Friday, April 28, 2006

For what it's worth

Examples of global gasoline prices per gallon and in dollar terms as of April 10: Germany, $5.60; U.K., $6.43; France, $5.80; and U.S., $2.88. (Japan was $4.30 one year ago and is likely in the $5-6 range today). Countries with gasoline prices significantly below(50% below) the U.S. are Saudi Arabia, Kuwait, Indonesia, and Venezuela among other oil producers.

Exxon Mobil's(XOM) ten year stock performance has appreciation of 210%: versus the S&P of 112%; Russell 2000 130%; technology 210%; oil and gas composite 230%,; and broker/dealers 1100%.
So Exxon Mobil, in a vital commodity, has performed on average in the stock market slightly below the level of its industry, at the level of aggregate technology over ten years, and radically below the results of the financiers who don't do the heavy lifting that keeps this country from European prices for gasoline.

This windfall profits rhetoric by the politicians is misguided and dangerous pandering for attention. Apple Computer had a huge year. So let's take some of their profits away because our teens were listening to their I-Pods in class(just joking, I must say, in case a member of congress or one of their minions reads this). Let's take companies that have long term perspectives and finally get their day and penalize them. Free enterprise? Capitalism? Oil company margins are the same over many years. We want them to take their profits and plow them back into research and development don't we.

Nigeria has civil unrest, Iran is bellicose, Iraq is in disarray, Venezuela is a dictatorship, Katrina disabled production and refineries, China and India's demand for energy grows and SUV's still rule the roads in America. Who do the politicians and the New York Times focus on when it comes to high oil prices? Exxon Mobil, it makes money, now that's an easy target.

Thursday, April 27, 2006

Hexcel Corporation annual report

Hexcel was mentioned in a March 11 comment about how Jim Kramer's Mad Money hysteria had infected me. I bought a modest amount of Hexcel(HXL) at the time that has been roughly stable. As a consequence I received HXL's annual report a few days ago and dove in to figure out what I had purchased. I know more than I did, but still not enough.

The CEO shareholder letter is either a compelling investment thesis or a masterful PR job. The letter outlines a company that makes a product, carbon fiber composites, that is seeing significant growth in applications as a strong and relatively lightweight replacement for metals used in commercial aircraft, military aircraft and equipment, wind power turbine blades, automobiles, and sports equipment. It's biggest segment is aircraft. As an example the letter states that "as the large commercial aircraft of today, averaging less that 12% of composites by weight, move in the next decade towards the 50% composite content of the Boeing 787, we expect to continue investing in growth". Given the current outlook for the cost of fuel, the move toward lighter materials seems inevitable.

As one of only two leading producers of carbon fiber composites today, HXL seems to be well positioned for strong performance and the CEO letter is extremely confident and enthusiastic. There is no mention of any challenges to their outlook. But what could go wrong for an investor? What are the issues?

1. The stock has appreciated 35% in the last twelve months, and by much more in the two years prior. Does the current value already reflect the potential described in the CEO letter?
2. We know that HXL has a competitive advantage in the production of carbon fiber today, but what are the barriers to entry in this industry and how long would it take other companies to ramp up and compete for this growth opportunity?
3. Why do brokerage and independent securities analysts in the aggregate have more sell and underperform ratings than buy ratings?
4. What, if any, is the significance of and impact of the fact that their private equity investors have either cashed out or are in the process of doing so.

And the envelopes please, one by one.

1. The company had a near death experience in 2001 and became highly leveraged with associated high capital costs after private equity investors came to the rescue. With a successful recovery and refinancing, it makes sense that the trajectory of the stock price would be high. If the CEO enthusiasm for much higher growth in revenues and earnings is on target a higher stock price should follow, but just decent earnings and revenue would likely leave the stock where it is at best.
2. There is no discussion whatsoever of competition or market positioning in the entire annual report. I don't know and can't find in the few research reports that I have access to the answer to this important question.
3. Negative analyst ratings can be a double edged sword. If they are correct, we've been warned. If not, and the companies performance forces upgrades, that will be a catalyst for accelerated growth in stock price. One way or the other this will play out in the next 12 months.
4. The private equity investors came to the rescue in 2001 and again in 2003. They took a risk that the public markets and the bankers were not willing to take, and they have been rewarded in a big way. The top 50 shareholder list of HXL as of year end includes many experienced and savvy hedge fund investors. It will be interesting to see, on or around the May 15, the 13F public reporting that shows whether these investors have stayed around for the future potential or whether they have followed the private equity groups out. If they are still around, that's a good sign.

But one thing here is sort of interesting. The private equity investors filed their S-1(the filing that allows for share issuance to make their investment liquid) on February 28. The lead private investor, with more than 15% of the company, was Goldman Sachs. Jim Kramer pumped the stock big time in early March. As a former hedge fund manager who started his career at Goldman, Kramer is networked with everyone. The possible pressure from new stock issuance was coming and Kramer's mass market investors would generally not know. It doesn't quite look right on the surface, but Jim Kramer's integrity is absolutely crucial to his success. My conclusion---he really does believe in the HXL story.

Time will tell. If the CEO is right, if Kramer is right, and if their competitive advantage in this product is sustainable for 3-5 years, HXL is a bargain today. IF, IF, IF.

Tuesday, April 25, 2006

GE's annual report

GE's 2005 annual report cover has the title "go Big". All I could think of when I saw it was holding my children's arms up when they were babies and saying "so Big". Anyway GE is an amazing company but it recently has not been an amazing investment. There are nine bullet points on the inside cover. Eight are superlatives about the company's performance. But the other bullet, in the middle of the list, includes this sentence, "total return for GE shareholders was negative 1.4% versus the S&P 500's total return of positive 4.9%".

Hmm. What follows is a brief critique of what stood out to me in this annual report.

Go Big. "We think big is beautiful...our goal is not just to be big, but to use our size to be great"(Tony the Tiger comes to mind). That is the beginning of the Chairman's letter. The second paragraph then explains why "big" can be bad in many companies, and the third explains why that is not the case at GE. The cat's out of the bag already? Maybe investors have been saying that they want to invest in a specific company and not the whole economy when they buy a stock. But GE will go on the offensive, go big.

Having a lot of capital can be great, having big clout with vendors can be great, having the ability to be global can be great, but only if, in GE's Chairman's words, "We expect every business to be a leader in its industry". Of GE's six major businesses, four seem to make that cut--Infrastructure, Commercial Finance, Healthcare, and Industrial. Those four also seem to tie together well, with three businesses producing major equipment and Commercial Finance having the ability to finance their customers needs to buy GE product and, with a foot in the door, lots of other stuff as well. Two businesses don't make it. The most obvious is NBC Universal. This business is unrelated to GE's core focus. It is not a leader in many of its businesses and most of the veteran senior folks at GE do not have much experience here. The returns are certainly not bad, and the growth outlook is ok but not up to GE standards. Their industry is highly competitive to say the least and in a period of significant change. It represents just 10% of GE. It's strong enough to spin off or IPO or sell, but not "so big" or strong that it will materially impact GE in a negative way. The message of increased focus and the willingness to manage their portfolio of businesses for strategic fit is a "great" message for investors that could materially impact GE in a positive way.

I should note that GE has stepped up to the plate recently on business portfolio management by selling much of its insurance business, but they waited until underperformance more or less forced their hand rather than deal with it earlier for strategic reasons.

The other major business that is not a strategic fit is likely consumer finance. It's just a hunch. There is no information in the annual explaining what consumer products the company sells, just four short paragraphs that say: that the ROE was 29%, 70% of the business is outside of the U.S., and they expect 15% growth in this business that represents 15% of GE profit. Sounds "great". The question is whether this business is related to GE's core businesses or whether it is just an opportunistic move by a company with tons of capital and great debt ratings(low cost of funds) to build an investment portfolio of consumer credit. There's nothing wrong with that, but it is not a market leader, I would be surprised if it is a brand in any traditional sense, and it creates one more issue for investors to ponder when valuing GE. How much are those earnings worth? Is it a business or an investment portfolio? What is the vulnerability to a credit cycle? This is complicated. To sum up this ramble, GE consumer finance looks great, but how does it fit and does it help the investment thesis?

As usual this GE annual report is filled with the usual well written gibberish about Six Sigma, culture, values, and a full page circle chart called "Execute for Growth". There's nothing wrong with this either. But GE was so successful putting out these kinds of messages during Jack Welch's reign that now it's almost boilerplate in corporate America. For such length, there seems to be nothing new here, nothing thought provoking or even really interesting.

The last page of the Chairman's letter begins with the title "Our Commitment to Investors". The first 7 paragraphs of this section(almost three quarters of the section) are spent on praising the Board of Directors. It can only be looked at as humorous. The section should have been titled "Our Board of Directors is Great". Each Director gets their own individual mention related to a specific expertise or contribution. Unfortunately the only one of these Directors whose "work" I know well is praised for a contribution that is ludicrous(unless of course he has been through a late life six sigma experience).

GE is, as I said at the beginning, an amazing company. It is global, innovative, and influential in many ways. By almost all accounts it has a strong management culture. It is "So Big" that every institutional investor must own it, and few can take the risk of underweighting it. But it has lost some of its aura and has become a conglomerate again, a "great" one of course but still a conglomerate where, as the Chairman says, "Size and diversity create consistent and strong performance for investors"(does this bring to mind that conglomerate dirty word "cross-subsidy"). It sounds good but it does not sound exciting. It certainly deserves at least the 17 forward p/e that it currently has, but not so long ago GE was a company that often sported a 25 to 30 p/e and during the boom extravagently higher. My overall question today is "Has GE become too satisfied with itself?"

I do believe that the relative performance of GE will soon become more positive than in 2005, and with continued performance in a stable market the stock may move up to $40 in 2006. And if GE begins to look and act a little more fiesty again, there is upside from there.