Thursday, October 26, 2006

Microsoft Q1 Result Analysis

Microsoft reported its first quarter earnings today. The earnings report can be viewed at the Microsoft website. Let us take a quick look at the earnings to see how the MSFT prospects look like.

The top line revenue increased by 11% this quarter compared to the previous years quarter. The break down in revenue in different divisions is as follows. Out of the one billion increase in revenue, XBox contributed about 400 million. Since XBox is selling at a loss, the top line growth in core businesses was 6.9%. The growth in each of the sub groups was as follows. Client grew by 2.7%, server grew by 17.5%, Office grew by 4.3%. The Online business saw a decline with more losses in the pipeline for the rest of the year.

Since XBox doesnt generate profits, let us look at the rest of the balance sheet to see how the operating margin looks like for this quarter. The operating income margin was still decent without significant deterioration and comparable to the FY06 Q1 levels. The R&D costs and sales, marketing costs increased by 17% and 12% respectively. If the same number of shares were outstanding as last year, the earnings would have come in at 32 cents a share. The share buy backs helped boost the earnings by three cents to 45 cents.

Surprisingly, the cash flow from operations declined year over year. The decline is about 6-7% compared to the same quarter from the prior year. This is despite the decrease in stock option expense and increase in receivables. The capital expenditures increased by 93% year over year. It looks as though the cash flows for the entire year will probably decline compared to the same period last year.

Despite the lackluster balance sheet, the stock will probably stabilize around the current price for FY07. The upside for Microsoft stock ( if any ) is going to be in fiscal FY08 when revenues from vista and office start kicking in and XBox losses decline further or make a slight profit.

Sunday, October 22, 2006

SanDisk (SNDK) Analysis

We looked at Sandisk and other flash manufacturers in the attached article. In that article, we noted

"In this article, we take a quick look at some of the flash memory manufacturers
and the trends in this area. Some of the companies in the flash memory area are
- Sandisk (SNDK), Micron Technology (MU), Lexar Media Inc ( LEXR ), Infineon,
Samsung and Toshiba. Samsung mainly makes deals with OEMs and doesnt deal with
retail marketing. We will analyze a couple of companies and SNDK in this

In the intervening months, the usage of flash memory has increased. It is used more commonly now and the volume is growing. Along with the volume, the cost per memory unit is declining. Meanwhile, the industry is consolidating. This is a very competitive business with many players. Meanwhile, the business is also consolidating with Lexar going private and Sandisk buying the Israeli based M Systems. Eli Harari, the CEO of SNDK estimates a growth of 200% in flash memory volume in 2006 compared to 2005.

Most of the electronic equipments get sold in the holiday season. Consequently the last quarter of the year is a big one for flash/memory manufacturers as well. As much as 40% of Sandisk's business occurs in the fourth quarter. Sandisk as a company is the leading provider of flash memory in the world and has done well to expand its base. SNDK has diversified into MP3 players and have cornered 10% of the market - a market dominated by Apple's iPod.

Next we will look into SanDisk's operarting margins. For the three months ended in July, the operating margin was 13.29%. ( net income/total revenues ). This was about 13.69% for the same period the year before. For the first six months, the operating margin is 13.89% - this compares to a margin of 22.73% in the same period the year before. Now let us move to this quarter - the operating margin this quarter was 13.74% where as the margin was 18.22% in the same quarter a year before. So clearly, the trend is for the margins to go down year over year. The cause for the margins to decline is primarily attributed to a glut in the Flash market where one of the manufacturers oversupplied the market.

Another important metric is the free cash flow. The company's free cash flow has been going up and down over the past ten years. Specifically, in the past four years, the numbers are 217 million, 101 million, 347 million and 241 million for this year respectively. So the cash flows are erratic and this typically means the company doesnt have market dominating power.

Another metric of interest in the high tech companies is the stock dilution year over year. Year over year, the dilution is about 4% and is expected to be much higher once the all stock deal closes for Israeli based MSystems Limited.

The stock dropped by over 20% on Friday last week because of the declining margins sited by the CEO - Eli Harari. There are two types of valuations that can be done - one is relative valuation where a company is compared to its peers in the same sector and the second is by looking at the future discounted cash flows to see the intrinsic value. In the technology sector, primarily the relative valuation approach works best. The intrinsic valuation approach doesnt work as well as one would find that the stocks are typically overpriced with huge expectations for future growth.

Doing relative analysis, one finds that SNDK is fairly priced with Friday's drop and probably can go up a bit to the $56 range. The comparison of SNDK is with Micron Technology and SNDK should enjoy a slight premium because of bette margins and its market leading position.

Sunday, October 15, 2006

Fedex Corporation Analysis

FedEx business can be described as follows, from the 10-K,

FedEx Corporation (“FedEx”) provides a broad portfolio of transportation, e-commerce and business services through companies operating independently, competing collectively and managed collaboratively under the respected FedEx brand. These operating companies are primarily represented by Federal Express Corporation (“FedEx Express”), the world’s largest express transportation company; FedEx Ground Package System, Inc. (“FedEx Ground”), a leading provider of small-package ground delivery services; FedEx Freight Corporation (“FedEx Freight”), a leading U.S. provider of regional less-than-truckload (“LTL”) freight services; and FedEx Kinko’s Office and Print Services, Inc. (“FedEx Kinko’s”), a leading provider of document solutions and business services. These companies form the core of our reportable segments.
Other business units in the FedEx portfolio are FedEx Trade Networks, Inc. (“FedEx Trade Networks”), a global trade services company; FedEx SmartPost, Inc. (“FedEx SmartPost”), a small-parcel consolidator; FedEx Supply Chain Services, Inc. (“FedEx Supply Chain Services”), a contract logistics provider; FedEx Custom Critical, Inc. (“FedEx Custom Critical”), a critical-shipment carrier; Caribbean Transportation Services, Inc. (“Caribbean Transportation Services”), a provider of airfreight forwarding services, and FedEx Corporate Services, Inc. (“FedEx Services”), a provider of customer-facing sales, marketing and information technology functions, primarily for FedEx Express and FedEx Ground.

Fedex revenue break down by segment is as follows:

Fedex Express - 66%

Fedex Ground - 16%

Fedex Freight - 11%

Kinkos - 6.6%

From volume growth point of view, Fedex express saw a one percent decline, Fedex ground increased by 13%. The latest 1o-Q provides more details:

Revenue growth for the first quarter of 2007 was primarily attributable to yield improvement across all of our transportation segments, volume growth at FedEx Ground and FedEx Freight and package volume growth in our International Priority (“IP”) services at FedEx Express. Yield improvements were principally due to higher fuel surcharges and rate increases. Volume increases at FedEx Ground resulted from increases in both commercial business and FedEx Home Delivery service, which helped mitigate the impact of domestic volume declines at FedEx Express. Shipment volumes grew 8% at FedEx Freight in the first quarter of 2007, while IP package volumes at FedEx Express grew 6% for the quarter. Revenues at FedEx Kinko’s decreased during the first quarter of 2007 primarily due to a continued competitive environment for copy services.
Operating income increased in the first quarter of 2007 primarily due to revenue growth and improved margins at FedEx Express and was slightly offset by reduced operating income at FedEx Kinko’s. Effective cost controls and revenue management actions contributed to increased operating margin at FedEx Express in the first quarter of 2007. FedEx Express operating income in the first quarter of 2006 included a $75 million charge described below.

The most interesting part of the 10-Q is the outlook statement:

While our growth rate is expected to moderate in comparison to our strong growth in 2006, we expect revenue and earnings improvement across all transportation segments in 2007. Our outlook is based on solid global economic growth, with the U.S. economy growing at a moderate, sustainable rate. We anticipate revenue growth in our high-margin services, productivity improvements and continued focus on yield management.
We anticipate growth in total U.S. domestic package volumes and yields, as well as continued growth in FedEx Express IP shipments and yields. We also anticipate year-over-year increases in volumes and yields at FedEx Freight as that segment continues to expand its LTL network and service offerings.
FedEx Kinko’s will focus on key strategies related to adding new locations, improving customer service and increasing investments in employee development and training, which we expect to result in decreased profitability in the short-term. In the first quarter of 2007, FedEx Kinko’s announced the model for new centers, which will be approximately one-third the size of a traditional center and will include enhanced pack-and-ship stations and a doubling of the number of office products offered. FedEx Kinko’s plans to open approximately 200 new centers across the United States during 2007, which will bring the total number of domestic centers to over 1,500.
We expect to continue to make investments to expand our networks and broaden our service offerings, in part through the integration and expansion of FedEx National LTL and our investments overseas. We anticipate that our new FedEx National LTL business will extend our leadership position in the heavy freight sector and provide new growth opportunities for our LTL operations in 2007 and beyond.
On September 25, 2006, we announced a $2.6 billion multi-year program to acquire and modify approximately 90 Boeing 757-200 aircraft to replace our narrow body fleet of Boeing 727-200 aircraft. We expect to bring the new aircraft into service during the eight-year period between calendar years 2008 and 2016 contingent upon identification and purchase of suitable 757 aircraft. The impact to 2007 of this program has been reflected in our expected 2007 capital expenditures of approximately $3 billion.
All of our transportation businesses operate in a competitive pricing environment, exacerbated by continuing high fuel prices. While our fuel surcharges have been sufficient to offset increased fuel prices, we cannot predict the impact on the overall economy if fuel costs significantly fluctuate from current levels. Volatility in fuel costs may also impact quarterly earnings because adjustments to our fuel surcharges lag changes in actual fuel prices paid. Therefore, the trailing impact of adjustments to FedEx Express and FedEx Ground fuel surcharges can significantly affect earnings in the short-term.
The pilots of FedEx Express, which represent a small number of FedEx Express total employees, are employed under a collective bargaining agreement that became amendable on May 31, 2004. In August 2006, FedEx Express and the pilots’ union reached a tentative agreement on a new labor contract. The proposed new contract includes signing bonuses and other compensation that would result in a charge in the period of ratification of approximately $145 million. Contract ratification is expected during the second quarter of 2007 but cannot be assured. If ratified, the new four-year contract will become amendable in 2010.

In July 2006, FedEx Express entered into a new seven-year transportation agreement with the United States Postal Service (“USPS”) under which FedEx Express will continue to provide domestic air transportation services to the USPS, including for its First Class, Priority and Express Mail. The agreement is expected to generate more than $8 billion in revenue for FedEx Express over its term, which begins on September 25, 2006, and ends on September 30, 2013. The agreement will replace the existing seven-year transportation agreement between FedEx Express and the USPS.

Interesting facts on Fedex are as follows:

The earning yield on Fedex ( at trailing P/E ) is 5.5 - which is slightly better than the long bond yield of 4.7%. On the forward P/E basis, the yield is 5.9% for FY07. However, FDX is growing at a brisk pace of about 10% per year along with cash flows and the growth rate will continue for the next several years. From the discount cash flow point of view, Fedex is definitely looking good at current prices with upside in the future. The demographics in the US and increasing wealth around the world will always need Fedex service for decades to come.

Saturday, October 07, 2006

Google - a strong sell?

In this article, we will look at two analysis of Google. One is based on the earning yield and comparing it to the long bond. The second one is based on discount cash flow analysis done by Aswath Damodaran.

At this years earnings of $10.00 and next years earnings of $13.50, the earning yield for Google in the next two years at today's price is 2.4% and 3.21% respectively. The ten year bond is currently trading at 4.6%.

Let us do a quick comparison to Microsoft and Yahoo! Googles top two competitors. Yahoo! has an earning yield of 1.9% and 2.56% respectively. Microsoft on the other hand has an earning yield of 5.15% and 5.99% respectively. On a comparative basis, one can see Microsoft, Google and then Yahoo! as the stocks to buy from the perspective of stability.

Aswath Damodar has done a discount cash flow analysis of Google. His analysis in his website based on discount cash flows puts a value of $110.00 for Google based on discount cash flow analysis.

The summary of these analysis shows that Google is a great momentum play. Google is likely do well in the short term but longer term the stock is likely remain stagnant or go down in value. One can definitely expect wild swings in Google stock in the upcoming months.

Sunday, October 01, 2006

Overview of Indian Markets and Funds

We have looked at emerging markets and BRIC stocks quite a few times in this blog. We will look at the Indian economy, the returns in BSE Sensex thus far this year and look at the India funds and the outlook for the sector in the coming several months.

First an outlook of the Indian economy. The Indian economy was expected to grow at ~7% rate this year and next. This is higher than the world wide economic growth prediction of 5.1% and 4.9% repsectively for this year and next. Financial Times reported that Indian economy grew at the rate of 8.9% in the first quarter of 06-07 fiscal year. This was above the analysts estimates of 8.5% growth. The inflation rate is going around 5-5.5% and the RBI is expected to increase the interest rates to 6.25% as a result. The interest rates are already much higher than that in China.

The Wallstreet Journal reports that the BSE Sensex Index has grown by 32.5% this year and on the average sports a P/E of 21. Of all the stock markets in the world, the Chinese and Indian markets are on the higher end of the valuation spectrum with a P/E of 21.

The prognosis for Indian economy is good and the economy is expected to grow at around 8% for the next three-four years. India runs a trade deficit with the rest of the world like the U.S. India has a very high degree of domestic consumption unlike the other Asian Tigers whose economy is propelled by export to the United States. At this rate of growth, the Indian companies will probably continue to grow at very fast rates making the current P/E not that high.

Now, let us take a look at India funds. We start by looking at the generic emerging market funds and then look at Indian funds in particular.

EEM is the iShares emerging market fund and has returned about 9.7% YTD. If one bought the ETF at the low 80's in the second quarter, the ETF has returned more than 20%. EEM has an expense ratio of 0.77%. EEM has approximately 5% exposure to India.

VWO is the Vanguard emerging market fund and has returned about 10.3% YTD. This correlates highly with EEM but has a lower expense ratio of 0.3%. VWO has a 7.1% exposure to India and it has done better than EEM recently.

IIF is Morgan Stanley India Investment Fund, Inc. is a non-diversified, closed-end management investment company. The Fund's investment objective is long-term capital appreciations, which it seeks to achieve by investing primarily in equity securities of Indian issuers. The Fund will invest at least 65% of its total assets in equity securities of Indian issuers; which for this purpose means common and preferred stock bonds, notes and debentures convertible into common or preferred stock, stock purchase warrants and rights, equity interests in trusts and partnerships and American , Global and other types of Depositary Receipts. The Fund may invest up to 25% of its total assets in unlisted equity securities of Indian issuers.

Currently IIF sells for about 2.48% premium to the net asset value. The management fees for this stock is 1.27%. The total return of IIF is 14.2% compared to the BSE Sensex Index return of 32.5%.

IFN India Fund is a closed-end management investment company. The fund seeks long-term capital appreciation through primarily investing in the equity securities of Indian companies. The fund will invest at least 80% of its total assets in the equity securities of Indian Companies. The management fees for this stock is 1.47%. The fund has returned 8.2% compared to the BSE Sensex index of 32.5%.

MINDX Mathews India Fund is a relative new comer to the block. The fund carries an expense ratio of 2.75% has returned 18.82% YTD.

ETGIX It has an initiation fee of 5.75% for small sums of money that declines to zero if the capital is greater than a million dollars. This is not targeted for individual investors but is targeted more towards institutional investors that want an exposure to India. The fund also has an expense ratio of 2.75% on top of the initiation fee. This fund has returned 19.67% YTD.

EEB ( Claymore/BNY BRIC ETF ) - This is a new ETF targeting only the BRIC countries - Brazil, Russia, India and China. The fund doesnt have the assets divided equally with all the four countries but it only specializes in these four emerging markets. The fund carries an expense ratio of 0.65% and returned 3% since inception.

Although both India and China look expensive at the moment compared to other markets, the growth in these markets make it look as though there is still upside for these companies.