Company Research

WaMu Attracts a Large Infusion of Cash

CURRENT RATING: HOLD

April 7, 2008 | 3:40 PM

Word that Washington Mutual, Inc. (WM) is in talks with private-equity firm TPG regarding a $5 billion cash infusion has the stock up over 26% today. WaMu desperately needs a boost as its stock has been in retreat for the better part of a year. Over the last few months, the company has cut its dividend by 73%, eliminated 3,000+ jobs and raised more the $3.7 billion through the issuance of preferred stock. The stock price has reflected this dire situation; as of Friday’s close, it has lost more than 70% of its value in just a year’s time. WaMu has taken punishing losses from bad calls in the subprime mortgage market, which have to date cost the company about $3 billion. A cash infusion from TPG will ease mounting capital-requirement pressure on WaMu and today stock investors are applauding the deal.

The $5 billion investment will significantly dilute the value of the current shareholders’ stake in the company, but after seeing the stock’s value plunge more than 70% in this crisis already, shareholders are unlikely to be upset if the infusion helps WaMu weather this storm. The TPG investment may be an inflection point for the mortgage crisis—the point where savvy investors finally find compelling value in some of the financial companies hardest hit by the credit crunch. That being said, there is still a lot of risk involved in the deal as WaMu is heavily impacted by the troubles in the mortgage market, especially in some of the hardest hit regions such as California and Florida. WaMu grew quickly from a regional savings and loan in the Pacific Northwest, into a national force riding a wave of profits from subprime and adjustable rate mortgages. Now, with the subprime and adjustable rate mortgage markets in shambles, it is feeling the pain.

Ockham Research is maintaining a Hold rating on WaMu stock. Our methodology is heavily weighted towards sales and cash-flow metrics. We employ a value methodology and when a stock has fallen out of favor with the market to the extent that WaMu has, it is likely going to be attractive to us based on historical norms. However, there are significant issues with WaMu that give us more than just a little concern. For example, the market has historically been willing to pay price-to-sales of between 1.326 and 1.97 for the stock. The current price-to-sales is currently only .578, but when you consider that the price has declined so much (about 70% in a year) this metric conceals the 40% decline in revenue reflected in our estimates. Even more distressing is the fact that cash flow is negative at present because of large losses on subprime and other mortgage-related investments. Thus we realistically cannot compare the stock’s current price-to-cash-flow valuation to previous historical norms. In short, assuming that WaMu survives this mess, the stock may represent a good value at current price levels. However, there is enough uncertainty about their survival that WaMu share’s are only suitable for the most stout-hearted and patient investors.

Investor's Toast Constellation Brands

CURRENT RATING: HOLD

April 3, 2008 | 11:40 AM

Constellation Brands (STZ)--a wine and spirits maker--reported a net loss of about $832 million for the fourth quarter of 2007. This translates to a per share loss of $3.90. However, the news was better than Wall Street was expecting and the stock has risen about 4% in morning trading. The silver lining in the report is that had it not been for items like $888 million in acquisition-related costs, restructuring charges and unusual items, the company would have earned about 34 cents per share. Analysts obviously were aware of the non-recurring costs in the quarter and had estimated earnings of 25 cents per share. The results were likely aided by an increase in exports abetted by the faltering value of the dollar, although 31% of sales came from outside the United States.

While Constellation did beat analysts’ estimates for the fourth-quarter, Ockham Research has reiterated its Hold rating on STZ, which was downgraded to this rating in the report written on February 22nd of the current year. From our perspective, Constellation is fairly valued after today’s rally. Price-to-sales--currently 1.115x--is appropriately in the upper quadrant of its historical normal range between .859 and 1.31. Price-to-cash flow, which is normally between 8.9 and 13.55, is currently only slightly below this range at 8x. Compared to last year’s results, revenues were off by 23%, and sales growth has slowed considerably. Furthermore, last year’s sales were up a paltry .16% from what they were 5 years ago. Profit margins were 6.4%, which is below STZ’s historical norm.

Based on the current stock valuation, there is no need to be overly enthusiastic about today’s mild beat of analyst estimates, especially in a quarter where good news did not translate into actual earnings. STZ stock, by our methodology, is fairly valued at $18.90- $23.84, so there is no real catalyst for a rating change. STZ has been acquiring wine and spirit makers fairly aggressively for many years, as was recently highlighted by the March 2007 purchase of Sweden’s Svedka Vodka. Management did offer guidance for net sales growth in the mid single digits and organic sales to grow in high single digits, and that would be a welcome improvement. However, we would like to see earnings continue to improve before upgrading Constellation Brands to a Buy.

The Last Major Write-down? Doubtful.

CURRENT RATING: HOLD

April 1, 2008 | 1:15 PM

European banks exposed to the U.S. real estate market absorbed more massive write-downs this morning. UBS announced its third write-down from the carnage and it was the largest to date at $19b. UBS also plans to ask shareholders to approve $15b in new financing. UBS raised $13b after its last massive write-down through a large investment by the Singapore Sovereign Wealth Fund and an undisclosed Mid Eastern investor. Deutsche Bank followed the UBS news with a $3.9b write-down as well. Since the subprime mortgage market began to falter last summer, there have been about $200b in related write-downs globally. Considering estimates of the total toll that this crisis will cost range from $400b all the way$1 trillion, it would seem to us a cause for concern that UBS and Deutsche Bank are unloading more bad debt. However, the U.S. stock market is rallying behind the hope that we have reached the nadir of the financial crisis.

While it is certainly nice to see a bit of optimism in the market, it is perplexing that it comes after news of a new wave of write-downs and emergency financing measures. Investors are hoping that at least in the short term the bulk of damage from the credit crisis is now at least known to the public. However, there is a good possibility of write-downs for banks and brokerages in the future; there is no reason to believe that UBS held risky subprime and Alt-A assets that are substantially different from those held by many other financial institutions. We sincerely hope that this is at least the last such write-down for UBS for some time, but even that is not assured. For example, even after the $19b UBS write-down they still have about $15b in subprime assets on their balance sheet, as well as $16b in Alt-A positions.

As we stated in the Razor’s Edge commentary from December 10^th— after its second write-down— UBS is clearly heavily implicated in the subprime and credit mess. We continue to advocate a Hold rating on the stock because we are not willing to declare that it is in the clear just yet. There is simply too much uncertainty in this market climate for a bank with so much tied to very risky assets, even though (as you can see in the price chart) the value metrics we follow closely have shown UBS to be “undervalued” from time to time during its stock price decline.

We are unconvinced that the credit crisis is subsiding, yet we are still bullish on the stock market for the long term investor. Currently, 48% of our coverage universe is rated a Buy, and less than 10% is rated a Sell. By our methodology — which is heavily influenced by current cash and revenue valuations versus historical averages— there are many undervalued stocks in this slightly oversold market, which seems the real reason behind this morning’s rally.

Monday brings Heartburn for Schering-Plough

CURRENT RATING: Strong BUY

March 31, 2008 | 12:55 PM

It was a rough Monday morning for stock owners of Merck & Co. (MRK) and Schering-Plough Corp. (SGP) as a panel of cardiologists recommended that Doctors sharply reduce their prescribing of the companies' jointly marketed cholesterol drugs Vytorin and Zetia. The cardiologists based their claim in the results of an “Enhance” study which found that there was no significant benefit to patients who took Vytorin and Zetia over the cheaper Zocor, which is available as a generic. Today, the shares of Merck are off about 15%, while Schering-Plough is down nearly 25% making its year-to-date loss nearly 50%.

As bad as the report from the cardiologists’ panel was for MRK and SGP, it begs the question: has the market overreacted to the news? Were Merck and Schering-Plough counting on this drug for 15% and 25% of future earnings respectively? According to earnings estimates from Goldman Sachs, it appears that the market has overreacted to the news. Goldman revised estimates on SGP after the news broke, and while they revised estimates downward, forward-looking earnings going out as far as 2012 show EPS only 12% lower than prior to the revision. Goldman is on the conservative end of the range of analyst estimates according to Yahoo! Finance, and they still see earnings growing almost 11% per year from 2008-2012 (EPS of $1.40 in 2008 to EPS of $2.11 in 2012).

It seems to us that the concerns about sales in SGP’s cholesterol drugs have been priced into the stock, and earnings growth still looks fairly strong. From a value prospective, SGP is attractive; in fact, with a price of $19.47 at the time the market closing last Friday, SGP was a full 54.4% below its average Price-to-Sales ratio at comparable sales levels. Likewise Price-to-Cash Earnings--currently 9.3x--is well-below the normal historically weighted average range of between 29.9x and 44x. With the sell-off today, these measures have only dropped further out of their normal range. Furthermore, Ockham Research has the healthcare sector rated the most attractively valued of the 10 sectors we rank each week. Clearly, from a long-term value prospective, this is about as cheap an entry point into SGP that you will find.

Boeing Clear for Take-Off

CURRENT RATING: BUY</