Newsletter Q3 1999
July 12, 1999
Do
Interest Rates Matter?
The
recent rise in interest rates has not had much effect on the stock market.
On June 30, the Federal Reserve raised interest rates by 25 basis
points. Stock investors instead
focused on the Fed's statement regarding a change in bias from tightening to
neutral, and stocks subsequently rallied.
Corporate borrowers, on the other hand, appear eager to sell debt as
the supply of corporate bond issues is expected to be plentiful in coming
months.
The
valuation model that I use for a comparison of the S&P 500 to the ten year
U.S. Treasury bond suggests that the S&P 500 is currently overvalued by
29% relative to the ten year U.S. Treasury bond.
Byron Wien, investment strategist at Morgan Stanley Dean Witter, also
maintains a quantitative model to compare stocks to bonds.
His model suggests that the S&P 500 is overvalued by 35% relative
to bonds. Accordingly, I have
been raising the percentage of cash in portfolios in recent months.
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Updates
Qualcomm's
(QCOM) price got another boost recently after President and Chief Operating
Officer Richard Sulpizio spent a week in Europe meeting with European
investment managers and analysts. Sometime
before the end of November, the International Telecommunications Union is
expected to endorse Qualcomm's CDMA as the third generation wireless standard.
Earnings estimates are currently $2.04 per share for FYE 9/30/99 and
$2.73 for next year.
The
price of the convertible preferred shares of American Real Estate Partners (ACP.PR)
has started to rise recently as the potential conversion date approaches.
The preferred shares will be convertible at the option of the company
in March 2000 and must be redeemed by the company by March 2010.
Carl Icahn is the general partner and owns 86.5% of the preferred
units. Because it is in his best
interest to convert at the earliest possible date, the Partnership will most
likely convert the preferred shares to depositary (limited partnership) units
in March 2000. If the Partnership
does convert the preferred units in March 2000, the conversion price (10.5
with accrued dividends) represents a 26% gain from last week's close of $8.31.
The depositary units are also undervalued as they currently sell for
less than 7X earnings, or less than the value of cash and U.S. Treasury bills
held by the Partnership.
The
Board of Directors of the Heritage U.S. Government Income Fund (HGA) has
proposed that the fund change from a closed-end structure by merging with an
affiliated open-end mutual fund. This
is a positive development as the mutual fund's shares will be redeemable at
net asset value. The fund will be
sending proxy material to shareholders for approval and the transaction is
expected to be completed by the end of October.
Earnings
estimates for Omniquip International (OMQP) have recently declined.
The Company's Snorkel Division manufactures elevated platform equipment
that accounted for 26% of sales during the March quarter.
The Snorkel Division was slow to respond to price cuts by competitors
earlier in the year but has recently cut prices to reduce inventory.
The company will take a restructuring charge of $2.2 million in the
current quarter to reduce the Snorkel workforce by 25% and consequently,
consensus earnings estimates have been lowered to $1.21 for the current FYE
9/30/99 and $1.53 for next year. I
continue to own the company, as the current price is a low multiple of the
earnings estimates and demand remains strong for the company's other product
lines.
Holly
Corporation (HOC) has recently moved up a little as concerns about the
Longhorn Partners lawsuit subside. HOC
had paid some legal bills for ranchers who had joined the City of Austin and
the Lower Colorado River Authority in a lawsuit against Longhorn Partners to
require an environmental impact study for a proposed product pipeline from the
Gulf Coast to El Paso. Longhorn
Partners has dropped all issues except for tortious interference in its
lawsuit against HOC. In the
meantime, product margins look favorable for the summer season and the company
is likely to earn in excess of $2.00 per share for the current fiscal year
ending in July.
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Additions
Borders
Group, Inc. (BGP) is the nation's second largest book retailer with 250
Borders superstores and 900 mall-based Waldenbooks stores. BGP's stock price has declined in the last year from a high
of 41.75 to the mid-teens due to concerns about internet competition.
In sharp contrast to Amazon.com, BGP makes money, has virtually no
long-term debt, and sells at a reasonable valuation.
Consolidated revenues for the fiscal year ending January 24, 1999
increased by 14.5% over the prior year. Consensus
earnings estimates are $1.17 for the current fiscal year and $1.38 for next
year.
Colonial
Properties Trust (CLP) is a large diversified REIT in the Southeast that owns
15,000 apartment units, 13.5 million square feet of retail shopping space and
2.7 million square feet of office space.
The dividend yield is currently 8.2% and dividends have grown at an
annual rate of six percent during the last five years.
MFC
Bancorp (MXBIF) is based in Geneva, Switzerland and provides private and
investment banking services. MXBIF
is conservatively financed with an equity/asset ratio of 62.8%.
For 1998, the company earned $1.67 per share.
Book value of $8.45 per share includes a mineral royalty interest in
Canada that has a much higher market value.
MXBIF currently sells for less than 5X trailing earnings.
American
Safety Razor (RAZR) was a short-term trading opportunity.
The price declined after a manufacturing facility was closed for a day
due to a bomb scare. There was a cash tender offer at the time, which provided an
attractive return for a two week holding period.
Geltex
Pharmaceuticals (GELX) was recently purchased for some accounts that are more
risk-tolerant. GELX develops
polymer-based, non-absorbed pharmaceuticals that selectively bind and
eliminate target substances from the intestinal tract.
Because the polymer-based drugs are not absorbed into the bloodstream,
they do not have side effects on internal organs such as the liver.
The company introduced their first product, Renagel, in 1998 for the
treatment of hyperphosphatemia, which affects 250,000 dialysis patients in the
U.S. GELX expects to file a new
drug application this summer for Cholestagel.
Clinical trials have demonstrated Cholestagel's ability to reduce
elevated cholesterol levels, a condition that affects 24 million Americans and
another 26 million people in Europe. Warburg
Dillon Read estimates that GELX will earn $1.20 in 2001 and $2.34 per share in
2002.
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Deletions
The
First Australia Income Fund (FAX) and Scudder International Bond Fund (SCIBX)
were sold. The discount to net
asset value on FAX had declined as the price rose, so it was no longer as
attractive as some other fixed income closed-end funds.
SCIBX was sold as the decline of the euro continued to reduce its net
asset value.
Profits
were taken on Telefonos de Mexico (TMX), Continental Airlines (CAL), and Atmel
(ATML). All three have performed well but the valuations were no longer as
compelling and I wanted to raise some cash due to the current high valuation
level of the U.S. stock market. Positions
may be established in these companies again at a later date.
If
you have any questions regarding your accounts, please do not hesitate to call
me.
Sincerely,
Robert G. Kahl,
CFA,
CPA, MBA
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Sabino
Investment Management, L.L.C.