Happy Days are Here Again

I love the smell of Napalm in the Morning

Gudovac's price targets remain more or less similar to those of 9-12 months ago. price in paretheses is the current price.

Owners might just observe good prices in the near term future.

The price that follows is Gudovac's buy target. In Green are the Stocks that are close to a buy target.

Red indicates stocks that are have a very long way to drop before Gudovac believes they represent good value.

ABB ($16) buy at $5

AA ($11) - $9

ALS - 30 Euros

AMSC ($28)- $5

CSX ($49)- $44

DOW ($25) - $12

EMR ($46)- $34

GE ($16) - $6

RBC ($57) - $31

Emerson Electric (EMR) - Order Intake remain steady: down 25%

Emerson Electric issued a interesting inter-quarter 8-k  on the 24.Sept.  Emerson indicates the order intake has stabilized at approximately 25% below last years figures.  The reduced order intake supports Gudovac's recent analysis of similar industrial companies here, & here.  

Gudovac suggested that Emerson might be a reasonable Enterprise to own back on 20.August, given its modest risk profile. Owning EMR at these prices levels is purely a function of each Owner's discount rate.  Some owners may not believes Emerson's expected return warrants purchase. Others may differ. Gudovac suggested that Emerson would provide a CAGR return of 6 5/8% bought at the prices of 20.August.  Gudovac believes the 6 5/8% return rate is still acceptable return for Emerson's risk profile. 

The decline in orders at Emerson is spread throughout their product lines as shown by the chart copied from the 8-k filing.  (all numbers in percentage change y.o.y.) The scope of decline implies that the decline is deep and will be persistent. 

Owners should be clear about the long term profit implications of backlogs which are 20 - 25% lower than the boom period levels. Management at any first rate Enterprise such as Emerson will proactively reduce variable costs in line with the decline in revenues. 

However, fixed costs will be difficult to bring down in lock step with order declines. Industrial companies simply have huge fixed costs imbedded into their cost structure. Owners can expect fixed costs to total 35% - 55% of revenues in these companies.  When modeling likely profitability in the medium term future, Owners should attempt to model changes in fixed and variable costs. 

Gudovac modeled the profit implications for ABB of a 25% decline in orders/revenues.  Such a decline results in a Enterprise which is near breakeven profitability.  This change has profound implications for the stock price. In ABB's case, Gudovac calculated that ABB stock price might drop by 75% from its current elevated heights.  

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Don't Get Massacred !

Gudovac1941

Methodology Thoughts and Observation

Economics - Capacity Utilization Aug. Good News

The Fed released the August Industrial Production and Capacity Utilization numbers one hour ago.  The numbers indicate a slight uptick in production.  Motor vehicle production was distorted by the cash-for-clunkers program. Manufacturing production ex. motor vehicles is up 0,4%. There may have been some flow through to other sectors (ie steel) from the cash-for-clunkers which distorted the results.  Owners should examine carefully next month's data to verify that Production and Capacity have leveled out. 

Owners should also note that Production may have leveled out, but a large gap remains between capacity and utilization.  The attached charts describe the situation in stark terms. Also note  Equipment production appears to have been bolstered by Defense orders. Private Equipment demand remains weak. 

Owners can conclude that Backlogs will remain at low levels. Margins will also remain weak. Gudovac examined the backlog and margin situation in some detail in July.  

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Don't Get Massacred !

Gudovac1941

Methodology Thoughts and Observations

Economics - Capacity Utilization Good News

The Fed released its Industrial Capacity numbers a few hours ago. They are finally good and show an increase, even after stripping out distortions which may have been caused by the Cash-for-Clunkers program.  Here is the lead paragraph plus 2 illuminating charts from the release. 

The first chart indicates how large the output gap is in total Industrial Production.  The second chart shows only Equipment Utilization which is the critical sector for Gudovac and his readers.  It is illuminating to see just how much business equipment has dropped in the US. The downward slope of the line is simply horrifying.  Defense purchases have clearly propped up US equipment suppliers.  Downward pressure on margins as well as tougher Terms and Conditions can be expected from Customers in orders being currently booked.Owners need to watch these indicators closely. 

However, Gudovac is pleased to see some growth in Utilization. This indicates that we just maybe, possibly, perhaps have leveled out. 

INDUSTRIAL PRODUCTION AND CAPACITY UTILIZATION

Industrial production increased 0.5 percent in July. Aside from a hurricane-related rebound in October 2008, the gain in July marked the first monthly increase since December 2007. Manufacturing output advanced 1.0 percent in July; most of the increase was due to a jump in motor vehicle assemblies from an annual rate of 4.1 million units in June to 5.9 million units in July. Excluding motor vehicles and parts, manufacturing production edged up 0.2 percent. The output of utilities fell 2.4 percent, reflecting unseasonably mild temperatures in July, and the output of mines increased 0.8 percent. At 96.0 percent of its 2002 average, total industrial production was 13.1 percent below its level of a year earlier. In July, the capacity utilization rate for total industry edged up to 68.5 percent, a level 12.4 percentage points below its 1972-2008 average.

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Don't Get Massacred !

Gudovac1941@gmail

Durable Goods Orders -

Gudovac hesitates to post economic information here. However, this graph tells the story in one stunning  image.  Click on image for high resolution.  This data should clarify the Backlog situation at Capital Goods companies.  

Please note, this data is only for the USA.  If one would overlay EU and BRIC's demand the picture would be different. Therefore, Owners need to understand a  Enterprise's market. Also note, this data does not represent final destination (ie to).  This data represents shipments from US plants.  

Therefore, the date includes Capital Goods which were manufactured in the US but ultimately exported.  Owners would do well to understand exactly how a) trade weighted declines in the US dollar vs. b) demand destruction vs. c) increases in local content might change future demand. 

Gudovac is confident that First Rate Management teams can respond pro-actively to changes in the macro-economic climate - benefiting their Owners.   

Gudovac is also confident that the USA will continue to be a manufacturing powerhouse . US share of world manufacturing output will continue  to remain in  20% range.  

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Don't Get Massacred !

Gudovac1941

Methodology Thoughts and Observations

GE vs. Alstom vs. ABB - Backlog and Bookings

Trouble Ahead  or Trouble Behind ? 

Why Examine Backlog and Bookings ?

Most observers believe Backlog is the most critical metric for pricing capital equipment companies.  

Owners might do well to compare the respective Backlogs and Bookings of GE, ABB, and Alstom. All three of these Enterprises supply equipment with lead times expressed in years.   A large turbine-generator set might have a lead time of 36 months from time of order placement. The Backlog represents  some 9 to 12 months future revenues at these 3 Enterprises   

Therefore, Backlog and Bookings information can provide insight to the owner of these Enterprises of their likely performance 12-24 months out. Backlog and Bookings information also provides owners broader economic signals.  Bookings represent booked orders often with a progress payment due with 30 days of issuing the PO.  A PO coupled with a progress payment is a leading indicator which owners can judge reasonably reliable. 

Owners seldom have such solid data on leading indicators. Owners would be wise to examine and compare Bookings data carefully. 

GE vs. Alstom vs ABB: Backlog and Bookings 

Owners can reach some preliminary conclusions based on the summary information presented above. The last row in the spreadsheet, Change in Absolute Backlog is illuminating. Backlogs declined 12% to 20% year over year.  

The decline in absolute backlog is consistent with macro-economic data. Customers and end users have little need to order new equipment when capacity utilization is low.  50% peak-to-trough declines in absolute backlog are possible over a cycle as old orders are shipped and no new orders are booked. 

These companies have only seen 12-19% declines in their Backlog. Therefore, owners can expect further backlog declines. Further declines are likely even with Emerging Market GDP growth remaining above 6%.  Emerging Markets still do not provide the majority of these 3 OEM's revenues. 

As the Backlog declines, operating managers become more concerned about marginal costs and marginal productivity. Manufacturing facilities for heavy equipment have shockingly large fixed costs which need to be covered by direct labor. Direct Labor may only be 5% - 12% of the COGS of an order.  Activity Based Costing  (ABC) has reduced distortions caused by the old style Burden Rate calculations. However ABC, still has not eliminated the need for order to cover overhead. A small decrease in direct labor (ie orders flowing through a facility) will have a dramatic effect on fixed cost coverage.  

Pressure to book orders to fill the plant becomes greater with every new order that is shipped. Owners need to carefully monitor gross margins and actual warranty costs (not provisions) to determine if inappropriate orders are being accepted. 

Another key metric for owner's to watch is Months of Revenue in Backlog.  A steep decline in this number will indicate either a) future declines in revenues or b) declines in quality of revenues (ie margin destruction). General Electric has seen a 17% drop in months of revenue in its equipment backlog (note, the numbers cited for GE are only for their equipment and service backlog - not the entire enterprise). Owners can expect that revenues for GE's equipment groups to decline by this scale by 1Q '10.  

Both Alstom and ABB have been able to manage their Months of Revenue in Backlog rates more consistently than General Electric.  Owners can expect pressure to accept 'bad orders' to be lower at Alstom & ABB than at GE in the future.  Owners might reasonably predict that revenues over the next few quarters will be more stable at Alstom and ABB than at General Electric. 

Tenders Up = Orders Up ?

ABB provided this most illuminating graph in its latest quarterly report. It is supposed to indicate a continued boom in activity. Tender activity are useful proxies for future orders. Tender activity is a soft number and is subject to any number of distortions. Gudovac believes ABB's managers are incorrect in concluding a record number of tenders equals a record number of orders - soon. 

One could also conclude from the data that a record number of projects are being red lighted at the last minute.  A tender may go out and then the project is delayed, and delayed, and delayed, and..... Many Projects may have been put on long term hold until more economic certainty returns.  Owners need to continue to monitor trends in this data for all OEM's. 

 

GE Backlog as of 30.June 09

 

GE's backlog slide was cleverly constructed. As Gudovac has noted before, GE's managers are the supreme masters of the craft of the Power Point Presentation.  This slide seeks to obscure the fact that the equipment backlog has shrunk by 17% y.o.y.  Viewer's attention is directed towards the blue and green graph which suggests backlogs are steady at $169 Billion.  

However, GE's best leading indicator of future business is new equipment orders. Gudovac appreciates that GE's managers are showing service booking information. This indicates they are serious about the effort to promote high margin service revenue.  GE's managers have promoted service in its own right for a long time.  Owners can be pleased that Service has a solid foundation at GE> 

 

Alstom Backlog as of 31. March 09

Alstom's presentation of its backlog information is clear and concise.  The breakout of service is welcome. Alstom's service business represents approximately 30% of its revenues. In the downturn, Service will represent possibly all of  Alstom's profits. Service tends to have a shorter cycle time. Therefore, Owners should balance backlog change with service growth. Alstom's Owners will need to watch the Service side of the Enterprise closely throughout the down cycle.   

ABB Backlog as of 3o. June 09

ABB provided Owner's with a number of slides presenting a a solid amount of data in a most compelling fashion.  The long term backlog trend graph shown here describes just how quickly the backlog situation has changed at ABB. A  trend graph for Alstom and GE would likely indicate a similar situation. Of particular note for Owners is the steep decline in large orders (orange). 

Until large orders expand, one can not expect significant growth in top line revenue.  

GE vs. Alstom vs. ABB  Backlogs and Bookings

The backlog and bookings information for these 3 OEM's provides a critical insight for the Owner.  At both Alstom and ABB, the next year's results are going to be rather predictable. GE's results will be less predictable due to the impact of GE Capital upon GE Industrial. However, in all 3 cases,  Mr. Market appears to focus closely on the latest results, instead of understanding how the current backlog will flow through the next few quarters. Owner's may be able to take advantage of Mr. Market's myopia. 

Owners don't need the Grateful Dead to tell them if there is Trouble Ahead  or Trouble Behind ? - the backlog tells them exactly what lies around the next bend. 

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Don't Get Massacred !

Gudovac1941

Methodology Thoughts and Observations

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Alstom - Areva Acquisition a Value Destroyer ?

Today's press release announcing that Alstom's managers will be making a bid for Areva should concern any Owner.  Here is the key language from the press release:

Schneider Electric and Alstom are considering making a joint offer to acquire Areva Transmission and Distribution (T&D), recently put up for sale by its parent company.

In order to achieve this, Alstom and Schneider Electric would create a common structure which would bid for Areva T&D and, if this offer is accepted, would ultimately transfer the transmission activities to Alstom and the distribution activities to Schneider Electric. Such a transfer of activities would have no social consequences

The high voltage Transmission (T) part of Areva T&D is very close to Alstom’s own activities in power generation. Alstom will bring to Areva T&D its expertise and knowledge in power networks and automated systems, its know-how in the management of large projects and the full benefit of Alstom’s worldwide commercial network which is particularly focused on power generation utilities, the primary market for high voltage activities.

The medium voltage Distribution (D) part of Areva T&D is a business in which Schneider Electric is very active and that it would like to reinforce. Schneider Electric would bring to Areva T&D its considerable technical and operational strengths in automation and medium voltage, its worldwide sales network, as well as a complementary access to Industry, Building and Infrastructures , major markets for medium voltage activities.

This consolidation around two major worldwide industrial groups, specialised in their own fields, would represent a considerable development opportunity for Areva T&D’s employees.

Gudovac presented his views on the subject on 8.July   when he suggested that ALS at 30 Euros was a good buy. Here were Gudovac's thoughts:

Alstom's managers could always do something truely destructive such as trying to make a big acquisition. Owners should apply a massive negative discount to Alstom if a big acquisition is even rumoured. 

Gudovac will be following these developments closely. 

Don't Get Massacred !

Gudovac1941@gmail.com

Methodology Thoughts and Observations

Alstom (ALO-Euronext) - Buy at 30 Euros

Today's Enterprise Value approx. 13 Billion Euros ( approx. 3/4 of TTM Revenues, approx 9-10x free cash flow, 43 Euros share price)

Buy at 7- 8x Free Cash Flow - approx 30 Euros


Background:

Owners should recognize that Alstom is really a dull repair business obscured by the glamour of 300 kph Trains and Big Coal Power Plants. The latest numbers ( released today ) reflect this reality.

New orders are in free fall. Alstom didn't release much margin information today on new orders. Gudovac can speculate that the slope of actual margin destruction is not-quite-as-steep as new order intake. By actual margins, Gudovac does not mean at what estimated margins the latest orders were taken. Rather, Gudovac expects the latest order estimates to have been subject to heroic assumptions about improved learning curves, material costs, and engineering.

Owners can expect actual gross margins in the thermal power group for new equipment to turn negative in 20-36 months as these Hail Mary orders flow through Alstom's facilities. Margins on transport are likely to experience similar downward pressure but will get hurt less than power.

Grim, but this forecast is not causing Gudovac to abandon all hope - because the negative margin orders will be a smaller portion of Alstom's overall business in 20-36 months. It is a well known secret within the industry that Alstom's operating execution on new projects is matched only by Siemens Orlando (ie weak). In contrast, Alstom service is able to execute at the highest level in the industry. As far as Gudovac is concerned, the less emphasis placed on new equipment, the better for Alstom and its owners.

The value of Alstom is in its service and renewables segments. These 2 segments will continue to grow. Service will grow at perhaps double GDP. Renewables will grow at near double digits rates. Fortunately, when Alstom was near collapse, the service business recieved significant attention. A solid foundation has been created at Alstom in its service business - almost 20% of Alstom's employees work in Service. The service business has the advantage of high margins, low capital requirements, and relatively quick cycle times.

Alstom also has cleaned up it's balance sheet. The terrifying leverage of prior years has been addressed by management. Despite the lack of leverage, owners should expect that Alstom's dividend will be cut drastically.

Therefore, at reasonable prices, owners can expect reasonable returns from Alstom. Gudovac is able to justify a relatively higher than normal free cash flow multple (7-8x) for Alstom due to low leverage and service franchise.

Prospective Owners need to examine these questions:

Will the service business be able to carry the company ?
Will a 20% increase in Servce revenue at 17% margin fill the chasm when Traditional Power Margins drop to 0% ?
Will renewables expand at a double digit pace ?
Will Alstom stop all capacity expansion - as necessitated by the sea change in economic environment ?
Will Alstom be able to continue to off shore jobs given the European political climate ?

Finally, Alstom's managers could always do something truely destructive such as trying to make a big acquisition. Owners should apply a massive negative discount to Alstom if a big acquisition is even rumoured.

Don't get Massacred !

Gudovac1941@gmail.com