slowing housing cools the construction activity and as the demand for the construction materials eases, basic metals and oil price see further downside. Stabilizing energy price and commodity will finally help Fed to terminate interest rate hike. If the economy is slowing enough, then we may actually see rate cut sometime next year.
Yes. We may see earning results not as good as previous Q’s as the economy is currently contracting. So I want you to for now stay with financials in which we may see some support to the downside by the prospect of Fed’s rate cut. Also biotech’s could be good as earning will not depend on the interest rate. If the US companies see slight decelerating earning momentum, investors may look abroad for more robust growth. As such, I think you should get some exposure to China whose economy is showing greater than 10% GDP growth (I will mention more about china later). Finally, techs are out of favor but I continue to look for a bargain in tech sector. Everything goes around in cycle and techs will be in vogue again if Fed pumps more liquidity into the market with rate cut next year.
In this spirit, I will talk about NVLS in my next stock message and show why I this tech stock for the long term.
Tuesday, September 05, 2006
Tivo: Where is the stock headed?
Tivo is a leading DVR (Digital Video Recorder) service company. The company's product revolutionized the way people watch TV. DVR records TV programs and allows to viewers to skip commercials. While watching TV programs, the viewers can also instantly rewind, pause, or play the programs in a slow-motion mode, making the device very useful for the sports program. Once you are used to DVR, watching TV without it is a painful experience. DVR is to watching TV as microwave is to cooking a meal. When you don't have it, you do not know what you are missing. Once you have it, you would feel terribly inconvenienced without it.
For this reason, DVR has been adopted by the TV viewers at a brisk clip. In 2000, any one hardly knew of DVR. Today there are estimated 10 to 12 million DVR users in the US. By 2009, this number is expected to surpass 50 million. The adoption of the DVR is accelerating among many TV viewers. If you knew this trend, you would think that Tivo share would be going higher and higher. However, the reality has been quite the opposite for Tivo. Since reaching the peak around $78 in 2000, the share price has seen sometimes abrupt and other times steady decline. And it has spent most of the time trading between $4 and $8 last two years. Shorts love this stock with 20% of the entire float being shorted today. Whenever the stock reaches the upper trading range, the shorts automatically sell shares, frustrating many long term investors. So why does investor remain so skeptical about Tivo long term future?
It is all about the competition.
Competition is the primary reason for Tivo stock's underperformance. Tivo currently makes money charging monthly subscription fees for DVR service, ranging $10 to $16 depending on your term commitment. Although Tivo was the very first company to market DVR for the mass, the big cable and satellite TV companies saw the big lucrative market in the DVR space and started selling their copycat version to their own subscribers. These big companies have the resources to subsidize the hardware and have the easy product distribution channel to promote their product. Tivo initially have struck a deal with AT&T cable for distribution partnership. Unfortunately, when AT&T cable unit was acquired by Comcast, the partnership fizzled as Comcast pursued its own DVR over Tivo solution. Tivo also had partnership with DirectTV; however, when the contract term ended in early 2006, DirectTV chose to go with its own DVR powered by NDS software. In the meanwhile, other cable companies such as Time Warner, Charter, Cox, and Cablevision started to deploy their own DVR system. In addition, Dish Echostar also had promoted their own DVR units, capturing 4 million DVR subscribers within a few years time frame. All these competition news clobbered the Tivo share price. Long time partner DirectTV going with its own DVR product took the share price from $12 to below $3 and at one point, I thought the company was not going to make it.
The concern of the competitions is legitimate. However, in my opinion, shorts have become too complacent on the prospect of the competition eating away all Tivo's lunch. For example, the news of DirectTV terminating relationship with Tivo has plagued the Tivo shares for last year and a half. Then finally Tivo struck a business partnership with Comcast to deploy Tivo software on Comcast DVR network. In addition, Tivo eked out DVR distribution deal with NCTC independent cable providers with 14 million subscribers. Tivo also announced small trial deal with Cablevision. Yet this news has been largely ignored over DirectTV terminating the business relationship with Tivo.In my opinion, more the shorts become complacent, larger the upside potential becomes for Tivo. Business fundamentals for Tivo have improved to the best level it has seen since 2000. Yet, the market has not properly accounted that into the share price. I believe this has created a good opportunity for us to put some of our speculative money with Tivo.
Improving business fundamentals and catalyst for share price appreciation
Tivo has been a pioneer in developing DVR product and owns extensive patent portfolio in DVR hardware and software. In April of this year, Tivo finally won long battled patent litigation against Dish. The jury has awarded Tivo with roughly 85 mil in damages. Following the lawsuit, DirectTV renewed business relationship with Tivo for existing DirecTV Tivo customers till 2010. Just last month, Texas court granted Tivo the injunction against Dish, forcing Dish to disable all 4 mil affected DVR. Next day, Dish was awarded the stay on the injunction while the higher court gathers all the legal documents to hear the appeal claim by Dish. I expect Dish will be forced to settle once injunction is enforced by the appellate court. This could instantly add 4 mil DVR subscribers available for service revenue and ad market. The settlement will instantly boost the subscriber count to 8.4 mil.
On the heel of possible injunction against Dish, cable providers are now rethinking their strategy to abandon Tivo. Cable providers can now use Tivo to snatch satellite customers who faces the terrible inconvenience once their DVR is no longer working until Dish finds the alternate solution that does not infringe on Tivo's patent. In addition, cable providers themselves face the prospect of litigation from Tivo. In lieu of this prospect, Cox recently announced the Tivo software deal on their DVR network. I expect Tivo to announce additional MSO deals from other cable providers such as Time Warner, Charter, Cablevision, ect. Tivo may also approach DVR manufacturers such as Motorola and Cisco for future business partnership based on recent patent win that validates its extensive IP in the DVR space.
Aside from the favorable litigation outcome that portends further business deals, Tivo also has the product momentum. Long waited HD DVR with internet content viewing capability (series 3) is about to be launched this fall. Also clearly differentiated current product which includes ability to control what kids watch (Kid's zone), internet content availability, and transferring recorded TV programs to mobile devices such as iPod and laptop is likely to create marketing momentum for the existing DVR product line.
And don't forget about the ad market.
If Tivo was a purely a hardware company, I would not be interested in the company as much as I am now. After all, all hardware products are eventually commoditized and if you are a single product hardware company, your chance of making prolonged success is very very slim. But Tivo is a service and ad company and many people don't perceive the company as such. Tivo DVR has a powerful software platform that is able to measure viewer habits, insert pop-up ads while the commercials are being skipped, and offer on-demand commercials for the targeted viewers. Tivo has recently struck business deals with ad agencies. In addition, Tivo also has business relationship with Neilson rating agency which rates TV program.
As DVR becomes more prevalent, more and more commercials will be skipped. Thus, traditional 30 sec TV ad will be highly ineffective as most of these ads will be skipped. Ad money is likely to flow into other methods that will capture the viewer's attention. This change in how the ad money is distributed into different channels is likely to benefit Tivo as the company has a software platform that accommodate several means of inserting ads according to selective TV viewers. Ad revenue has a high margin and large potential. I see Tivo possibly becoming Google of the TV world. Google used its powerful search engine capability to dominate in the internet ad market. Tivo has the best search capability of the TV programs and platform to measure people's viewing habits. As Tivo garners more and more subscribers, ad revenue will become a bigger piece of the overall company revenue. In the future, I expect ad revenue will surpass that of core DVR business.
Latest earning results and secondary stock offering
Last week, Tivo released Aug earning results. Loss came in at 7 cents which is less below expected 14 cents. Net sub adds were low at 1000 as the company pull backed on the marketing expense and mainly relied on Tivo web site to sell its DVR. If you take out the high litigation expenses against Dish, Tivo actually had a earning close to breakeven this Q. Over the next two Qs, I expect Tivo could be more aggressive in marketing its DVR in the seasonally strongest Q of the year. This will show higher loss figures. However, as Comcast deployment which kicks in late this year and additional subs added in the second half of this year may help Tivo to achieve profitability by Aug of next year as the company pulls back on the marketing expenses. So Tivo shows higher loss figures to grow faster in the second half of the year and as it pulls back on the hardware subsidy cost and marketing expenses in the first half, larger sub number helps the company to achieve higher profitability.
After the market close today, Tivo announces secondary offering of additional 8.2 mil shares. I expect the company to use the proceeds to work on engineering cost to help MSO to adopt Tivo software, to fund the more aggressive marketing campaign, and to support litigation expenses against Dish and other companies. Secondary offering will dilute current shares counts and hence could pressure the stock in the near term. However, I want you to use the dip to add your position as I see positive catalysts mentioned above to be the topics to focus as we go forward.
Conclusion
Tivo is a high speculative play. In my opinion, shorts have overstayed its welcome. Expect volatility in the near term. If injunction against Dish is overturned, the stock could shave off another $1 from its current price. However, given the improving outlook, the stock will come back eventually. On the other hand, if injunction against Dish is enforced, I see the stock bleaching above $10. More than 20% of the shares are shorted. Too many analysts have sell or hold rating. Jim Cramer always talks down on the stock. I believe that when everyone hates the stock, you buy the stock. And do not be surprised to see the shares break above $15 when some analysts mildly turn positive.
For this reason, DVR has been adopted by the TV viewers at a brisk clip. In 2000, any one hardly knew of DVR. Today there are estimated 10 to 12 million DVR users in the US. By 2009, this number is expected to surpass 50 million. The adoption of the DVR is accelerating among many TV viewers. If you knew this trend, you would think that Tivo share would be going higher and higher. However, the reality has been quite the opposite for Tivo. Since reaching the peak around $78 in 2000, the share price has seen sometimes abrupt and other times steady decline. And it has spent most of the time trading between $4 and $8 last two years. Shorts love this stock with 20% of the entire float being shorted today. Whenever the stock reaches the upper trading range, the shorts automatically sell shares, frustrating many long term investors. So why does investor remain so skeptical about Tivo long term future?
It is all about the competition.
Competition is the primary reason for Tivo stock's underperformance. Tivo currently makes money charging monthly subscription fees for DVR service, ranging $10 to $16 depending on your term commitment. Although Tivo was the very first company to market DVR for the mass, the big cable and satellite TV companies saw the big lucrative market in the DVR space and started selling their copycat version to their own subscribers. These big companies have the resources to subsidize the hardware and have the easy product distribution channel to promote their product. Tivo initially have struck a deal with AT&T cable for distribution partnership. Unfortunately, when AT&T cable unit was acquired by Comcast, the partnership fizzled as Comcast pursued its own DVR over Tivo solution. Tivo also had partnership with DirectTV; however, when the contract term ended in early 2006, DirectTV chose to go with its own DVR powered by NDS software. In the meanwhile, other cable companies such as Time Warner, Charter, Cox, and Cablevision started to deploy their own DVR system. In addition, Dish Echostar also had promoted their own DVR units, capturing 4 million DVR subscribers within a few years time frame. All these competition news clobbered the Tivo share price. Long time partner DirectTV going with its own DVR product took the share price from $12 to below $3 and at one point, I thought the company was not going to make it.
The concern of the competitions is legitimate. However, in my opinion, shorts have become too complacent on the prospect of the competition eating away all Tivo's lunch. For example, the news of DirectTV terminating relationship with Tivo has plagued the Tivo shares for last year and a half. Then finally Tivo struck a business partnership with Comcast to deploy Tivo software on Comcast DVR network. In addition, Tivo eked out DVR distribution deal with NCTC independent cable providers with 14 million subscribers. Tivo also announced small trial deal with Cablevision. Yet this news has been largely ignored over DirectTV terminating the business relationship with Tivo.In my opinion, more the shorts become complacent, larger the upside potential becomes for Tivo. Business fundamentals for Tivo have improved to the best level it has seen since 2000. Yet, the market has not properly accounted that into the share price. I believe this has created a good opportunity for us to put some of our speculative money with Tivo.
Improving business fundamentals and catalyst for share price appreciation
Tivo has been a pioneer in developing DVR product and owns extensive patent portfolio in DVR hardware and software. In April of this year, Tivo finally won long battled patent litigation against Dish. The jury has awarded Tivo with roughly 85 mil in damages. Following the lawsuit, DirectTV renewed business relationship with Tivo for existing DirecTV Tivo customers till 2010. Just last month, Texas court granted Tivo the injunction against Dish, forcing Dish to disable all 4 mil affected DVR. Next day, Dish was awarded the stay on the injunction while the higher court gathers all the legal documents to hear the appeal claim by Dish. I expect Dish will be forced to settle once injunction is enforced by the appellate court. This could instantly add 4 mil DVR subscribers available for service revenue and ad market. The settlement will instantly boost the subscriber count to 8.4 mil.
On the heel of possible injunction against Dish, cable providers are now rethinking their strategy to abandon Tivo. Cable providers can now use Tivo to snatch satellite customers who faces the terrible inconvenience once their DVR is no longer working until Dish finds the alternate solution that does not infringe on Tivo's patent. In addition, cable providers themselves face the prospect of litigation from Tivo. In lieu of this prospect, Cox recently announced the Tivo software deal on their DVR network. I expect Tivo to announce additional MSO deals from other cable providers such as Time Warner, Charter, Cablevision, ect. Tivo may also approach DVR manufacturers such as Motorola and Cisco for future business partnership based on recent patent win that validates its extensive IP in the DVR space.
Aside from the favorable litigation outcome that portends further business deals, Tivo also has the product momentum. Long waited HD DVR with internet content viewing capability (series 3) is about to be launched this fall. Also clearly differentiated current product which includes ability to control what kids watch (Kid's zone), internet content availability, and transferring recorded TV programs to mobile devices such as iPod and laptop is likely to create marketing momentum for the existing DVR product line.
And don't forget about the ad market.
If Tivo was a purely a hardware company, I would not be interested in the company as much as I am now. After all, all hardware products are eventually commoditized and if you are a single product hardware company, your chance of making prolonged success is very very slim. But Tivo is a service and ad company and many people don't perceive the company as such. Tivo DVR has a powerful software platform that is able to measure viewer habits, insert pop-up ads while the commercials are being skipped, and offer on-demand commercials for the targeted viewers. Tivo has recently struck business deals with ad agencies. In addition, Tivo also has business relationship with Neilson rating agency which rates TV program.
As DVR becomes more prevalent, more and more commercials will be skipped. Thus, traditional 30 sec TV ad will be highly ineffective as most of these ads will be skipped. Ad money is likely to flow into other methods that will capture the viewer's attention. This change in how the ad money is distributed into different channels is likely to benefit Tivo as the company has a software platform that accommodate several means of inserting ads according to selective TV viewers. Ad revenue has a high margin and large potential. I see Tivo possibly becoming Google of the TV world. Google used its powerful search engine capability to dominate in the internet ad market. Tivo has the best search capability of the TV programs and platform to measure people's viewing habits. As Tivo garners more and more subscribers, ad revenue will become a bigger piece of the overall company revenue. In the future, I expect ad revenue will surpass that of core DVR business.
Latest earning results and secondary stock offering
Last week, Tivo released Aug earning results. Loss came in at 7 cents which is less below expected 14 cents. Net sub adds were low at 1000 as the company pull backed on the marketing expense and mainly relied on Tivo web site to sell its DVR. If you take out the high litigation expenses against Dish, Tivo actually had a earning close to breakeven this Q. Over the next two Qs, I expect Tivo could be more aggressive in marketing its DVR in the seasonally strongest Q of the year. This will show higher loss figures. However, as Comcast deployment which kicks in late this year and additional subs added in the second half of this year may help Tivo to achieve profitability by Aug of next year as the company pulls back on the marketing expenses. So Tivo shows higher loss figures to grow faster in the second half of the year and as it pulls back on the hardware subsidy cost and marketing expenses in the first half, larger sub number helps the company to achieve higher profitability.
After the market close today, Tivo announces secondary offering of additional 8.2 mil shares. I expect the company to use the proceeds to work on engineering cost to help MSO to adopt Tivo software, to fund the more aggressive marketing campaign, and to support litigation expenses against Dish and other companies. Secondary offering will dilute current shares counts and hence could pressure the stock in the near term. However, I want you to use the dip to add your position as I see positive catalysts mentioned above to be the topics to focus as we go forward.
Conclusion
Tivo is a high speculative play. In my opinion, shorts have overstayed its welcome. Expect volatility in the near term. If injunction against Dish is overturned, the stock could shave off another $1 from its current price. However, given the improving outlook, the stock will come back eventually. On the other hand, if injunction against Dish is enforced, I see the stock bleaching above $10. More than 20% of the shares are shorted. Too many analysts have sell or hold rating. Jim Cramer always talks down on the stock. I believe that when everyone hates the stock, you buy the stock. And do not be surprised to see the shares break above $15 when some analysts mildly turn positive.
Sunday, September 03, 2006
Economic data suggests moderation not recession
Last two days, the market faced more economic data to assess the state of the economy. Yesterday, the consumer confidence number plunged to the lowest level in 7 months, triggering fear that the economy may be falling harder than expected. Fed FOMC minutes also showed that many of the fed officials were hawkish, citing need for additional tightening. However, Fed official also noted lower energy price and faltering housing sector as mitigating factors for further interest rate increase. In fact, lower energy price and slowing housing market are exactly what has been happening. In addition, preliminary GDP number came in at 2.9%, higher from 2.5% last month, showing the economy is holding. However, this number is still far below mid 5% that we were seeing early summer, indicating cooling economy. Finally closely Fed watched figure non-core PCE deflator (Bernanke's favorite number to gauge the inflationary pressure) came at 0.1% gain, smallest gain this year, indicating comfortable inflation level; yet overall personal spending rose healthy 0.8%, showing consumers are not dead.
All this economic data shows the economy moderating, but not entering recession. I believe that Fed won't be raising the interest rate this year. As more data unfolds into this scenario, I am betting that we are set up for the nice year rally after choppy Sept and Oct. I still expect the economic data to be mixed as the economy makes transition from robust growth into subdued growth. However, I am expecting lower energy price as the year progresses, barring another terrorist attack and Iranian nuclear escalation. In addition, as the housing enters slowest time of the year, I see steep deceleration in the housing market. I was surprised to see that prices of new homes and condos are falling by more than 10% with various incentives (free appliance and floor upgrades). I visited KB home just across the street from where I live and found out that sold homes are coming back to the market; people are actually giving up their deposits and rethinking their decision to buy homes. I see no reason for Fed to raise rate from this point on.
I said this to some of you before: if the rate rises above 5.5%, I am out of the market. With weakening housing market, I believe the economy is a fragile state. But as long as Fed stays at the current rate, I believe it can still manage less hard landing. In this environment and under my thesis of no more rate hike, I like financial sector first. I think they will be the first to benefit from the stable interest rate environment. I also emphasize having exposure to non-cyclical sector such as health care and biotechs. As we get a confirmation from Fed they are done, we can move into tech, retails, and even home builders.
All this economic data shows the economy moderating, but not entering recession. I believe that Fed won't be raising the interest rate this year. As more data unfolds into this scenario, I am betting that we are set up for the nice year rally after choppy Sept and Oct. I still expect the economic data to be mixed as the economy makes transition from robust growth into subdued growth. However, I am expecting lower energy price as the year progresses, barring another terrorist attack and Iranian nuclear escalation. In addition, as the housing enters slowest time of the year, I see steep deceleration in the housing market. I was surprised to see that prices of new homes and condos are falling by more than 10% with various incentives (free appliance and floor upgrades). I visited KB home just across the street from where I live and found out that sold homes are coming back to the market; people are actually giving up their deposits and rethinking their decision to buy homes. I see no reason for Fed to raise rate from this point on.
I said this to some of you before: if the rate rises above 5.5%, I am out of the market. With weakening housing market, I believe the economy is a fragile state. But as long as Fed stays at the current rate, I believe it can still manage less hard landing. In this environment and under my thesis of no more rate hike, I like financial sector first. I think they will be the first to benefit from the stable interest rate environment. I also emphasize having exposure to non-cyclical sector such as health care and biotechs. As we get a confirmation from Fed they are done, we can move into tech, retails, and even home builders.
AMGN: Deserves more respect
Amgen (AMGN) is the second largest biotechnology company behind Genentech (DNA) in terms of the market cap. While DNA stock price has soared by greater than 200% last five years, AMGN stock has practically gotten nowhere. In my opinion, this trend is about to change. I believe there are several pipeline catalysts for the stock in the second half of this year and the stock is poised to outperform the market.
A little bit about the history
AMGN was the first biotech company to successfully develop product pipeline in the research level into a full commercialization stage. The company hit a homerun with Epogen which stimulates the red blood cells for anemia in kidney dialysis and other general anemic conditions. Epogen was soon followed by more advanced drug called Aranesp to treat anemia in the renal and oncology settings. The company continued to push ahead with Neupogen/Neulasta to treat neutropenia (condition lacking white blood cell counts especially after the radiation treatment for the cancer treatment (chemotherapy)). Finally, Enbrel address rheumatoid arthritis, psoriasis, and other inflammatory conditions. Each of these drugs represented multi-billion dollar opportunity and helped the company to achieve current annual revenue run rate of 14.2 Billion. In 1990's, AMGN was a darling of the wall street. Impressed by the strong revenue growth quarter after quarter, the stock soared by 1000% (ten beggar) from 1990 to 2000. However, since 2000, the stock has essentially gotten nowhere. While its large cap biotech peers such as DNA, GENZ, CELG soared last two years, AMGN has essentially done nothing, frustrating the investors.
What is wrong with AMGN?
The answer lies in the product pipeline. In biotechnology, the stock valuation methodology that many analysts use are very different from other sectors such as financials and industrials. With the biotech stocks, people typically look at the possible earning that is two to three years out based on the products in the pipeline. If the pipeline addresses very large untapped market such as cancer, MS, ect, the company PE expands rapidly based on the expected earning 2 to 3 years out. I have seen PE of some biotech companies that focus on the cancer area to approach near 50 when the biotech sector is in favor (CELG and DNA). If the pipeline addresses specialty select area (GENZ), the PE typically ranges low 20 to mid 20. In this sense, for biotech stocks to do well, you need to have very exciting late to mid stage pipeline that will show exciting growth potential two to three years from now.
As AMGN entered year 2000, its pipeline hit the brick wall. There was a big void the in the mid-stage pipeline which portended lack of future blockbuster drug. While the existing drugs continued to generate decent revenue growth and steady earning (EPS) growth, the investors took down the stock multiple from mid 30 to low 20. Recently based on 2007 EPS estimate, AMGN is trading with PE just above 15. This PE is lower than S&P average and more inline with large pharma companies. So AMGN, one of the premier biotechnology companies, is trading like a pharma company. In my opinion, the sentiment on AMGN has gotten too negative and the stock is poised to rally from here on.
Catalysts for the future rally
Heavy R&D expense during last 5 years is finally paying off for AMGN. AMGN now is armed with one of the most potent late to mid-stage pipeline in the company's history. Pmab (which will be market as Vecibix) is likely to hear from FDA on the approval status by end of the September. Pmab will be initially targeted for mid to late stage colorectal cancer treatment. However, it is expected that Pmab will be also used with DNA Avastin to target the early stage colorectal cancer. In addition, AMGN may also explore Pmab's potential in other areas of cancer treatment. Pmab is expected to be another multi-billion dollar drug for AMGN. FDA approval news as well as other clinical trial data on Pmab is likely to please investors in the second half of this year, adding more enthusiasm in viewing AMGN shares.
For the next year, AMGN is likely to release more oncology related drug data with other products in the pipeline. I expect more visibility in the pipeline as the year progresses. In particular, AMGN is targeting AMG 706 for thyroid cancer and Gleevev-refractory, AMG 162 (Denosumab) for post-menopausal osteoporosis, bone cancer, RA, as well as prostate and breast cancer, and AMG 531 for immune thrombocytopenic purpura (ITP). Unlike the previous times which lacked pipeline products in the oncology settings (cancer), AMGN now is armed with very powerful lineup of cancer drugs and may directly challenge DNA in the cancer market. While DNA sees more competitions, AMGN has everything to gain as the company currently does not have strong exposure in the oncology area.
Other catalyst includes the resolution of the pending litigation with Roche. Roche is trying to enter into US anemia market owned by AMGN. The news of Roche entering into the anemia franchise has knocked off good 6 to 7 points off the share price late last year. According to Smith Barney, the firm believes that AMGN has a good chance of defending its patent on EPO franchise. AMGN owns an extensive patent on anemia drugs and it has to show Roche infringes on a single item of multitude of patents that AMGN possesses. The firm noted that the pre-trial processes are going smoothly and there could be a resolution of the patent litigation by the year end. Timely resolution of this patent lawsuit can help share to start a nice rally.
Compelling valuation
AMGN is a lowest PE biotech company that I know. The company is executing well on all operational metrics. Earning continues to grow and I expect the company to do in excess of $4.5 in 2007. The company has recently started very aggressive stock buyback program, adding 5 billion to existing 2 billion (total 7 billion). The share counts could shrink while the earning rises. The company is also outsourcing manufacturing operation abroad (latest expansion in Scotland and Costa Rica) to take advantage of the lower tax rate and to reduce the cost. In the meanwhile, the pipeline has strengthened and as FDA approves AMGN oncology drugs, PE may also expand to lower 20 levels, more consistent with undervalued large cap biotech companies. I am betting AMGN will go from extremely undervalued stock to undervalued stock. As the valuation unfolds, the stock should be trading somewhere between $90 to $100, which is a healthy upside from current price of $68 and a change.
A little bit about the history
AMGN was the first biotech company to successfully develop product pipeline in the research level into a full commercialization stage. The company hit a homerun with Epogen which stimulates the red blood cells for anemia in kidney dialysis and other general anemic conditions. Epogen was soon followed by more advanced drug called Aranesp to treat anemia in the renal and oncology settings. The company continued to push ahead with Neupogen/Neulasta to treat neutropenia (condition lacking white blood cell counts especially after the radiation treatment for the cancer treatment (chemotherapy)). Finally, Enbrel address rheumatoid arthritis, psoriasis, and other inflammatory conditions. Each of these drugs represented multi-billion dollar opportunity and helped the company to achieve current annual revenue run rate of 14.2 Billion. In 1990's, AMGN was a darling of the wall street. Impressed by the strong revenue growth quarter after quarter, the stock soared by 1000% (ten beggar) from 1990 to 2000. However, since 2000, the stock has essentially gotten nowhere. While its large cap biotech peers such as DNA, GENZ, CELG soared last two years, AMGN has essentially done nothing, frustrating the investors.
What is wrong with AMGN?
The answer lies in the product pipeline. In biotechnology, the stock valuation methodology that many analysts use are very different from other sectors such as financials and industrials. With the biotech stocks, people typically look at the possible earning that is two to three years out based on the products in the pipeline. If the pipeline addresses very large untapped market such as cancer, MS, ect, the company PE expands rapidly based on the expected earning 2 to 3 years out. I have seen PE of some biotech companies that focus on the cancer area to approach near 50 when the biotech sector is in favor (CELG and DNA). If the pipeline addresses specialty select area (GENZ), the PE typically ranges low 20 to mid 20. In this sense, for biotech stocks to do well, you need to have very exciting late to mid stage pipeline that will show exciting growth potential two to three years from now.
As AMGN entered year 2000, its pipeline hit the brick wall. There was a big void the in the mid-stage pipeline which portended lack of future blockbuster drug. While the existing drugs continued to generate decent revenue growth and steady earning (EPS) growth, the investors took down the stock multiple from mid 30 to low 20. Recently based on 2007 EPS estimate, AMGN is trading with PE just above 15. This PE is lower than S&P average and more inline with large pharma companies. So AMGN, one of the premier biotechnology companies, is trading like a pharma company. In my opinion, the sentiment on AMGN has gotten too negative and the stock is poised to rally from here on.
Catalysts for the future rally
Heavy R&D expense during last 5 years is finally paying off for AMGN. AMGN now is armed with one of the most potent late to mid-stage pipeline in the company's history. Pmab (which will be market as Vecibix) is likely to hear from FDA on the approval status by end of the September. Pmab will be initially targeted for mid to late stage colorectal cancer treatment. However, it is expected that Pmab will be also used with DNA Avastin to target the early stage colorectal cancer. In addition, AMGN may also explore Pmab's potential in other areas of cancer treatment. Pmab is expected to be another multi-billion dollar drug for AMGN. FDA approval news as well as other clinical trial data on Pmab is likely to please investors in the second half of this year, adding more enthusiasm in viewing AMGN shares.
For the next year, AMGN is likely to release more oncology related drug data with other products in the pipeline. I expect more visibility in the pipeline as the year progresses. In particular, AMGN is targeting AMG 706 for thyroid cancer and Gleevev-refractory, AMG 162 (Denosumab) for post-menopausal osteoporosis, bone cancer, RA, as well as prostate and breast cancer, and AMG 531 for immune thrombocytopenic purpura (ITP). Unlike the previous times which lacked pipeline products in the oncology settings (cancer), AMGN now is armed with very powerful lineup of cancer drugs and may directly challenge DNA in the cancer market. While DNA sees more competitions, AMGN has everything to gain as the company currently does not have strong exposure in the oncology area.
Other catalyst includes the resolution of the pending litigation with Roche. Roche is trying to enter into US anemia market owned by AMGN. The news of Roche entering into the anemia franchise has knocked off good 6 to 7 points off the share price late last year. According to Smith Barney, the firm believes that AMGN has a good chance of defending its patent on EPO franchise. AMGN owns an extensive patent on anemia drugs and it has to show Roche infringes on a single item of multitude of patents that AMGN possesses. The firm noted that the pre-trial processes are going smoothly and there could be a resolution of the patent litigation by the year end. Timely resolution of this patent lawsuit can help share to start a nice rally.
Compelling valuation
AMGN is a lowest PE biotech company that I know. The company is executing well on all operational metrics. Earning continues to grow and I expect the company to do in excess of $4.5 in 2007. The company has recently started very aggressive stock buyback program, adding 5 billion to existing 2 billion (total 7 billion). The share counts could shrink while the earning rises. The company is also outsourcing manufacturing operation abroad (latest expansion in Scotland and Costa Rica) to take advantage of the lower tax rate and to reduce the cost. In the meanwhile, the pipeline has strengthened and as FDA approves AMGN oncology drugs, PE may also expand to lower 20 levels, more consistent with undervalued large cap biotech companies. I am betting AMGN will go from extremely undervalued stock to undervalued stock. As the valuation unfolds, the stock should be trading somewhere between $90 to $100, which is a healthy upside from current price of $68 and a change.
JPM: Boring stock with exciting upside
JPM (JP Morgan Chase) is the third largest integrated bank in the US behind Citigroup and Bank of America. JPM participates in several branches of the financial services that range from investment banking, consumer banking, consumer loans, commercial and residential mortgages, as well as credit card business. I believe that JPM is likely to be primary beneficiary of the moderating economy and stabilizing interest rate environment.
Unpleasant History and looming turnaround
JPM was formed by a mega merger between JP Morgan and Chase Bank. The merger initially brought disastrous results for the combine entity. As tech bubble burst in the middle of 2000, investment banking environment deteriorated significantly. JP Morgan and Chase did not share common business operation. The business was simply stitched together with significant overlap in the client base for similar line of investment business. When the clients started to pull back their spending, JP Morgan Chase was hit harder than other investment banking firms. The company started to show significant earning shortfalls and the street lost the confidence in the management team and took the stock price to multi-year low level in late 2002.
The things started to turn around when new CEO Jamie Dimon join the company via Bank One acquisition to expand the consumer banking business. Dimon left Citigroup when he failed to become a CEO to lead the turnaround efforts at Bank One. The Bank One share soared under Jamie Dimon's leadership which emphasizes details and cost cutting in running his business. Simply put, Jamie Dimon has been superb in streamlining the business and maximizing the shareholder return. Last Q results show signs of life for JPM. JPM handily beat the consensus EPS estimate by whopping 12 cents although the guidance was still cautious under the difficult interest rate environment. To me, JPM is being conservative with its guidance and upside to the consensus EPS number exists for the quarter ending in June.
Several areas for business operation efficiency improvement represents substantial upside room for earning leverage
Operational margin and net profit margin of the well-run banks such as Citigroup, Bank of America, and Wells Fargo are well ahead of JPM's number. While operational margin and net profit margin number typically are in the low fifties and high twenties respectively, JPM number is barely above 40% op ex and 21% for net profit. ROE (return on equity) also lags the competitions as well. Ironically, these lags in the operational metrics represent extra rooms for the share price appreciation. In my opinion, current CEO with proven track record of cutting the cost and elevating shareholder equity will be successful in raising performance metrics in par with other large integrated bank such as C and BAC. JPM is currently on the run rate of achieving $4 EPS. Based on this number and closing share price of $45.52, the company is trading with PE slightly higher than 11. Average PE for S&P now stands just above 15 so the stock is cheap on a relative basis.
Now what would happen if JPM is able to improve performance metrics to the level that is inline with its competitors? By analyst estimate, JPM is thought to be making roughly 65 billion for its fiscal year 07. If I apply net profit margin of Citibank (~32%) with the outstanding share count of 3.47 Billion, the company would make approximately $6 a share which is 50% higher than the current EPS of $4. If I multiply extremely conservative PE of 10, assuming continued difficult rate environment, still share price of $60 is possible strictly based on the operational performance improvement. If Fed finally stops interest rate hiking, I believe the PE multiple for the banking sector will expand to 13 to 14 on a forward basis and take the share price to somewhere between $70 to 80 level if the management is indeed successful in streamlining the company operation and make JPM highly profitable entity. The current CEO has been hiring new senior management team, outsourcing operation to India to cut cost, and upgrading the database system to make operations more efficient. Again this is not going to happen overnight and I think investors need to be patient over next two years to see this. However, the bottom-line is that there is a significant share price upside potential from the current level.
Fed is nearly done.
In my opinion, Fed is nearly completed its rate raising cycle. Fed has been aggressively hiking rates for 17 consecutive times to fight inflationary pressure. Finally the economy is showing signs of moderating with steep cooling in the housing and consumer spending related sectors. I believe cooling economy will offset the effect of rising energy and material cost and inflationary pressure will remain in check. At worst case, Fed may have to do a few more tweaking but it appears as though it is almost done with the interest rate hiking. Stabilizing interest rate environment is particularly bullish for large integrated banks. According to research report published by Lehman (08-09-06), large banks tend to outperform the market showing 9% gain three month post completion of rate hike, 20% six months out, 32% one year later, and 69% two years later. In case of pause, large integrated still outperformed the market (in the year 84, 88, 94, and 99). Lehman report also outline that even in the case of the yield inversion, large integrated bank fared well as the investors anticipate the next rate move for Fed is to cut to a lower level. Thus, unless Fed continues to raise rates aggressively, JPM is poised to rise further as Fed is nearing its rate cycle. Additional rate hike by Fed may initially trigger sell-off in the stock; however, I expect economy will decelerate more noticeably thereafter and as investor anticipate the rate cut, the stock price will see a firm support.
Conclusion
Boring stock with great upside potential. Buy it and wait it out. Get paid while you wait with nice dividend that yields 3.00%. If you stick with the stock for a couple of years, you will be pleasantly surprised by amount of money you have made. It is my top pick for 2006 as upside greatly outweighs downside.
Unpleasant History and looming turnaround
JPM was formed by a mega merger between JP Morgan and Chase Bank. The merger initially brought disastrous results for the combine entity. As tech bubble burst in the middle of 2000, investment banking environment deteriorated significantly. JP Morgan and Chase did not share common business operation. The business was simply stitched together with significant overlap in the client base for similar line of investment business. When the clients started to pull back their spending, JP Morgan Chase was hit harder than other investment banking firms. The company started to show significant earning shortfalls and the street lost the confidence in the management team and took the stock price to multi-year low level in late 2002.
The things started to turn around when new CEO Jamie Dimon join the company via Bank One acquisition to expand the consumer banking business. Dimon left Citigroup when he failed to become a CEO to lead the turnaround efforts at Bank One. The Bank One share soared under Jamie Dimon's leadership which emphasizes details and cost cutting in running his business. Simply put, Jamie Dimon has been superb in streamlining the business and maximizing the shareholder return. Last Q results show signs of life for JPM. JPM handily beat the consensus EPS estimate by whopping 12 cents although the guidance was still cautious under the difficult interest rate environment. To me, JPM is being conservative with its guidance and upside to the consensus EPS number exists for the quarter ending in June.
Several areas for business operation efficiency improvement represents substantial upside room for earning leverage
Operational margin and net profit margin of the well-run banks such as Citigroup, Bank of America, and Wells Fargo are well ahead of JPM's number. While operational margin and net profit margin number typically are in the low fifties and high twenties respectively, JPM number is barely above 40% op ex and 21% for net profit. ROE (return on equity) also lags the competitions as well. Ironically, these lags in the operational metrics represent extra rooms for the share price appreciation. In my opinion, current CEO with proven track record of cutting the cost and elevating shareholder equity will be successful in raising performance metrics in par with other large integrated bank such as C and BAC. JPM is currently on the run rate of achieving $4 EPS. Based on this number and closing share price of $45.52, the company is trading with PE slightly higher than 11. Average PE for S&P now stands just above 15 so the stock is cheap on a relative basis.
Now what would happen if JPM is able to improve performance metrics to the level that is inline with its competitors? By analyst estimate, JPM is thought to be making roughly 65 billion for its fiscal year 07. If I apply net profit margin of Citibank (~32%) with the outstanding share count of 3.47 Billion, the company would make approximately $6 a share which is 50% higher than the current EPS of $4. If I multiply extremely conservative PE of 10, assuming continued difficult rate environment, still share price of $60 is possible strictly based on the operational performance improvement. If Fed finally stops interest rate hiking, I believe the PE multiple for the banking sector will expand to 13 to 14 on a forward basis and take the share price to somewhere between $70 to 80 level if the management is indeed successful in streamlining the company operation and make JPM highly profitable entity. The current CEO has been hiring new senior management team, outsourcing operation to India to cut cost, and upgrading the database system to make operations more efficient. Again this is not going to happen overnight and I think investors need to be patient over next two years to see this. However, the bottom-line is that there is a significant share price upside potential from the current level.
Fed is nearly done.
In my opinion, Fed is nearly completed its rate raising cycle. Fed has been aggressively hiking rates for 17 consecutive times to fight inflationary pressure. Finally the economy is showing signs of moderating with steep cooling in the housing and consumer spending related sectors. I believe cooling economy will offset the effect of rising energy and material cost and inflationary pressure will remain in check. At worst case, Fed may have to do a few more tweaking but it appears as though it is almost done with the interest rate hiking. Stabilizing interest rate environment is particularly bullish for large integrated banks. According to research report published by Lehman (08-09-06), large banks tend to outperform the market showing 9% gain three month post completion of rate hike, 20% six months out, 32% one year later, and 69% two years later. In case of pause, large integrated still outperformed the market (in the year 84, 88, 94, and 99). Lehman report also outline that even in the case of the yield inversion, large integrated bank fared well as the investors anticipate the next rate move for Fed is to cut to a lower level. Thus, unless Fed continues to raise rates aggressively, JPM is poised to rise further as Fed is nearing its rate cycle. Additional rate hike by Fed may initially trigger sell-off in the stock; however, I expect economy will decelerate more noticeably thereafter and as investor anticipate the rate cut, the stock price will see a firm support.
Conclusion
Boring stock with great upside potential. Buy it and wait it out. Get paid while you wait with nice dividend that yields 3.00%. If you stick with the stock for a couple of years, you will be pleasantly surprised by amount of money you have made. It is my top pick for 2006 as upside greatly outweighs downside.
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