<THE EVENING NEWS>
Friday, July 17, 1998
DJIA 9337.97 +9.78 (+0.10%) S&P 500 1186.69 +2.67 (+0.23%) Nasdaq 2008.76 +8.20 (+0.41%) Value Line ndx 965.81 +0.24 (+0.02%) 30-Year Bond 105 12/32 -7/32 5.74% Yield
PepsiCo Inc. (NYSE: PEP) popped up $1 9/16 to $39 1/2 after reporting second quarter earnings from continuing operations of $0.33 a share, up from $0.27 last year and in line with estimates. The beverage and snack company said revenues grew 3% and volume growth was up 8% for snacks and 6% for beverages. Pepsi was slated to report earnings next Tuesday but decided to release results early after its shares tumbled 5% on Tuesday on a lower-than-expected increase in June sales at its Frito-Lay snack division. Although Q2 EPS from continuing operations was up 23%, total income rose 19% to $494 million as the company aggressively bought back 21.2 million shares during the quarter. Plus, Pepsi benefited from a lower tax rate, 31.3% versus 36.6% -- what the company calls "astute tax planning." Before taxes, earnings gained 10%. During the quarter, the company completed the launch of its new line of WOW! fat-free snacks, which it says has inspired more enthusiastic calls and letters than any other product in Frito-Lay history. Lehman Brothers raised its rating on Pepsi to "buy" from "outperform," and Prudential reiterated its "buy" rating and a 12-month price target of $51 a share.
Enterprise network hardware, software, and services company Sun Microsystems (Nasdaq: SUNW) gained $2 1/16 to $52 in trading that was more than three times its 30-day average volume after reporting fourth quarter earnings of $0.73 per share (excluding charges). That compares with $0.61 in the year-earlier period and analysts' mean estimate of $0.71. The company said it continues to gain market share, and with $1 billion spent in research and development in the fiscal year just ended, it continues to be "a force to be reckoned with." Sun is benefiting from expected delays in Microsoft's (Nasdaq: MSFT) Windows NT 5 software and Intel's (Nasdaq: INTC) Merced microprocessor as it jockeys for more orders for its computer workstations and servers.
QUICK TAKES: Dell Computer (Nasdaq: DELL) rose $3 13/16 to $117 9/16 after CEO Michael Dell said the company's Internet sales have grown to $6 million a day and that he expects total foreign sales to hit $6 billion this year... Internet networking company Cisco Systems (Nasdaq: CSCO) jumped $4 to $99 3/4 after CS First Boston started coverage with a "strong buy" rating... Broadcast.com (Nasdaq: BCST), formerly AudioNet, tore through the roof, gaining $44 3/4 to $62 3/4 from an initial offering price of $18 per share. The company aggregates and broadcasts streaming media programming on the Web... Boeing (NYSE: BA) climbed $1 1/4 to $50 after the U.S. Export-Import Bank said it will back Russian air carrier Aeroflot's purchase of 10 aircraft from the aerospace and aircraft company.
Lucent Technologies (NYSE: LU) moved up $2 1/8 to $94 7/8 after CS First Boston initiated coverage of the telecommunications equipment company with a "strong buy" rating... Eli Lilly & Co. (NYSE: LLY) added $3 1/8 to $67 9/16 after Lehman Brothers reinitiated coverage on the drug maker with a "buy" rating with a price target of $107... Discount brokerage Charles Schwab (NYSE: SCH) gained $4 7/16 to $41 1/4 after reporting Q2 EPS of $0.28, up from $0.23 in the year-ago period. The Wall Street Journal reported that Schwab's agreement with CS First Boston, which gives Schwab preferred underwriting or selling participation in CSFB-led primary debt offerings, brings the two closer to a merger... Independent software company Sybase Inc. (Nasdaq: SYBS) jumped $1 1/16 to $10 1/16 after reporting Q2 EPS of $0.01, an improvement from last year's loss of $0.23. Analysts had predicted a loss of $0.09.
Enterprise storage systems and software maker EMC Corp. (NYSE: EMC) added $4 3/16 to $52 7/16 after reporting Q2 EPS of $0.36, up from $0.25 a year ago and beating analysts' mean estimate of $0.33... Consumer and business services company Cendant Corp. (NYSE: CD) picked up $7/8 to $15 1/2 as its chairman, Walter Forbes, came under renewed pressure to resign in the wake of the company disclosing accounting fraud at its CUC International business... Avionics components manufacturer DeCrane Aircraft Holdings (Nasdaq: DAHX) took off today, rising $5 1/16 to $22 11/16 after announcing it has agreed to be acquired by Donaldson, Lufkin & Jenrette's (NYSE: DLJ) DLJ Merchant Banking Partners II for $23 a share in cash, a 30% premium to DeCrane's closing price yesterday.
Voice and data transport and network access systems Tellabs Inc. (Nasdaq: TLAB) was up $1 15/16 to $86 11/16 after Merrill Lynch raised it to a "long-term buy" while CS First Boston started coverage with a "strong buy" rating... Enterprise reporting software company Actuate Software Corp. (Nasdaq: ACTU) charged up $7 3/4 to $18 3/4 from an initial offering price of $11... Internet hardware and software company Netopia Inc. (Nasdaq: NTPA) shot up $1 9/16 to $10 1/8 after Business Week's "Inside Wall Street" column quoted a Warburg Dillon Reed analyst as saying the stock could reach $12 this year... Beef and pork producer IBP Inc. (NYSE: IBP) moved up $2 15/16 to $20 7/8 after reporting Q2 EPS of $0.36, beating the First Call mean estimate of $0.26. Goldman Sachs raised its rating on the company to "market perform" from "market underperform."
Anadigics Inc. (Nasdaq: ANAD) climbed $2 1/4 to $20 after Prudential Securities upgraded its rating on the maker of gallium arsenide integrated circuits to "buy" from "hold"... Transaction processing systems maker PAR Technology Corp. (NYSE: PTC) rose $3/4 to $7 1/4 a day after subsidiary ParTech Inc. announced a $2.4 million order from Chick-fil-A Inc... Genetic research systems company Molecular Dynamics (Nasdaq: MDYN) soared $2 1/4 to $12 1/8 after announcing that Genset S.A. (Nasdaq: GENXY) has placed a multi-unit order for its MegaBACE 1000 DNA sequencing systems... Call-center products and services company Aspect Telecommunications (Nasdaq: ASPT) rang up $2 13/16 to $34 3/16 after CS First Boston started coverage of the company with a "buy" rating.
Ardent Software (Nasdaq: ARDT) up $7/8 to $14 3/4; Q2 EPS: $0.18 vs. $0.07 last year; Estimate $0.13
ChiRex Inc. (Nasdaq: CHRX) up $2 1/16 to $18 1/2; Q2 EPS: $0.19 (before charges) vs. $0.15 last year; Estimate: $0.04
Dialogic Corp. (Nasdaq: DLGC) up $5 1/2 to $36 3/8; Q2 EPS: $0.42 vs. $0.29 last year; Estimate: $0.42
Dole Food (NYSE: DOL) up $1 9/16 to $52 1/4; Q2 EPS: $1.35 vs. $1.17 last year; Estimate: $1.31
Fore Systems (Nasdaq: FORE) up $1/8 to $25 1/8; Q1 EPS: $0.14 vs. $0.05 last year; Estimate: $0.13
Inso Corp. (Nasdaq: INSO) up $4 3/8 to $20 1/4; Q2 EPS: $0.05 (before unusual items) vs. $0.03 last year; Estimate: Breakeven
QLogic Corp. (Nasdaq: QLGC) up $13 to $50 1/2; Q1 EPS: $0.52 vs. $0.35 last year; Estimate: $0.43
Veritas Software (Nasdaq: VRTS) up $6 13/16 to $56 13/16; Q2 EPS: $0.21 (before charges) vs. $0.13 last year; Estimate: $0.15
VideoServer Inc. (Nasdaq: VSVR) up $1 3/8 to $14; Q2 EPS: $0.04 vs. $0.02 last year; Estimate: $0.02
Aircraft and defense electronics systems manufacturer Northrop Grumman Corp. (NYSE: NOC) was shot down $6 3/4 to $90 5/8 after the board of fellow defense contractor Lockheed Martin Corp. (NYSE: LMT) decided late yesterday to call off the proposed $10.7 billion merger of the two companies. The decision came after talks about antitrust concerns with the U.S. government, which was opposed to the deal, broke down on Wednesday. Lockheed Martin moved up $1 1/2 to $105 7/16 today. Since the government would have been the merged company's biggest customer, scrapping the deal seemed a better alternative than facing the Feds in court and engendering any animosity. Already, market observers are speculating that Northrop may yet merge with another defense company to stay competitive. But in a conference call today, chairman Kent Kresa said Northrop will "thrive" in the days ahead as an independent company. "We're not for sale and weren't for sale when Lockheed came to us," he said.
Oil exploration and production company Triton Energy (NYSE: OIL) was drilled $9 7/8 to $20 5/8 after the company put to rest some of the recent speculation that it would put itself up for sale. Instead, it sold a 50% interest in its assets in the Gulf of Thailand Joint Development Area to Atlantic Richfield Co. (NYSE: ARC). The company also said its CEO has resigned and that it will take a $160 million restructuring charge over the next two quarters. However, Triton's new interim CEO indicated that it understood shareholders would likely be upset about its inability to find a suitable suitor. "People did expect the sale of the company," Robert Holland told Reuters. His comments suggested that Triton may still evaluate a serious merger offer, should one come down the pike. Moreover, the company effectively raised its profile to potential acquirers today by bringing oil industry insider and current Cooper Cameron Corp. (NYSE: RON) CEO Sheldon Erikson on board as its new chairman.
QUICK CUTS: Shaving products and batteries maker Gillette Co. (NYSE: G) was nicked $2 to $58 3/8 after Merrill Lynch lowered its near-term rating to "accumulate" from "buy"... Power tools maker Black & Decker Corp. (NYSE: BDK) was nailed with a $2 1/2 loss to $62 1/2 after Prudential Securities downgraded the firm to "hold" from "buy" following its fiscal Q2 earnings report. On Thursday, the company reported EPS of $0.57, up from $0.47 a year ago and in line with analysts' expectations... Programmable logic chip maker Xilinx Inc. (Nasdaq: XLNX) was zapped for $4 5/16 to $37 1/16 after reporting fiscal Q1 EPS of $0.35, missing the First Call mean estimate of $0.41. Excluding a $2.6 million start-up loss associated with an investment in a wafer fabrication facility, earnings were sequentially flat at $0.39 per share.
Internet portal company Excite (Nasdaq: XCIT) was down $3 1/4 to $88 3/8 after reporting a Q2 loss of $0.10 per share, knocking the stuffing out of the Street's estimate of a loss of $0.39 per share. However, Lehman Brothers downgraded the stock to "neutral" from "outperform"... Telecommunications network constructor and operator Able Telecom Holdings (Nasdaq: ABTE) fell $1 5/8 to $10 as its mud-slinging battle with investment firm Asensio & Co. continued. Today, Asensio cited Able federal filings and alleged the company would have reported a fiscal Q1 loss if not for a "highly improbable" operating improvement at its recently acquired COMSAT unit.
Wireless telecommunications equipment and software maker Glenayre Technologies (Nasdaq: GEMS) slid $2 1/4 to $9 7/8 after reporting that manufacturing problems and disappointing orders from Asian clients resulted in breakeven fiscal Q2 results compared to the $0.24 per share earned a year ago. The Street had been expecting earnings of $0.15 per share in the quarter... Enterprise resource planning software developer DataWorks Corp. (Nasdaq: DWRX) was knocked down $4 to $8 11/16 after saying its fiscal Q2 EPS will be between $0.05 and $0.08, below the $0.21 the Street had been expecting... Programmable logic device maker Lattice Semiconductor Corp. (Nasdaq: LSCC) fell $1 5/8 to $35 on a Lehman Brothers downgrade to "outperform" from "buy."
Metal-oxide chip maker Atmel Corp. (Nasdaq: ATML) slid $3/4 to $13 7/8 after reporting break-even fiscal Q2 results, missing the Street's estimate of earnings of $0.03 per share in the quarter. The results excluded a $70 million restructuring charge to write down assets and reduce staff... Automated call center technologies company Periphonics Corp. (Nasdaq: PERI) was cut $1 25/32 to $8 15/32 after reporting fiscal Q4 EPS of $0.08, missing the Street's estimate of $0.20... Medical diagnostic systems maker Cytyc Corp. (Nasdaq: CYTC) lost $1 1/2 to $18 3/16 after reporting a fiscal Q2 loss of $0.44 per share, worse than the $0.39 per share loss a year ago and below the Street's forecast of a $0.34 per share loss.
Irish telecommunications billing solutions provider Saville Systems PLC (Nasdaq: SAVLY) was sham-rocked $5 to $33 after saying it will report fiscal Q2 EPS between $0.20 and $0.22, lower than the $0.28 earned last year but in line with the $0.21 First Call mean estimate... Communications chip maker PMC-Sierra (Nasdaq: PMCS) lost $7 to $39 7/8 after reporting fiscal Q2 EPS of $0.29 (before charges), which was in line with the Street's expectations... Insurance holding company PennCorp Financial Group (NYSE: PFG) dropped $2 to $12 after saying it is "not aware" of the reason behind its stock's recent activity. Its shares have tanked 39% since Monday... Coated materials and safety products maker W.H. Brady Co. (Nasdaq: BRCOA) fell $5 3/8 to $22 after saying its fiscal Q4 EPS will be below the $0.40 earned last year.
Chip maker STMicroelectronics (NYSE: STM) lost $5 13/16 to $66 1/8 after reporting fiscal Q2 EPS of $0.69 versus $0.66 last year. However, the firm warned that it will be "difficult" to achieve sequentially higher results in Q3... American Airlines parent AMR Corp. (NYSE: AMR) dropped $5 3/16 to $73 1/2 after being ordered to pay $2.4 million in damages to the family of a victim of an American Airlines plane crash in 1995... Information technology provider and systems integrator Sapient Corp. (Nasdaq: SAPE) fell $4 3/4 to $54 3/8 after Q2 EPS of $0.18, beating the Street's estimate by a penny. However, Morgan Stanley Dean Witter downgraded the company to "neutral" from "outperform."
Return on Invested Capital (Part 1)
Yesterday, Alex Schay linked into his column our standard piece on return on invested capital (ROIC). This has been our standard article on ROIC for about a year and a half now, so maybe it's time to update it and relay what we hope is an improved understanding of the concept.
Return on invested capital is sort of like return on equity (ROE), but greatly improves on it. Return on equity (net income divided by average shareholders' equity in use over the period being looked at) takes into account in the denominator only the net assets in use by the corporation. A major failing in this regard is that certain liabilities mandated by GAAP (Generally Accepted Accounting Principles) reduce in the ROE equation the amount of resources at the company's disposal. Depending on the circumstances, though, these liabilities should not be counted as a reduction in the capital working for the benefit of shareholders. They should be counted as an addition to capital in use by shareholders. That being the case, moving an amount out of liabilities and into owners' equity necessarily increases the denominator of the ROE equation and thus lowers the company's return on equity.
For example, insurance underwriter Cincinnati Financial (Nasdaq: CINF) owns large stakes in bank holding company Fifth/Third Bancorp (Nasdaq: FITB) and telecom services concern ALLTEL Corp. (NYSE: AT), both of which are being carried on its books at market value rather than at cost. Because banks and insurance companies have to mark their investments to market (value them on the balance sheet at market value), they also have to record a liability for taxes that would have to be paid if they were to liquidate the holdings. This liability is called a "deferred liability," because payment (or realization) of the liability is deferred until realization of the gain takes place. For CinFin, the difference between the cost and market value of these investments at year-end was $2.78 billion. That means there's a deferred tax liability on the books equal to its tax rate times the amount of this unrealized appreciation in investments.
Say CinFin has no intention of selling these investments within the next ten years? The deferred tax liability might exist in the mind of the company's creditors, insurance examiners, and accountants, but in the minds of the people running the company, the value of the liability is much less than the balance sheet states it to be. The company's operating managers can make investments and operating decisions based on a net value of these assets that is much larger than the balance sheet indicates. The amount of capital at the disposal of operating managers is much closer to the value of the assets on the balance sheet and not the value of the net assets (the investments minus the deferred tax liability) indicated by the balance sheet. They haven't put aside $1 billion to cover this liability, so investors must charge management with a larger amount of owners' equity in assessing the company's return on owners' equity for the period.
To reflect the difference and bring the amount of owners' equity closer to the actual amount of invested capital at the company's disposal, an investor or analyst would make changes to the following balance sheet:
Fixed maturities, at fair value...$2,751,219
Equity securities, at fair value...5,999,271
Other invested assets...46,560
Deferred income taxes...$1,406,478
Total shareholders' equity...4,716,965
Total liabilities and shareholders' equity...$9,493,425
We wouldn't make any adjustments to the asset accounts. Therefore, the sum of liabilities and owners' equity has to still match the amount of total assets. About 71% of the deferred tax liability is due to the appreciation of the Fifth/Third and Alltel stock, and these are by far the largest identifiable single equity positions the company has. So we'll just treat these two in making adjustments.
We'll assume the company plans on holding these investments for another ten years, and that the company can invest a sum of money in the S&P 500 and generate an 11% yearly return on that investment to cover the liability once it is realized. Based on the current gain that is on the balance sheet, it would need to set aside $382.4 million to cover the $1.086 billion liability for the unrealized appreciation of these investments on the balance sheet ($382 million invested at 11% per year for 10 years = $1.086 billion). That equals $704 million, which reduces deferred taxes and thus, total liabilities, by that amount, and is transferred to owners' equity. Therefore, the liabilities and owners' equity accounts look like this:
Deferred income taxes...$702,478
Total shareholders' equity...5,420,965
Total liabilities and shareholders' equity...$9,493,425
Last year, Cincinnati Financial earned $299.38 million. On the first amount of owners' equity, the company would have generated an ROE of 6.35%. On the revised amount of owners' equity, the company's ROE was 5.5%. By making these adjustments, we can tell how the company is performing with the actual amount of investable assets under the control of its operating people. Insurance companies and banks make underwriting and lending decisions based on statutory limitations involving owners' equity, so these liabilities do indeed dictate the amount of business CinFin can do. But if we make these adjustments across a group of companies we're comparing as investors, we get a better idea of how well the company is operating.
On Monday, we'll work into a full definition of ROIC and how that better refines some of these looser adjustments to just owners' equity. In short, not all assets are funded by owners' equity, so looking at just owners' equity as a measure against which return is compared is going to miss the boat at times. Those companies that finance their assets with just a sliver of owners' equity and a boatload of liabilities can drive the value of owners' equity to zero pretty quickly with just one misstep. A 20% return on owners' equity in a company with very low leverage (defining leverage for these purposes as the ratio of assets to owners' equity) is a much different and preferable result to a company with very high leverage generating an ROE of 20%. We need an alternative definition of capital that measures the full amount of capital in use by a company's managers, whether that capital was raised through equity or through debt. In other words, we want to look at the company's performance independent of its financing decisions. ROIC the way to do that.
Please see the Motley Fool's Conference Calls page for call information and links to synopses.
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