BeaconIdeas

Survival of the Fittest: Best Buy and the Consumer Electronics Space

Last month, in the wake of post-liquidation store closings at competitor Circuit City, electronics retailer Best Buy (NYSE: BBY) reported fourth quarter earnings that soundly trounced street estimates: excluding one-time charges associated with layoffs and its Speakeasy corporate VoIP subsidiary. The retailer had diluted earnings of $1.61 a share compared to analyst consensus averaging $1.38. Despite an uncertain sales environment and intense competition from low-cost providers like Amazon.com (Nasdaq: AMZN) and WalMart (NYSE: WMT), Best Buy’s specialized pursuit of growth channels and market share make it well positioned to capitalize off of a stronger economy down the road. 

A recent piece in the Wall Street Journal reported on Best Buy’s investment in private label electronics: the electronics retailer markets low-cost flat panel televisions, video cables, flash drives, and electronics accessories under in-house brands. Make no mistake, the company is not trying to reinvent the wheel or establish itself as a design leader (leave that to the gang in Cupertino); Best Buy is focusing on offering simple and affordable products that its engineering team has improved upon based on the intimate knowledge of consumer preferences it gleans from its retail stores. This strategy has resulted in some shelf space recalls and caused some competing electronics manufacturers to resist being carried at Best Buy Stores, but the numbers tell the story: in the past fiscal year, the company’s private label brands reported 40% sales growth, and a poll by market research firm iSuppli found that the Best Buy private brands Insignia and Dynex had a market share of 4.9% of the flat panel television market in December of 2008—this figure is more than double the December 2007 number.

For the 2008 fiscal year, consumer electronics made up 41% of Best Buy’s domestic sales; the private label products focus squarely on this category bringing higher margins to this area responsible for a large amount of the company’s revenue. Based on the encouraging growth the private lines have experienced thus far, this product set should favorably boost profit margins in the coming years without over shadowing the well advertised blockbuster products of the firm’s partner/suppliers.

Best Buy has established a network of 160 stores in China though its 75% stake in Five Star, a Chinese retailer of consumer electronics (with seven to twelve more locations in the pipeline this year). International revenue was up 37% through new store rollouts and same store sales growth in Canada and China, and domestic internet sales were up a healthy 25%. The bottom line is that Best Buy is a growth oriented retailer that is well positioned to both survive and thrive.

Disclosure: Mr. Corn is Chief Investment Officer – Equities of Beacon Trust Company. Through various equity strategies under his supervision he is long Best Buy, Amazon, WalMart and Apple Inc. (Nasdaq: AAPL).

Shout out: Look who is back; former Clear Indexes grand prize winner and ace intern Jimmy Baker who researched and drafted this post. Welcome back Jimmy!

Money Going to Work

With the equity markets showing some life and enough pundits calling for a big correction, perhaps the inevitable move down will be milder than forecasted.

Money may be moving into equities. That is the impression I am getting by the release from the Investment Company Institute (a lobbying organization for the Mutual Fund Com pies). 

Total money market mutual fund assets decreased by $11.34 billion to $3.806 trillion for the week ended Wednesday, April 22, the Investment Company Institute reported today. Taxable government funds decreased by $7.77 billion, taxable non-government funds increased by $2.08 billion, and tax-exempt funds decreased by $5.66 billion.

During these past two weeks in previous years, the cash probably would have gone to pay taxes, but this is not a year people are writing big checks to Uncle Sam. Markets rising, money flowing out of money markets may bode well for Mutual Fund companies. These firms have been fighting outflows for over a year along with a falling market. The environment is evolving. I have added three firms to three of the portfolios I manage. It is earnings season and we are beginning to see what Q1 looked like for these firms and where the subsector may be headed.

As MarketWatch reported, three asset managers reported today with mixed results.

Three asset managers that announced their results before Thursday's trading saw different moves in their stocks during the day. Shares of Invesco Ltd. (NYSE: IVZ) and AllianceBernstein (NYSE: AB) were down about 8% and 15% respectively by midday, while Janus Capital Group's (NYSE: JNS) stock was up roughly 6%. Profit plunged at all three firms, but while Janus reported quarterly net outflows of $900 million and said the situation had stabilized, AllianceBernstein saw net outflows of $20 billion. Invesco saw net inflows of $9.3 billion, but fees earned from investment management fell 41%.

I do not hold any of these stocks but I do hold Federated Investors, Inc. (NYSE: FII) which reported mixed results this evening. FII actually saw net inflows. They do not trade after hours and I am curious what the market reaction to their report will hold (the report also from MarketWatch).

Federated Investors, Inc. (NYSE: FII) first-quarter net income attributed to Federated was $35.1 million, or 34 cents a share, down from $55.8 million, or 54 cents a share, in the year-ago period. Total revenue at the investment management firm rose to $310.6 million from $305.7 million last year. Total managed assets were $409.2 billion, up 21% from the same period a year ago. Average managed assets were $411.7 billion, up 28% from quarter ended in March 2008.

I also hold Eaton Vance Corp. (NYSE: EV) which reports next 5/29, and Franklin Resources Inc. (NYSE: BEN) which reports next week. Each of these firms has differentiating attributes.

Today’s results demonstrate that the market perceives these firms uniquely based on the reaction to each firm’s results. Each firm has its focused asset class and distribution channels.

The macro view is positive for the industry. Will the stocks rise? Did all that cash flowing out of money funds find its way into equities? Has recent market gains translated into better earnings? The answers will be in the reports and forecast for the rest of 2009.

Disclosure: Mr. Corn is Chief Investment Officer – Equities of Beacon Trust Company. Through various equity strategies under his supervision he is long Eaton Vance, Franklin Resources and Federated Investors.

 

Shareholder Friend or Foe: Goldman Sachs Group Inc. (GS)

Growing up in the business there are names that used to bring up awe. The “agency” was the CIA, perhaps now replaced with the triple shot Navy SEALs. The “firm” especially while a private partnership was always Goldman Sachs. Much has changed for Goldman as well including the acceptance of government bailout money.

I have stayed on the sidelines watching the main stream media and fellow financial bloggers debate Goldman’s recent earnings report and major move in the form of selling shares to pay back TARP funds.

Many intelligent pieces have been posted so my chime-in is quick. I think many are missing the simplicity of the real issues.

The earnings are sustainable or not. I believe the earnings number is, but not the sources of revenue. Goldman is positioned to bob and weave to find where the profits are better than most.

My focus is the motivation of the stock sale.

Some basics: it dilutes common shareholders. It raises money NOT to build the business. Use of proceeds is not to gain market share or to enter new business lines or markets. In general this makes the share sale a bad investment. But we are not experiencing “in general” times.

The use of proceeds is to pay down TARP debt. The prevailing assumption of premise is to get out from under the government having a say concerning compensation.

The company’s perspective is that they want to hire, retain and grow the best and brightest. They see an opportunity to recruit from competitors those who can drive the company to excellence during the next business cycle. This could be the best use of proceeds and the single most shareholder friendly thing seen in years, or the least.

The skeptics say this use of proceeds is about greed. It is about big wig Wall Streeters who want their multimillion dollar pay outs. They want their masters of the universe pay scale to match their egos even after “We the People” had to bail them out – and don’t forget the payouts from AIG direct to Goldman.

The answer: to be determined. No one can stop the wheels that are in motion. Market participants and investors of all sizes can vote with their cash. Each can decide to buy and hold Goldman stock, short them or stay away.

For now I am watching from the sidelines.

The Search War is Long Over

Ever since the word Google became a verb, Googled an adjective and Google Desktop launched, this war was won.

I saw a recent piece on Paidcontent.org “Yahoo’s Search Share Due For Another Fall” which is now old news since it was posted last Thursday.

From an investment perspective, I believe there are still insights to be gained that underscore investment themes.

Yahoo’s market share has dipped slightly over the last year, according to comScore, in the face of stiff competition from Google (NSDQ: GOOG)—but it may fall farther still.

Yahoo’s share has been eroding since Google was launched.

A Dow Jones report suggests that Yahoo’s share could drop another three percentage points over the next 12 to 18 months, with the loss of several distribution deals with big PC makers. It appears to be the first time that the impact of those deals—which made Yahoo (NSDQ: YHOO) the default search engine on new Hewlett-Packard and Acer PCs—has been quantified.

This is not small news. The pre-installed head strart is a real advantage. I for one immediately turn my machine into Google and Firefox enabled in the first few minutes. I then repeat the process after my Window’s machine needs its hard drive reformated, usually within in a year.

Yahoo told the news service that while it might lose some share, it would not be as high as three percent, “mainly because consumers will continue to use Yahoo search even if they buy a new computer pre-loaded with a rival’s toolbar.”

You have to be kidding me! The firm in a distant second place believes that who… consumers will go to them for search? The same consumers who “Goggles” things instead of searching for them?

Still, the number is noteworthy not only because it would add to Yahoo’s woes, but also because it gives a rough sense of how much Microsoft (NSDQ: MSFT) could potentially benefit from several major distribution deals it has struck recently for its Live Search. Microsoft replaced Yahoo as the default search engine on new HPs earlier this year and it also announced a similar deal with Dell, which went into effect in February. Together, those two firms account for 56 percent of new PC shipments in the United States, according to Gartner. By contrast, Yahoo’s partners, HP and Acer, accounted for 42.7 percent of shipments. So, if the search share Yahoo is set to lose is proportional to the market share of its old partners, it looks as though Microsoft could eventually get a very significant four-percentage-point boost.

The loss of the pre-installed advantage is another significant nail in the coffin. The final statement says it all.

Yahoo’s search share fell to 20.6 percent in February, down from 21.6 percent a year ago, according to comScore (NSDQ: SCOR). Microsoft’s share dropped to 8.2 percent, from 9.6 percent a year ago.

This news is predictable. It is also investable.

Disclosure: Mr. Corn is Chief Investment Officer – Equities of Beacon Trust Company. Through varies equity strategies under his supervision he is long Google and Microsoft.

iTunes Price increase – It was inevitable

I know I am not the first to blog about the price increase on Apple’s (NASDAQ: AAPL) iTunes store from $0.99 to $1.29.

Do I think it will enhance shareholder value? I hope so.

I heard the news on my daughter’s friend’s Facebook page. An 11 year old writing on walls asking for links for free music, fancy that. After a discussion on the percentage price increase per song (30.30%), the conversation moved on to an ethics lecture (priceless), and then as the resident annoying adult I am then provided an iPod/iPhone MP3 technology dissertation (less than free since no one was listening).  

The tech change is material. Songs can be shared in unlimited quantities and played on any portable device. As far as the pricing goes, Apple states that the vast majority of the songs on iTunes will remain $0.99. We all know that does not include new songs from popular artists.

The competition is pretending to react. Yahoo (NASDAQ: YHOO) today changed its strategy offering free music-related customized aggregation pages. Their users will be able to customize the page, add connections to iTunes or Amazon (NASDAQ: AMZN) as well as other sites like Google’s (Nasdaq: GOOG) YouTube. Yahoo appears to be playing tag along rather than attempting to compete directly with Apple – a smarter choice.

Of course I had read this was coming, but like some evolving relationships that have to move forward (like a shark) or die, I simply was not prepared.

Leave it to Apple to sell the razors at a strong price and still be able to raise the price of the blades.

Disclosure: Mr. Corn is the Chief Investment Officer – Equities of Beacon Trust Company. Apple, Google and Amazon are constituents of various investment strategies under his management. He owns shares in these firms directly through his investments in these strategies.

Ready, Shoot, Aim

I really was stunned and in disbelief this evening when reading the lack of preparation of our Federal government. Here I have been thinking, a stress test for banks. It sounded like an excellent assessment tool with little qualitative wiggle room for influence and lobbying. We have already lived through the crash of Citigroup, Inc. (NYSE: C) and the near crash of Wells Fargo & Company (NYSE: WFC) and even the struggles of the venerable JPMorgan Chase & Co. (NYSE: JPM) which has recently climbed back to be down less than 50% its 52 week high. As all quants know, a stress test is specifically designed with desired outcomes, benchmarks and plans for interpretation. As far as I can tell from reading the Wall Street Journal – not so much.

Top federal bank regulators plan to meet early this week to discuss how to analyze the results of stress tests being conducted on the country's 19 largest banks, people familiar with the matter said.

Regulators announced the tests two months ago as part of an effort to determine how much assistance big banks might need to continue lending if the economic downturn worsens. The government is wrestling with how to bolster the lenders without appearing to prop up banks that are beyond repair.

So they plan to meet early this week. Question one: how can they conduct the test without the knowledge of how the results will be graded and their specific methodology? Question two: what the H-E double toothpicks have they been doing since the announcement?

Meanwhile, Treasury Secretary Timothy Geithner said Sunday that the Obama administration would consider removing top management and boards at financial companies if the government were to offer "exceptional" assistance to keep the firms operating.

"When in the future -- or I would say if in the future -- banks need exceptional assistance in order to get through this, then we'll make sure that assistance comes with conditions, not just to protect the taxpayer, but to make sure this is the kind of restructuring necessary for them to emerge stronger," Mr. Geithner said on CBS's "Face the Nation." "Where that requires a change of management and the board, we will do that."

So the penalty for failure is decapitation. Mind you, many banking heads should lose theirs – if you pardon the pun, but, again, what is the benchmark for this ruling? Is it based on media or political heat? Or is it a percent of overall capital at risk or in distress? Now that I am long banks through my tax dollars I would like a little SarBox and transparency in Mr. Geithner’s coffee. What is good for the goose as the saying goes.

At this week's meetings on the stress tests, regulators also are expected=2 0to discuss how new changes to accounting rules might affect each bank's performance in the tests. The Federal Accounting Standards Board voted last week to make it easier for banks in some cases to limit losses on assets they don't intend to sell. Some government officials think this could significantly improve some banks' condition on paper.

I have rarely seen a team so outed in one short article before. Had I just been missing this seat-of-the-pants management the whole time? Aren’t these players coordinated by one coach? Didn’t the government bully this accounting change? So what are the desired outcomes?

Frankly I believe that the Government is doing an OK job. In fact I give them to date a C+. The problem I have to address daily is portfolio construction and stock selection when there may be another melt down, or another melt up. What bank stocks will perform best: too big to fail, regionals who never took TARP money or restructured? I am equally concerned about failure of the government to thoroughly clean up this mess and loosen credit to point of real GDP growth.

A simple lesson my sixth grader could teach our appointed officials would really help the 300 million of us counting on them: proper planning prevents poor performance. Know your goals, communicate them clearly, and stick to them even if the going gets tough.

The next three generations are counting on it!

Disclosure: No positions in the stocks mentioned.

Credit Car Issuers versus Credit Card Processors

In the credit card food chain, there are essentailly two types of firms, issuers and processors.

The processors - and there are only two Mastercard Incorporated (NYSE: MA) and Visa, Inc. (NYSE: V) – provide electronic payment serivces and act as promoters of the cards they process (they do the “Priceless” ads etc). Their business depends on consumers making purchases. They are the ‘house’ gaining a piece of every transaction.

 

The issuers are banks. They issue cards to businesses, consumers and governement agencies. They also gain a piece of every transaction and many collect an annual fee, just for being avilable. They also take on credit risk when people use ‘credit” cards, and not charge cards. The difference is charge cards are paid upon recipt of the monthly bill. Credit cards are paid off over time, adding risk and reward to the issuer. The reward is in the form of interest. The rates can be high or competitive depending upon the issuer, the card holder and where interest rates are holding. The risks are late payment and default.

There are banks who issue a lot of cards, making credit cards a material part of its business such as Citigroup, Inc. (NYSE: C) and Capital One Financial Corp. (NYSE: COF). These are not pure plays in the credit card business as they have many other business lines.

There are however, two firms that have closed the loop and are both issuer and processer. American Express Company (NYSE: AXP) and Discover Financial Services (NYSE: DFS). These are pure plays and the two majors in this industry.

So how has the recession impacted consumer behavior and what should we expect to happen to the revenue and earnings results of these companies?

A recent Mintel study examines the credit card payment behavior of Mass Affluent (MA) Americans. The study defines “Mass Affluents” to be U.S. households earning between $100,000 and $2 million. These are the best and most sought after customers. The results of the study indicate that only 48% of MA’s, who spend “significantly more” than the average consumer “currently feel financially secure.” That feeling has translated into over 55% of those surveyed, have cut down or deferred overall spending due to the recession.

Although 78% of the Mass Affluents did not change their credit card payment behavior, the remaining 22% “was split evenly between those who formerly paid balances in full but now don't, and those who didn't formerly pay in full, but are now making even smaller monthly payments.” Of the Mass Affluents, only 62% pay off their balance in full each month and 5% pay the minimum amount due. These numbers indicate that the Mass Affluent population is facing growing debt and even this group is experiencing growing unemployment. The accrued debt reflected on monthly credit card statements is a constant reminder of financial instability which continues to impact retailers adding to economic contraction.   

The most frightening element of the study is that Mass Affluents only represent 10% of America. If people among the wealthiest, cushiest, decile of America are accumulating debt and unable or unwilling to pay off their bills, what does this mean for the majority of America? The increase in credit card debt is having detrimental effects on American businesses as well as consumers and their psyches.

Credit Card companies are suffering from changes in consumer behavior. Closed Loop companies such as Discover and American Express are involved in all aspects of the credit card business and are directly in the line of fire of credit risk. As debt piles up, closed loop companies need to fight to recoup accrued payments as evidenced by both AXP and DFS having already needing billions Federal TARP Funds. Open loop companies on the other hand have a lot less risk. Although decreased retail spending hurts both open and closed loop companies, open loop companies benefit from consumers’ need to buy more purchases on credit.

The impact of the different business model of open loop and closed loop companies can be seen in the chart below. In the past year, the open loop companies outperformed the S&P 500 Index and the close loop companies underperformed the S&P 500 Index by a wide margin.

  

What is not seen is the impact on issuer (read bank) balance sheets, loan loss provisions and how they are accounted. As we eased mark-to-makret rules, a lack of transparency may grow. This is not investor friendly, but, admitidly may be the best road to recovery and for tax payers to have some relief as borrower of last resort.

Disclosure: No current positions but I selectively short (NYSE: COF), (NYSE: AXP) and (NYSE: DFS).

Shout out: This post was originall drafted by star analyst Emily Needell.

Cash is On the Move

Total money market mutual fund assets decreased by $22.15 billion to $3.834 trillion for the week ended Wednesday, April 2, according to the Investment Company Institute.

The question is where is it all going? Gold ETF assets have dropped.

Equities are rising like the Yankees after All-star break. Take a close look at today’s action (thank you WSJ for the data).

Issues	NYSE	Nasdaq	Alternext
Advancing	2,728	2,194	389
Declining	410	588	167
Unchanged	47	119	81
Total	3,185	2,901	637

And then look where the volume is, buyers (helping advancers) not sellers.

Share Volume
Total	1,866,279,555	2,778,091,731	16,141,288
Advancing	1,703,016,475	2,392,595,292	8,926,478
Declining	158,754,220	363,169,085	5,464,410
Unchanged	4,508,860	22,327,354	1,750,400

There are trillions of dollars to move back into equities, and they eventually will as the appitie for risk advances. I am anxious to see what the enevitable pull back will do to sentiment, and if a change in mood will send this same cash back to the sidelines.

Good News for Banks / Good News for Investors

The fact is today, as tax payers, we are all long banks. Think of it as we all went long (KBE) with no hedge, and we are all in. This afternoon I noticed a small glimmer of sunshine peaking through, a small sign that our investment may not go to zero.

I read with great interest this afternoon on MarketWatch:

The Federal Reserve Bank of New York received no bids for loans through its Term Security Lending Facility, it said Thursday. The central bank got no takers for $25 billion in Treasurys.

This is pretty amazing considering the diversity of people, counterparties and elected officals with pitchforks that are circling banks. Even some of the strongest names have taken direct investments, loans or participated in some sort of government assistance.

The TSLF program was started in March 2008 to help banks access liquidity and improve the functioning of financial markets. The program offered 28-day loans in exchange for appropriate collateral from the Fed's 16 primary dealers, the biggest bond traders, which include most of the biggest U.S. banks. Many of the last several operations have drawn demand for less than the Fed offered to loan.

My take mirrors the fixed income manager interviewed in the article. Financing needs are obviously being met elsewhere and this program may be “self-closing.” These are very good signs (albeit baby steps) toward a strenghtening financial system.

We need strong banks to fuel the economy, we all get it. I still have issues with being long an industry by particiaption as a tax payer.

Disclouser: Long banks, curtesy the US government, long select banks as a portfolio manager.