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Newsletter Q1 2000
December 31, 1999
The
Best of Times
The
S&P 500 Index now sells for 33X earnings and has a dividend yield of 1.2%.
Based upon either earnings or dividends, the S&P 500 valuation is
at a historically high level. Jim
Stack of InvesTech Research estimates that the NASDAQ Composite Index, which
includes companies that are losing money, is now selling for more than 175X
earnings. While many internet and technology companies sell at large
multiples of revenue, other companies sell at low multiples of current cash
flow. For example, there are now
many real estate investment trusts that have double digit dividend yields.
The
Federal Reserve has increased the money supply at a rapid rate in anticipation
of Y2K liquidity demand. As of
December 15, the monetary base was 13.6% higher than a year ago.
It is widely anticipated that the Fed will increase interest rates at
their next meeting on February 1 and many economists expect additional rate
increases to follow. Historically,
rising interest rates and high stock valuations have not been a favorable
combination for the stock market. Accordingly, I plan to maintain cash balances in excess of
10% for most accounts.
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Updates
The
Board of American Real Estate Partners will decide whether or not to convert
the preferred units to limited partnership units in March.
Carl Icahn is the general partner and owns 86% of the preferred units
and 82% of the limited partnership units.
There is a high probability that the preferred units will be converted
to limited partnership units. The
conversion should act as a catalyst for Mr. Icahn to realize the value of the
partnership assets. During the
first nine months, the Partnership had earnings of $1.55/L.P. unit.
At the current price, the limited partnership units sell for less than
80% of the value of the Partnership's cash and U.S. Treasury bills, 41% of
book value, and 5X earnings.
Qualcomm
(QCOM) has become a beneficiary of internet/technology speculation.
Revenues for the FYE 9/30/99 increased by 18% over the prior year.
The price of the stock, however, has appreciated over 2300% since the
start of the calendar year. QCOM
recently agreed to sell its consumer phone business to Kyocera, leaving
revenues of approximately $2 billion for the remainder of the business.
When options are included, the company has a market capitalization in
excess of $130 billion. At a
valuation of 65X revenue, I will continue to reduce the position and may sell
all remaining shares absent instructions to the contrary.
Holly
Corp. (HOC) continues to turn in good operating results and the stock price
continues to suffer under the cloud of a billion dollar lawsuit brought by
Longhorn Partners. The draft of
the environmental impact study for Longhorn Partners' proposed product
pipeline states that there would be a significant adverse impact unless a
proposed 34 part remediation plan is carried out.
This supports HOC's contention that the lawsuit by Longhorn Partners is
frivolous but investors continue to avoid the stock. HOC now sells for a little over 5X FY 2000 estimated
earnings.
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Additions
AMR
Corp. (AMR) plans to spin off its 83% interest in SABRE Holdings Corp. (TSG)
to shareholders. AMR shareholders
will receive .7 shares of SABRE for each share of AMR that they own.
The value of the SABRE shares is $35 based upon current market prices.
Excluding SABRE, AMR sells for 7X earnings.
SABRE has a division, Travelocity.com, that will be merging with
publicly traded Preview Travel and continue to operate under its current name.
The combined entity should become the dominant market leader in
internet travel bookings. The stock market does not currently appear to assign much
value to Travelocity.com, which should become the third most-visited internet
site, behind Amazon and eBay.
AmeriSource
Health Corp. (AAS) has over $9 billion in revenue and is the fourth largest
wholesale distributor of pharmaceutical and related health care services in
the United States. Through 20
distribution centers, the company delivers more than 75,000 products dispensed
in hospitals, clinics, nursing homes and alternate care sites. The price of AAS was hit hard after they reported earnings
for the September quarter of $0.45 per share, which was 13% higher than a year
ago but below analysts' estimates. AAS
currently sells for 8X the FY (9/30) 2000 consensus earnings estimate.
Autodesk,
Inc. (ADSK) develops and markets software for architectural design, mechanical
design, mapping, and animation. Autodesk
introduced their Design 2000 series during the year to address specific
industry needs. By the end of
2000, ADSK should begin announcing a set of web-based applications and
services, for which it is now ramping expenses.
The consensus earnings estimate for FY (1/31) 2001 is $1.74 per share
but free cash flow is approximately $.85 higher.
A portion of the position was sold for a profit in some accounts at
quarter-end to provide a source of funds for other purchases.
Gehl
Company (GEHL) manufactures, sells, and finances light construction and
agricultural equipment. From 1994
to 1998, Gehl increased earnings per share by 180%. There continues to be strong demand for Gehl's products.
Revenues for the first 9 months of the year were 11% higher than a year
ago. The company has a
conservative balance sheet and sells for 6X the 1999 consensus earnings
estimate.
General
Motors (GM) owns 69% of Hughes Electronics (GMH) and there have been
persistent rumors in the financial press that the Board of Directors will spin
off some or all of GMH to GM shareholders.
Hughes Electronics currently has a market value of $27 billion or $43
per GM share. Since Hughes
Electronics does not currently contribute to earnings, the remaining GM
business after a complete GMH spinoff would sell for less than 4X earnings.
Kellwood
Company (KWD) is a manufacturer and marketer of branded and private label
apparel, supplying over 18,000 retailers. Fiscal year 1999 sales exceeded $2.1
billion. Major brand names
include Sag Harbor, Kathie Lee, Slate, and Koret.
The company's Vision 2000 program has been successful in improving
profit margins and reducing working capital needs. KWD sells for less than 7X the consensus estimate for fiscal
year (4/30) 2000.
The
Meditrust Companies (MT) are a paired share real estate investment trust,
comprised of two companies whose shares trade together under a single ticker
symbol. MT has 302 La Quinta
hotel properties, which generate 68% of revenue, and 387 healthcare properties
and mortgages. For the first nine
months of 1999, the Companies had funds from operations of $234 million (or
$1.63 per diluted share). The
price of the shares has suffered along with the rest of the REIT industry.
Management has stated that they may reduce the dividend by as much as
50% in early 2000. Like many
other REITs, the negative factors appear to be fully reflected in the price of
the shares. MT currently has a
dividend yield of 32%, before any dividend reductions, and sells for 29% of
book value.
PacifiCare
Health Systems, Inc. (PHSY) is a leading managed health care company with HMOs
in 9 states and Guam. PHSY has
more than 3.5 million members and owns the largest Medicare+Choice program,
Secure Horizons. Medicare
premiums are expected to increase by 3.5% in 2000.
In addition, premium increases of 5-7% for commercial members and
reduced benefits should result in an effective price increase of 8-10%.
The company has significant non-cash expenses due to the amortization
of goodwill. PHSY sells for less
than 7X 1999 free cash flow.
The
John Hancock Investors Trust (JHI) is a closed-end fixed income fund that
invests in U.S. Treasuries, Agencies and corporate bonds.
JHI currently sells at an 18% discount to net asset value and has a
yield of 8.6%.
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Deletions
In
October, the Heritage U.S. Government Income Fund was merged into the Heritage
Income Trust. The former
was a closed-end fund that was purchased at a discount to net asset value (NAV).
After the merger, the Heritage Income Trust was redeemed at NAV and
used as a source of funds for the purchase of the John Hancock Investors
Trust.
Two
utilities (Kansas City Power & Light and Constellation Energy) were sold
to realize tax losses and/or to use as a source of funds for purchases with
higher expected returns.
KLM
Royal Dutch Airlines (KLM) was sold to realize a tax loss.
Proceeds were used for the purchase of AMR Corporation.
Leap
Wireless International, Inc. (LWIN), a spinoff from Qualcomm, was sold as it
reached my price objective. LWIN
is a development stage company and is expected to lose over $15/share in 2000
so profits were taken.
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.