Newsletter Q4 2001
October 11, 2001
Market Overview
The
tragic events of September 11 have had a significant effect on the economy.
Prior to the attacks, aggressive monetary stimulus by the Federal Reserve
and fiscal stimulus from the $40 billion tax cuts failed to revive the
economy. Much
of the weakness in corporate profits had been isolated to the
telecommunications and technology sectors.
Industries that have suffered since September 11 include airlines,
aerospace, entertainment, hotel/gaming, and insurance.
The airlines have been able to entice some customers back with price
cuts but it may be a long road back to profitability.
The
decline in corporate profits is reflected in recent employment data.
First-time claims for state unemployment benefits rose more than
expected for the week ended September 29 to a nine-year high of 528,00.
According to Challenger, Gray and Christmas, an outplacement firm,
there have been announced layoffs of 1.37 million jobs for the first nine
months of the year, compared to 614,000 for the prior year.
Over 200,000 of the announced job cuts came in the last 19 days of
September.
Since announced layoffs are a leading indicator for unemployment
claims, further weakness in the employment data is expected.
According
to the Federal Reserve, real GDP grew by 0.2% in the second quarter.
Consumer and government expenditures contributed to the positive
growth, offset to a large extent by a decline in fixed investment.
Economists polled by Bloomberg now expect the economy to contract by
0.5% and 1.0% in the third and fourth quarters, respectively, as consumer
spending slows.
They also expect the unemployment rate to rise from the current 4.9%
to 5.5% in the first half of next year.
The
sharp decline in the financial markets in the week following September 11
reflected an emotional reaction but the subsequent rally appears to be
inconsistent with the economic fundamentals.
One factor that has contributed to the rally has been the liquid
state of investor balance sheets.
According to Tom Galvin, chief strategist at Credit Suisse First
Boston, the ratio of money market funds to the value of U.S. stocks reached
its highest level since 1982. Interest rates on money market funds have
declined to 3% so, he contends, it was inevitable that investors would be
forced "up the risk spectrum."
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Updates
Harmony
Gold Mining Company's (HGMCY) stock price has moved up recently.
HGMCY is one of the few gold mining companies that remains largely
unhedged and benefits from higher gold prices.
The Company estimates that a 15% increase in the price of gold to
$300/ounce will increase free cash flow by approximately 80%.
Worldwide gold demand is currently about 3,150 metric tons compared to
mine production of 2,250 tons.
The difference is met from sales by central banks, which still have
about 31,500 metric tons of gold.
HGMCY continues to sell at a low valuation of 4.7X estimated earnings
for the current fiscal year.
La
Quinta Inns (LQI) and Equity Inns (ENN) have had lower occupancy rates since
September 11.
For the week ending September 22, hotel industry revenue per available
room (RevPAR) declined by 37.3%.
LQI and ENN properties consist mostly of mid-scale roadside hotels, so
the companies had more modest declines of about 8% and 23% respectively, for
the same week.
Both have shown improvement in each of the succeeding weeks.
Holly
Corporation (HOC) reported record earnings of $4.84 per share for the fiscal
year ended July 31.
In addition to strong refinery industry margins, the Company benefited
from the cost reduction and efficiency program that it implemented in May
2000. Earnings
for the current fiscal year are expected to be lower due to lower industry
refinery margins.
Value Line estimates that the Company will earn $3.30 per share for
fiscal year 2002.
U.S.
auto industry sales declined by 9% in September.
The decline was consistent with expectations prior to September 11
because the auto companies offered 0% financing to mitigate the sales
slowdown. General
Motors (GM) fared better than the industry, with a sales decline of 3%, due to
strong sales of its light trucks.
GM now seems less likely to sell Hughes Electronics (GMH) because the
decline in the price of News Corp. Ltd. makes a transaction less attractive.
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Additions
Methanex
Corporation (MEOH) is the world's largest producer of methanol, a basic
chemical building block that is used to manufacture a variety of products.
In 2000, MEOH sales accounted for roughly 24% of global sales for
methanol. Approximately
30% of methanol production is used to make MTBE (methyl tertiary butyl ether),
an additive that causes gasoline to burn more completely.
Although methanol prices have declined in recent months, longer-term
demand is expected to increase because methanol is a leading fuel alternative
for fuel cell applications.
Ford, for example, currently expects to introduce a methanol fuel cell
powered car by 2004.
According to MEOH estimates, if one percent of U.S. vehicles operated
on methanol, global demand would increase by 10%.
MEOH
recently completed a Dutch auction to purchase 29.2 million shares (17.9% of
outstanding shares) for cancellation.
Your shares were tendered at a price of $6, which exceeded the market
price, and subsequently repurchased at a lower price if cash was available.
After completion of the Dutch auction transaction, the Company expects
to have a cash balance in excess of $300 million.
MEOH is authorized to buyback another 11.5 million shares through
August 2002.
MEOH currently sells for less than 4X estimated free cash flow for
2001.
Telefonos
de Mexico (TMX) was added to several accounts during the quarter.
TMX provides domestic and international telephone service in Mexico.
The Company controls about 95% of the market, with 12.4 million access
lines.
TMX
currently sells for 9X estimated earnings, a much lower valuation than its
U.S. counterparts.
Teekay
Shipping Corporation (TK) provides international crude and petroleum product
transportation services through the world's largest fleet of medium-sized (Aframax)
oil tankers.
In April 2001, the UN governed IMO (International Maritime
Organization) passed a resolution to accelerate the scrap rate of single hull
tankers. Consequently,
approximately 30% of the current world tanker fleet is expected to be scrapped
by 2006. The
current world tanker fleet is operating at close to full capacity and new
ships are expected to be insufficient to cover the shortfall.
This should increase shipping rates and benefit TK, which has one of
the most modern fleets.
TK currently sells for less than 4X estimated earnings.
Sirius
Satellite Radio Inc. (SIRI) plans to start broadcasting 100 channels of
digital quality radio via satellite in the fourth quarter of this year for a
monthly subscription fee of $12.95.
The service will include 50 channels of commercial-free music of almost
every type and 50 channels of news, sports, talk, comedy and children's
programming.
SIRI has approximately $400 million in cash, which should be adequate
until the fourth quarter of 2002.
The Company has agreements to install three band (AM/FM/ Satellite)
radios in Ford, Chrysler, BMW, Mercedes, Porsche, Mazda, Jaguar and Volvo
vehicles as well as Freightliner and Sterling heavy trucks.
ICN
Pharmaceuticals (ICN) was added to several accounts during the quarter.
Sales of Rebetol slowed during the second and third quarter.
It appears as though some doctors were putting patient treatments on
hold when studies indicated that an improved version of the hepatitis C
combination therapy (Schering-Plough's Peg-Intron A and ICN's Rebetol) was
more effective.
Schering-Plough announced the U.S. launch of its improved version of
the combination therapy and supplies should be available at pharmacies by the
end of October.
Royalties from Rebetol should begin advancing again in the current
quarter.
Petroleo
Brasileiro S.A. (or Petrobras, PBR) is an integrated oil company, operating
primarily in Brazil.
PBR's stock price has declined along with other Brazilian stocks this
year. Petrobras
has been able to increase its reserve position, finding oil and gas at a lower
cost than most of its peers.
PBR has proven reserves of 9.8 billion barrels and has a market
capitalization of approximately $20.8 billion.
The Brazilian government, which owns 55.7% of PBR, has plans to
privatize the Company and deregulate the industry.
PBR currently sells for 4.3X estimated earnings and has a dividend
yield that should exceed 5%.
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Deletions
and Reductions
ArvinMeritor
(ARM) was sold at a small loss.
Earnings estimates for ARM had declined since positions were
established and the balance sheet had become more highly leveraged due to the
merger.
Kellwood
Company (KWD) was sold at a profit.
KWD announced that they would not meet analysts' expectations for the
quarter ending in July based upon soft demand from their customers.
Given the price of the stock, upside potential appeared to be limited.
Remaining
positions in Galileo International (GLC) and AmerisourceBergen (ABC) were sold
at a profit.
Both stocks had been winners but other opportunities offered more
potential.
Positions
were reduced in La Quinta Inns (LQI) and General Motors (GM) earlier in the
quarter to reduce the economic sensitivity of the portfolios.
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.