Saturday, January 31, 2009 analysis

Amazon's business is as follows:

We seek to be Earth’s most customer-centric company for three primary customer sets: consumer customers, seller customers and developer customers. In addition, we generate revenue through co-branded credit card agreements and other marketing and promotional services, such as online advertising.

Consumer Customers

We serve our consumer customers through our retail websites and focus on selection, price, and convenience. We design our websites to enable millions of unique products to be sold by us and by third parties across dozens of product categories. We strive to offer our customers the lowest prices possible through low everyday product pricing and free shipping offers, including Amazon Prime, and to improve our operating efficiencies so that we can continue to lower prices for our customers. We also provide easy-to-use functionality, fast and reliable fulfillment through our global fulfillment center network, timely customer service, and a trusted transaction environment.

We fulfill customer orders in a number of ways, including through the U.S. and international fulfillment centers and warehouses that we operate and through co-sourced and outsourced arrangements in certain countries. We operate customer service centers globally, which are supplemented by co-sourced arrangements. See Item 2 of Part I, “Properties.”

Seller Customers
We offer programs that enable seller customers to sell their products on our websites and their own branded websites and to fulfill orders through us. We are not the seller of record in these transactions, but instead earn fixed fees, revenue share fees, per-unit activity fees, or some combination thereof.

Developer Customers
We serve developer customers through Amazon Web Services, which provides access to technology infrastructure that developers can use to enable virtually any type of business.

It is interesting that Amazon has added a new category of customers called "Developer Customers" for whom it provides technology infrastructure to enable any type of technology business.

Amazon's top line increased by 29.19% whereas the bottom line increased by 35.5% year over year before the dilutive effects of stock options. More importantly, the free cash flow increased by 15.5% year over year, a lower rate than EPS growth. Although free cash flow increased at a lower rate, Amazon has been able to retire debt ( almost 800 million ) and increase its assets.

46.6% of Amazon's sales come outside of north america. The remaining 53.4% come from within north america. While the north america margins declined year over year, the international margins increased.

From a growth perspective, Amazon's growth in media was 20%, growth in electronics and other goods was 45% and the other segment was 29%. The total other revenue was 542 million in 2008.

Also, Amazon's shipping costs are negative. It costs Amazon money to ship goods to the customers. In 2008, Amazon spent 1.465 billion in shipping costs of which it was able to recover 835 million from the customers.

While amazon is a well run business and is doing well, the total share count has increased by about 30% in the last ten years. Amazon also trades at a price/cashflow multiple of 19, which is higher than some better run businesses in this field. The trend of increasing in share count continues to go up. Also, in this environment, there are many cheaper alternatives available to invest one's money.

Saturday, January 24, 2009

Microsoft Analysis

Microsoft announced FY09 earnings and employee layoffs on 22nd January, 2009.

First let us take a look at Microsoft's earning per share and margins for the last ten years. Microsoft's earning per share increased from 0.71/share to 1.87/share in the last ten years. It is expected to stay the same this year as well.

Cashflow per share increased from 0.84/share to around 2.16/share in the same period. However, the interesting thing here is the margin before income taxes. The margins declined to 39.4 cents on the dollar in 2008 from 60.2 cents on the dollar in 1999.

The number of shares outstanding declined from 10.964 billion to 9.490 billion. The company bought back stock in the open market in the last year and has further declined the number of shares outstanding to 8.914 billion.

For the first six months of FY 2009, the cost of revenue went up by 8.64%. The cost of R&D increased by 22.86%. Sales and marketing expenditures went up by 9.88%. The total expenditures increased by 10.8% for the first six months of FY09 compared to FY08.

Let us look at the revenues and profitability of each of the divisions at Microsoft.

Windows Client had revenues of 8.2 billion and income of 6.2 billion. The windows client revenue declined on a year over year basis by about 500 million. The server and tools division revenue and income increased by about 600 million making up for the downward shift in windows client. The online services business revenue increased slightly but it also opened a huge loss of 900+ million. The entertainment and devices division (includes XBoX and Zune) had flat revenue and declining profits. The cost of corporate level activity increased year over year. Consolidated net income declined to 11.9 billion from 12.3 billion dollars year over year despite increase in revenue.

Microsoft also announced layoff of 1400 employees immediately with 3600 more to follow in the next year and half. Interestingly enough, MAC gained market share against windows by about 1% point in the Oct-Dec quarter. The increase in operational expenditures will keep the EPS near 2008 levels.

As an investment, the EBT margin for Microsoft declined in the most recent quarter to about 35% from about 38%. The increase in costs continues to be a factor. Unless the company takes some measures to cut down on its various spending initiatives, it is likely that the stock will continue to underperform the broader market.

Sunday, January 18, 2009

USB Analysis

US Bancorp (USB) is bank with presence in north america and europe. It has the following lines of business.

1. Payment Services. USB got 27% of its revenue in 2007 through payment services segment. This segment involves corporate payment systems, merchant payment services, NOVA information systems, Retail payment services (debit, credit card) and transaction services.

2. The second segment involves wholesale banking - which earned 19% of USB revenue in 2007. This involves corporate, commercial and real estate banking.

3. The third segment involves wealth management and securities services. This accounted for 12% of USB's earnings in 2007. USB allows individuals, muncipalities and businesses build, manage, preserve and protect wealth and distribute obligations.

4. Consumer banking which involves home mortages supplied 40% of USB revenue in 2007.

This mix changed slightly into 3Q 2008 where payments accounted for 27% of revenue, consumer 41% of revenue, wealth management 13% of revenue and wholesale accounted for 19% of revenue.

Let us analyze USB with the criteria that WEB established for Wells Fargo in 1990.

a. Is the management team able?

b. Dont have a larger headcount than necessary.

c. Attack costs when profits are at record levels as they are under pressure.

d. Stick with what they understand and let their abilities, not their egos determine what they attempt.

For the first question, USB seems like a well run company without being affected by the problems in subprime and other lending despite its large exposure to the California market. Richard Davis has run the company well.

USB hasnt had any layoffs as experienced by Citi, BAC and other players. Wells Fargo also played its hand conservatively. However, its acquisition of Wachovia probably altered its asset mix.

Attack costs when profits are at record levels as they are under pressure. This is somewhat answered by no layoffs - keeping the costs under control with personnel has paid off for USB.

Finally, USB hasnt tried to swallow smaller companies using TARP money. Let us take a look at the 3Q conference call. This was an exchange between Mike Mayo and Richard Davis.

Mike Mayo - Deutsche Bank
Following up on the deal question, why wouldn’t you go out and buy another bank that’s less efficient, especially if you had a government guarantee? Also, are there certain parts of the country that you are interested in, either near or long term?
Richard Davis
Did you say “why wouldn’t we?”
Mike Mayo - Deutsche Bank
Yes, why wouldn’t you? I mean it makes sense what you have done and now the price has come down and maybe even some government assistance. Everyone asks, “what about U.S. Bancorp?” Everyone else has shown some kind of move, whether it is JP Morgan or Bank of America or Wells Fargo.
Richard Davis
I hear you. Now first of all, you know me and I am not motivated by what everybody else is doing. It only works if it works for us. The prices actually don’t come down. I mean the fact of the matter is that there is more money in the market. I suspect that the target prices might actually go up. So for us it’s just going to have to be a deal, like I said, that fits all of our criteria which is immediate accretion and long-term value. I do think that there is more of that out there. I am telegraphing that we are more active and more interested than we might have been before, but it doesn’t change any of the parameters and it doesn’t change our appetite for taking risk. It’s got to be the right deal and it’s got to make sense. So sure, we are looking at it more.

Let us look at the bank as a whole and how it compares to others.

Asset Size: 247 billion
Deposit: 140 billion
Loans: 170 billion
Customers: 14.9 million
Market Cap: 32.1 billion
Branches: 2769
ATMs: 5159

Through 3Q 2008, the ROA was 1.45% and and ROE was 16.6%. Let us see how this compares to Buffett's Wells Fargo buy in 1990. The ROA and ROE numbers were hampered by Q3 weakness. This is likely to reduce further with Q4 numbers.

Wells Fargo is big - it has $56 billion in assets - and has been earning more than 20% on equity and 1.25% on assets.

The growth in net charge offs and loan loss reserve build is expected to accelerate in Q4 2008. It is expected that the company will take 600 million in charge offs and 650 million to build reserves in Q4 2008. This compares to a total cost of 748 million in Q3 2008. While the increase in charge offs and loan losses will reduce the income, we expect the income to be still positive. The company paid out more in dividends than what it earned in Q3 and we definitely expect the dividend to come under pressure in 2009.


From Buffett's 1990 letter to share holders on Wells Fargo:

Of course, ownership of a bank - or about any other business - is far from riskless. California banks face the specific risk of a major earthquake, which might wreak enough havoc on borrowers to in turn destroy the banks lending to them. A second risk is systemic - the possibility of a business contraction or financial panic so severe that it would endanger almost every highly-leveraged institution, no matter how intelligently run. Finally, the market's major fear of the moment is that West Coast real estate values will tumble because of overbuilding and deliver huge losses to banks that have financed the expansion. Because it is a leading real estate lender, Wells Fargo is thought to be particularly vulnerable.

None of these eventualities can be ruled out. The probability of the first two occurring, however, is low and even a meaningful drop in real estate values is unlikely to cause major problems for well-managed institutions. Consider some mathematics: Wells Fargo currently earns well over $1 billion pre-tax annually after expensing more than $300 million for loan losses. If 10% of all $48 billion of the bank's loans - not just its real estate loans - were hit by problems in 1991, and these produced losses (including foregone interest) averaging 30% of principal, the company would roughly break even.

USB is likewise in a strong position. The recession in 2008 is more severe than the one in 1990-1991. The economy will likely continue to contract in Q1 2009 and Q2 2009. The stress in residential housing market may continue into 2009. It is likely that the stress will spread to other areas such as commercial real estate - this can put further pressure on the bank. However, there are segments of the bank that continue to do well.


In 2008, the company received 6.599 billion in TARP payments. At a rate of interest of 5%, the company is required to pay out $330 million to the federal government every year.

Dividend payout:

Another factor is the dividend yield. While the stock paid out $1.70 in 2008, the earning as well as payout is likely come under pressure in 2009.

We expect 2009 to be a good year to invest in USB if the current market conditions dont lead to a full blown depression.

Sunday, January 11, 2009

Pepsi (PEP) Analysis

Pepsi has the following business segments which generate most of its profits.

Dominant in salted foods market
•36% profit from north america

Pepsi beverages
•28% of profits from north america

Pepsico International
•29% profits

Quaker Foods
•7% profits

In the last ten years, Pepsi has performed impressively. Its EPS has increased from $1.23 to $3.55 (expected ) this year. The cash flow per share has increased from $1.98/share to $4.70/share. ROE has remained stable and EBT margin has also remained stable. Overall, Pepsi has performed well in the past ten years. It has also taken the lead in US with 38% of savory snacks market and 25% of US liquid beverage market.

In FY09, the profit growth has stalled into the third quarter. From Pepsi's 10-Q:

Total operating profit increased 5% and margin decreased 1.4 percentage points. The unfavorable mark-to-market impact of our commodity hedges reduced operating profit growth by 2 percentage points and reduced margin by 0.4 percentage points. Leverage from the revenue growth was offset by the impact of higher commodity costs. The impact of foreign currency contributed 2 percentage points to operating profit growth and the impact of acquisitions contributed 1 percentage point.
Other corporate unallocated expenses decreased 2%. Lower deferred compensation costs and the favorable impact of certain other employee-related items were partially offset by higher costs associated with our ongoing business transformation initiative, increased research and development costs and foreign transaction losses. The decrease in deferred compensation costs is offset (as a reduction to interest income) by losses on investments used to economically hedge these costs.

Also, the profit growth for the first 36 weeks of the year increased 4% compared to the year before. The fourth quarter is expected to be tough with rough economic conditions worsening the down draft.

Pepsi is cheap now with a price to cash flow ration of 13 with stable cash flows. The cash flow growth may be limited for the next couple of years but may increase there after. Most of the growth will probably will come from outside the US.

I expect Pepsi to report lesser earnings after Q4 as the north america segment should see some declines given the hard Q4. Investors may be able to get Pepsi stock at better prices once the Q4 results are out.

Saturday, January 03, 2009

Getting credit score information for free

Saturday's WSJ suggested the following sites to check out free credit score.

Of the three sites, I found only offering free credit score. had the free score bundled with some other service. 

The credit score is an approximation as the agencies that provide the scores use custom formula that is not accessible.

Thursday, January 01, 2009

Berkshire Hathaway (BRKA) Analysis

Warren Buffett's Berkshire Hathaway has been hammered this year by a declining share market. We have analyzed Berkshire Hathaway several times in this blog. Warren Buffett has had an outstanding record handicapping winners and has been the greatest investor of all times.

In this analysis, we take a numbers view of Berkshire Hathaway, whose earnings have been lumpy. These are the numbers from Value Line publication. From 1998 to 2008, the EPS for Berkshire has grown from 1021/share to an estimated 5685/share in 2008. The book value of Berkshire has grown from 37,800/A share to an estimated 77,420 in 2008. The insurance premiums collected per share has grown from 3606/share to an estimated 16450/share.

However, 1998 and 2008 represent vastly different times. In 1998, the bull market was hitting a crescendo whereas in 2008, the bear market probably peaked. Berkshire share scaled new peaks in 1998 where as it has hit some historic lows in 2008.

Even in this scenario, Berkshire can be conservatively valued at $110K - 120K/A share. Now, this doesnt even take into account the prospects for 2009.

Several things stand out for 2009. The most skilled investor is in charge with Charlie Munger, who is second to none. Apparently Buffett has been getting better at investing in his seventies. The bear market provides a great investor good places to put his money to work. The sage of Omaha had about 40 billion to invest in 2008 and most of the money has been invested. Assuming 10% yield, we are looking at 4B in income to bolster the balance sheet which will contribute 2500/A share. Let us take a conservative estimate and assume that the earnings will be less and will only contribute $1500/A share.

In addition, many Berkshire companies will be solidifying their position in this downturn and enhance their moats. The operating earning after the downturn is over would be significantly higher. The second thing is that many hedgefunds writing catestrophe insurance have gone belly up reducing the competition for re-insurance. Lastly, the downturn is expected to last for sometime before the full recovery. This should provide the Oracle more opportunities to invest his ever increasing war chest.

If SP500 recovers in 2009, so will Berkshire's equity portfolio. This will provide the double whammy of increasing book value, decline in mark to market losses for the put contracts expires long time from now and increased income from other SP500 companies such as GS and GE. We are witnessing the transfer of wealth from the weak to the strong.

I am betting on atleast 20% rebound in BRKA in 2009 and may be more in 2009 and 2010.

SNY (Sanofi-Aventis ) Analysis

SNY is a french based company with executives from France, Germany and Britain. It has significant operations around the world. It is a dominant drug company in Europe followed by the US and the rest of the world.

It has a dominant presence in the flue shot vaccine. The company also produces vaccines for Polio/Whooping Cough/Hib, adult booster vaccines, meningitis, pneumonia, other vaccines. The company is seeing double digit growth in vaccines year over year. Vaccines make up about 10% of the revenue overall. The company is also a leader in the treatment of thrombosis ( blood clotting ) and diabetes. The main drugs of the company are Lovenox, Plavix, Stilnox, Taxotere, Elaxatine, Lantus, Copaxone, Aprovel, Tritace, Allegra, Amaryl, Xatral, Actonel, Depakine, Nasacort. The revenue jump for pharmaceuticals is in low single digits. The unfavorable dollar to euro conversion rate isnt helping the company either.

Geographically, the company has major presence in Europe with 43% of its revenue coming from Europe. 35% of its revenue comes from the US. The remaining come from other parts of the world.

The French companies Total and L'Oreal hold significant stakes in the company at 12.64% and 8.65% respectively. The companies' voting rights are at 19.06% and 14.34% respectively. The American ADR holders may not have the same rights as the share holders in Euronext exchange. As a result, it is likely that dividends will continue to get paid at increasing rates in the future.

Although the top line has been stagnant in Euros for the past three years, the operating income available to shareholders has increased. The increase has come from the decrease in "Impairment of property, plant and equipment and intanglibles" charge in the past few years.

Although the book value of the company may seem quite high, majority of the book value is in the form of goodwill and intangibles. The company acquired Aventis recently.

The company is less exposed to expiring patents and has quite a few new drugs in the pipeline. Even without the new drugs, the company sports attractive dividend yield and price/cashflow ratios.