Monday, July 27, 2009

Beat it!

Greetings good citizen,

Much of the ‘optimism’ behind rising stock values is being driven not by increased sales but by merely ‘beating expectations’. Roughly half of all market participants reporting so far have ‘beat expectations’, while overall sales are down roughly 30%.

Worse, many companies are ‘beating expectations’ by slashing costs, a perpetual exercise in ‘right-sizing’ that will damage the company’s profitability once demand returns…not that anyone honestly expects that to happen anytime soon.

Naturally, there is a limit to how much a company can slash and remain viable. If the vendors you’ve wrung price concessions out of don’t start seeing orders, sizable ones, pretty damn soon, they’re likely to re-price before accepting a smaller order. Smart vendors will include retroactive price increases if the order quantity drops once the order is placed.

Sadly, most vendors are ‘captives’ of large producers and those large producers know it. The vendor may have dozens of other customers but most of their ‘capacity’ is devoted to the ‘major customer’…which is to point out that the vendor (usually) cannot survive on the volume of work sent in by their ‘minor’ customers.

Most vendors ‘try’ to diversify their customer base but few succeed. Resources are too scarce and commit dates too unyielding.

Here lies purchasing agent hell but I digress…

Onward to tonight’s offering

Earnings solid but profits are soft

Positive earnings have helped stock markets rally this year despite the recession.

Published: July 26, 2009

If the key to happiness is low expectations, then stock investors must be over the moon. More than a third of the companies in the Standard & Poor’s 500-stock index have reported second-quarter earnings. While overall profits were down by about a third from a year earlier, more than three-quarters of the companies beat analysts’ expectations, according to Thomson Reuters. That is on track to be the highest ratio ever. [This begs the question of if we are dealing with nitwit analysts or nitwit investors…or both!]

Investors should not get ahead of themselves, however. Optimism that companies are handling tough times better than many had predicted has helped lift the S.& P. 500 index by more than 20 percent since late March. Yet the foundations of a sustainable recovery look shaky. Nonfinancial companies have managed to increase earnings mostly by sharply cutting costs. Manufacturing and trade inventories have been falling all year, according to the Commerce Department.

The relatively quick and easy fixes of the last quarter will be harder to replicate as time goes on. If companies cut too deeply, eventually nobody will be there to answer the phone. Inventories sink to the minimum levels required to do business.

What companies will need is revenue growth, which is closely tied to economic growth. This is where the news is worrisome. At the S.& P. 500 companies that have reported so far, revenue shrank 2 percent, on average, from the second quarter last year.

A rise in spending by American consumers and businesses that might increase revenue does not look imminent. Companies are planning further cutbacks in both employees and capital expenditures, according to a recent National Association for Business Economics survey. That probably means lower sales of everything from clothes to power plants. Also, consumers and businesses are squirreling away cash, so even when spending does turn up, the rebound will be slow.

Combined with more optimistic forecasts from analysts, all this suggests that expectations will be much tougher to beat the next earnings season. Unless businesses and consumers open their pocketbooks soon, the stock market rally could easily falter.

Backed-Up I.P.O.’s

When will European initial public offerings bounce back? The market for new stock issues has been virtually shut for over a year. Companies raised just 465 million euros ($661 million) in the first half of 2009 — a pittance compared to the billions in recent years. Yet bankers are back on the marketing trail, pitching furiously. Investors, they say, are warming up to risk. Add to the mix a backlog of companies waiting to go public, and the stars are aligning for a return of I.P.O.’s after the summer break. [Bizarrely, brokers are no longer constrained to make sure a given company/business plan is viable before offering them for sale to the investing public. ‘Buyer beware’ is the new watchword of the street as the now publicly traded investment houses have lost their concern for protecting their clients.]

European companies are taking their cues from the United States, Brazil and Asia, where the market has already thawed. Brazilian companies, for example, raised $6 billion in the first half of the year. In Europe, asset managers have so far concentrated on handing money over to already-listed companies in secondary offerings.

On the supply side, there is a backlog of companies waiting to go public. Private equity companies are looking to exit investments in companies via I.P.O.’s. The pipeline is slowly filling up. Yoox, an international online fashion retailer, wants to list at the end of this year or next. In theory, no industries are off limits, say bankers, as long as companies have powerful brands or are market leaders — and provided they can demonstrate that their earnings have bottomed. In practice, regulated and less cyclical sectors, like renewable energy, might have an easier time.

The biggest problem seems to be valuation. Investors will be cautious at first, and will scrutinize new issues carefully. For highly indebted companies owned by private equity firms, this may be a problem. Low valuations could make it difficult for existing owners to turn a profit.

That said, the market seems likely to reopen in the fall. If history is any guide, as soon as a window opens, companies will try to dash through it. Given that it typically takes three to six months to ready a company for an I.P.O., the real flood may not arrive until early next year. At that point, the risk could be a glut of I.P.O.’s. But that is not a worry for today.

Once again we encounter a ‘typical’ MSM piece that starts off with ‘doom and gloom’ and transitions to ‘happy talk’. A lot of economies have their hopes pinned to ‘alternative energy’ but there aren’t enough buyers of these products to keep even the best capitalized manufacturer in a steady income stream.

Let us turn our attention for a moment to the bone-dry I.P.O. markets. While there could potentially be an economy saving innovation waiting to go public, it’s not likely in our highly inter-connected world.

One of the most fleeting things in the world these days is a ‘secret’ and this is especially true of business secrets.

That’s not to say that something won’t be held out to the public as ‘the next big thing’ but somehow I don’t think a next generation I-Phone or another computer operating system is going to ‘save the global economy’.

So consider the ‘closing argument’ here as an ‘advertisement’ for a pending flood of I.P.O.’s that will surface around the first of the year and serve as additional ‘eyewash’ for a still foundering global economy…

Thanks for letting me inside your head,


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