Sonic Restaurants (SONC): Did We Notice?

Source: Tim Parker, Benzinga

Tim makes an interesting point and nudges us in the direction of an important question.

It’s not so important where Sonic Restaurants (SONC) are today in terms of expectations — although if you hold/follow SONC, you want to know that the return forecast is now 2.5% (thanks to the price surge brought to our attention by Tim) and that the company has a below-average quality ranking.

But we have to wonder whether we “noticed” Sonic before the price move?

We flagged SONC as “interesting” and it made our short list of study candidates back on 11/29/2011 — so we’d politely challenge the characterization that “nobody noticed.” Here’s the short list from that update:

Source: This Week Update, Manifest Investing, 11/29/2011

As shown on a current chronicle for SONC, the return forecast was elevated at stock price of $6.71 and the projected annual return was approximately 20-25%.

RSI Breaks, Death Crosses & Confirmations …


1. The disruption period following the early 2005 relative strength break (RSI declining to less than 70 after a sustained period above 70) is not something that would surprise us.

2. The death cross (short-term trailing average breaks below long-term trailing average) circa Halloween 2007 basically “intervened” and disrupted (BIG) any potential recovery following an oversold break to the upside. As is often the case, carnage ensues — and carnage is exacerbated for poor and average quality stocks.

3. SONC was stuck in the carnage zone until a series of higher lows in the relative strength index (confirmation) materialized in late 2011.

4. SONC is still not potentially overbought (RSI = 68.6) but it’s getting there and with the projected annual return in low single digits, we’d be actively shopping for higher PAR replacements in any portfolios that contain SONC. (Those who deploy trailing stops should probably consider them — as a minimum — for SONC.)

We don’t operate under any pretense that we’re right all of the time. (Our target is to select outperforming stocks 60% of the time or more, that’s sufficient for differentiated superior performance — and can produce 3-5 percentage point relative returns over the long term.) But we do like to check historical “flags” and selections to see what we can learn. And that learning often includes huge doses of humility. We’ll be looking at some analyses that didn’t work out quite nearly as well … and seeing if dining on a little crow can bolster our long-term investing efforts too.

Thanks, Tim.

March Madness: Bring Out Your Dead

March Madness? Bring Out Your Dead.

This week’s Value Line update includes quite a surge for a number of companies. Take a look at the accompanying “Materially Stronger” list in the 3/29/2013 update. As a reminder, an appearance on this list means that the Value Line analyst has “step changed” the long-term low price forecast by 20-25% since the last report 13 weeks ago. And in the case of Issue 6 companies — relatively few of them are in our sweet spot or better, AFTER the bump. But they’ve gone from a return forecast dripping in red ink to in most cases, low to mid-single digits.

MORTICIAN: Bring out your dead!
Bring out your dead!
CUSTOMER: Here’s one — nine pence.
DEAD PERSON: I’m not dead!
CUSTOMER: Nothing — here’s your nine pence.
DEAD PERSON: I’m not dead!
MORTICIAN: Here — he says he’s not dead!
CUSTOMER: Yes, he is.
MORTICIAN: He isn’t.
CUSTOMER: Well, he will be soon, he’s very ill.
DEAD PERSON: I’m getting better!

Source: Monty Python and the Holy Grail (YouTube Video)

Insert [Value Line analyst] for CUSTOMER and you’ve got a pretty good rendition of the situation for many of the Issue 6 companies.

We have no difficulty imagining the gaggle of Issue 6 analysts in a group huddle with someone in a leadership position imploring the lot of them that these stocks aren’t dead yet. And the result of that group hug was a collective reassessment of expectations for the materials and homebuilding companies in their coverage.

In defense of the analyst gaggle, analysis of companies that have been subjected to a depression is quite challenging. The difficulty factor that accompanies normal cycles (variable frequency and amplitude) is compounded by a bath tub effect where it becomes difficult to envision “the other side.” We talked about this during the March Round Table citing conditions at Bank of America (BAC). In a nutshell, the banking industry went from a collective return on equity (along with significantly damaged book values) of 15-20% to 0-5% during the Great Recession. Many have recovered or are expected to recover to the 8-10% range — but it’s still a mystery as to how robust or rapid the recovery will be … or whether historical levels will ever be seen again.

But the current recovery is a work in progress. That is, until the next time the wheels come off and the analysts resume “bringing out their dead.”

Fusion Screen (3/26/2013)

Fusion screen 20130326
Some stock study candidates based on a combination of fundamental characteristics (growth, profitability, valuation and return forecast in combination with the quality ranking) and timely technical characteristics (e.g. relative strength index momentum and price pressure, etc.)
Note the frequency of oil & gas field services along with a integrated petroleum company among the results.
The information technology companies (INFY, AAPL and INTC) continue to be prominent as well.

March Round Table: March Madness

Rt banner 20130326-512

During the March 2013 session of the Round Table, our noble knights (and fair damsel Anne Manning) elected to close out (“sell”) the positions in Adobe Systems (ADBE).

The annualized relative return achieved on the selections of ADBE by Anne Manning and Ken Kavula was +16.5% and +14.5% respectively. Huzzah and thanks, Anne.

Bank of America (BAC) was also batted about. The fundamentals have been a wreck and they’re still impacted by the Great Recession. Book value was hammered and is still recovering — a condition quite widespread amongst all banks. Return-on-equity (ROE) has been staggered and perhaps somewhat permanently altered. In the case of BAC, a quick sensitivity analysis on two different thresholds for projected ROE illustrates how muddy and choppy the waters still are for BAC. Hugh also noted the cobbled-together nature of many of these banks since 2008 during the crisis and that spinoffs and restructurings probably hold fairly promising — and quite confusing — potential.

What levels of profitability (ROE) will banks like BAC achieve going forward. We know that 15-20% was commonplace back in 2000-2005 … and that ROE levels have been restored to a fraction of their historical levels. As shown here, the analyst consensus for BAC is currently approximately 5%, but likely increasing. If it were to rebound to 10% (still far below 15-20% levels) … the return forecast (PAR) is 18% versus the paltry level shown on the dashboard. This is part of what Hugh has been thinking for a few years since his famous, “I want to own a bank.”

Where do you think ROE levels for banks in general are headed?

In celebration of William Shatner’s 82nd birthday, Ken and Cy added Priceline (PCLN) to the Round Table tracking portfolio. Continuing with the theme of mayhem and madness, Hugh and Mark also agreed on a selection (a condition that we’ve rarely seen amongst all the knights over the last three years) and presented Intel (INTC). Hugh shared some thoughts on diving beneath the surface of customary analysis to take a look at inventory trends.

If you’d like to hear Hugh expound on this theme, let us know and we’ll schedule a webcast to share legendary tales of companies like Lucent, SafeSkin and Cisco Systems.

The road ahead for Intel is not without a speed bump or two as the transition from PCs to other devices and hardware continues. The company always has been and likely will be, a growth-cyclical, and it will likely remain that way with a long-term growth trend in the 6-8% range for the foreseeable.

But it’s a clear leader in its industry with solid margins. As shown here, Value Line has the long-term low total return forecast at 17% — not too shabby.

The audience closed the session by voting for Priceline (PCLN) over Intel in a clear birthday cake tribute to Captain Kirk — and price negotiators everywhere.

Value Line Low Total Return Screen (3/29/2013)


Companies of Interest

Whoa. We’ve not seen a listing for “Materially Stronger” like that in quite a while!

But keep it in context. Despite significant strengthening of fundamentals, virtually none of these show up on the study target list. And in fact, we had to stretch the parameters in order to have a list.

We made an exception for Blyth (BTH) because usually a quality ranking of 14 would normally keep it off the list. But the return is speculative and if you can build a case for a turnaround, BTH could be worth a closer look.  BTH is clearly a restructuring-in-progress.

Fluor Corp (FLR), a Beardstown Ladies favorite, is here as a reminder. Some of you may recall that the Ladies continued to hold FLR despite a low single-digit PAR a few years ago (something we explored during a Dashboard Diagnostics webcast). The reminder is that stocks can stay overbought for a long time — but that vigilance, and in some cases, protective measures can be prudent.

Colgate-Palmolive (CL) is on the list because 10.2% is a pretty solid return forecast when the average return forecast is only 6.8% and the excellent quality rating stands out here. (Plus, it’s my Dad’s favorite stock)

Sonoco Products isn’t about gasoline and it’s a good study although probably worth waiting for a stock price dip before getting wrapped up in it.

Materially Stronger: Lumber Liquidators (LL), Masco (MAS), Simpson Mfg (SSD), Universal Forest Products (UFPI), Eagle Materials (EXP), Martin Marietta (MLM), Texas Industries (TXI), Mastec (MTZ), HNI (HNI), Tempur-Pedic (TPX), KB Homes (KBH), Lennar (LEN), Pulte Homes (PHM), Ryland Group (RYL), Fastenal (FAST), International Paper (IP), Headwaters (HW), NRG Energy (NRG), Potlatch (PCH), Lowe’s (LOW), Tractor Supply (TSCO)

Materially Weaker: Foster Wheeler (FWLT), St. Joe (JOE), GT Advanced Tech (GTAT), AES (AES)

Market Barometers

The median Value Line low total return forecast is 6.8% vs. 6.8% last week.

As the first quarter of 2013 comes to a close, it’s probably time to check in on our run-for-the-hills indicator, the track record for new highs vs. new lows.

Despite the generally bullish and potentially overbought general market, there’s no reason to load up the family truck and head for the hills, Beverly or otherwise, Jed.

Cisco Systems (CSCO): Watch, Wonder, Wait

Cisco Systems (CSCO) appeared in this week’s update under the flag of “Materially Stronger” and at the same time was mentioned in a series of articles that called into question the long-term viability or sustainability of some of their product lines (hardware). We talk about threats and opportunity analysis a fair amount here, so it seems like a good time for a deeper dive and closer look at Cisco Systems.

The company is #11 in the MANIFEST 40 so it’s no stranger around here.

CSCO also serves as something bigger than a poster child for rhino confusion. Why? Because when the stock price reached $80-90 back at the advent of Y2K, the company was the most STRONGLY RECOMMENDED stock on Wall Street at a time when our return forecasts were screaming SELL based on a DOUBLE-DIGIT NEGATIVE PAR! The CSCO situation (and madness) was the centerpiece of an article I wrote for Better Investing at the time.

Let’s break it down. First, “Materially Stronger” in our weekly updates simply means that the Value Line analysts have given the long-term low price forecast a significant boost. What is significant? We’re watchful for 20-25% step changes (up or down) and we share these as “flags” with our community.

The long-term low price forecast for CSCO of $30, translates to a long-term low total return forecast of 11.7%.

Business Model Analysis

Profitability Analysis

Under assumptions of a 6% sales growth forecast, a projected net margin of approximately 20% and an average P/E expectation of 13x, a case can be made for a projected annual return of 11.7%.

From the Business Environment to Skeptical Rhinos

FBR Capital Downgrades Cisco — Sees Reductions in Hardware

FBR Capital downgraded Cisco (NASDAQ: CSCO) from Market Perform to Underperform with a price target of $17.00 (from $22.00) saying routers and switches hit a dead end.

“We believe Cisco will become increasingly more challenged to offset weaker-than-expected routing and switching demand as it works to transition to a more software- and service-centric business model,” the analyst said in its downgrade report. “Looking ahead, we see the potential for additional negative technological trends that could significantly blur the lines between routers, switches AND servers.”

Now I don’t know anything about the track record of FBR Capital. It’d be bolstering if we had any idea how their opinions translate into long-term results, but we don’t have that.

What we have is a threat to profitability at CSCO. We could nutshell and capture this question with a potentially-similar situation from a few years ago. A number of community members at the time cautioned us to avoid the rosy consensus at one of our favorite companies. They urged us to consider reality. We ignored them (a little) at our own peril.

The company was Garmin (GRMN). The warnings had to do with a ubiquitous threat to their business model at the time. It was, in perfect hindsight — a clear and present danger. [Ed. Note: GRMN has navigated (pun intended) the choppy waters of these challenges pretty well, but it was a speed bump of considerable impact.]

So the question is: Is Cisco Systems exposed to the same type of threat to product, inventories, profitability AND STOCK PRICE as we saw with Garmin?

I don’t know.

So I turned to a very reliable research partner, our own Technology Manager, Kurt Kowitz. Kurt has a powerful skill of boiling this type of thing down into something concrete and credible. (By the way, Kurt and Hugh McManus were among the throng issuing the warning about the challenges faced at Garmin back in 2007-2008.)

As he always does, he responded with: It really boils down to one phrase/theme, Software-Defined Networking. “Companies Google and Facebook have adopted the Openflow protocol within their data center operations.” Ouch. “Yeah, sounds like a shift that might seriously undercut a traditional market.”

So it’s back to Cisco Systems. And now we’re gleaning through the most recent quarterly conference call transcript looking for signs of things related to (1) threats to forward profitability and/or (2) anything specific about this software-defined networking.

And we find a brief discussion relevant to the subject in the form of a “disciplinary lecture” given by the horse’s mouth itself, John Chambers:

“If you watch, we’re seeing a common theme, I think many of you [rhinos] were concerned in fair question two years ago about should we maintain our gross margins with the vast majority of the markets not a player, and you’re going to see rapid deterioration, it was the number one pressure on our stock margins. And if you watch what we have done is the reverse.’

Our emphasis added: We’ve prevailed, actually increased margins despite what you believed would probably happen. (Go back and review the accompanying profitability analysis graphic.)

Chambers continued:

“We have gotten very good stability across the gross margin base, you are seeing this in that 61% to 62% guidance, it will go up and down by quarter based on the mix, but you are right we are clearly modeling in continuing good growth dramatically faster in our data center business, and remember UCS is also combined with Nexus. And it is a process I want to be careful but you see it is a little bit lower half of the business Nexus, is a little bit over a third, and when you model those two together you begin to get good gross margins and that’s different than our peers.”

(He often jabs and picks on peers, nothing new to see here, people.)

“Secondly, and most of our peers when they install servers, they are selling commodity products. Have we re not selling commodity products. We get premiums, we get architectures, we get standardized on, we showed stronger margins there and yes your overall assumption is right, we are moving rapidly to software … which gets you better margins, 13 of the 14 acquisitions were software, cloud, recurring revenue streams and recurring revenue as one of your colleague said earlier, the good news about it is very predictable. The bad news is when you start from a low base, it takes you a while to get to size where it really becomes material for you, but it’s a nice way of saying I couldn’t be more pleased with the margin stability and well, it’s hard to look out very far in this industry, I like the stability we are seeing in and I see nothing that at the present time is making nervous on that …”

How much cash do they have (for further acquisitions and development?)  Answer: $46.4 billion (1/26/2013) [Source: Value Line]

The Bigger Picture

CSCO has the cash and the track record. They’re actively responding to the challenge.

If you hold CSCO, be vigilant for slippage in profitability. Be aware that the global recession will certainly lead to some weakness as the worldwide economy cycles.

Here’s a slightly elongated look at one of our newly favored 10-year charts, displaying the 1990s. If you were there, you remember the 1990s. This again shows how resilient an excellent company can be in the aftermath of a corrective disruption. By the way, that 1998 contagion thing was more massive than very many of us remember. Most of us were too busy being rationally exuberant at the time.

And we close with a current chronicle going back a few years for Cisco Systems (CSCO).

The quality ranking is virtually top shelf with no signs of weakness. If profitability slips (vs. peers/competitors) the deterioration will show up in the quality ranking.

The return forecast is not exciting — equivalent to a fairly solid “HOLD” for most portfolios at approximately 11-12%. And we also see that patience can be rewarded with a return forecast closer to 20% from time-to-time. The time to accumulate would be then.

For Cisco Systems (CSCO):  Watch carefully. Wonder. Wait.

Challenge Club (March 2013)

The Challenge Club voted to accumulate Qualcomm (QCOM) and to buy Echo Global Logistics (ECHO) during the March session.

Financial Results

The unit value for the Challenge Club is $24.31, up +2.1% from last month ($23.80). The Wilshire 5000 is up +3.3% over the last thirty days.

Since inception (1999), the annualized total return for the Challenge Club is 6.8% — with an annualized relative return checking in at +3.1%.

Challenge vs benchmark 20130323

Sorting by Return Forecast (PAR) & Sweet Spot Analysis

With MIPAR at 6.8% — the target for the overall portfolio PAR is 11.8-16.8%.

This range serves a dual purpose as it’s also the sweet spot for individual stocks — companies that would be attractive with PAR from 12-17% so long as quality is suitable.

All three primary portfolio characteristics (overall return forecast, quality and growth) are suitable and within the target range with the greatest need for a growth boost — if anything.

Candidates for Accumulation: AFLAC (AFL), QUALCOMM (QCOM) …

Challenge dash sort 20130322r

Challenge valuation 20130322

The ending dashboard for the portfolio can be found and monitored continuously here.

Nicholas Financial (NICK): On The Block

Nicholas Financial, Inc., established in 1985, is a consumer finance company, that specializes in purchasing and servicing auto loans made by franchised and independent auto dealers, via a network of company owned and operated branch offices.

This analysis was provided by Eddy Elfenbein in his Crossing Wall Street blog last night. Check his Buy List. If you (1) own, (2) are hunting or (3) are stockwatcher following one of these companies for your investment club partners — we’d urge you to bookmark Crossing Wall Street. Eddy will help you.  Thanks, Eddy.

Nicholas Financial Gets Buyout Offer

After the closing bell on Wednesday, Nicholas Financial (NICK) announced that it “received an unsolicited, non-binding indication of interest from a potential third-party acquirer.” In English, this means probably someone wrote down a price on a napkin, slid it to the board and said, “How’s this?” I have no idea who it is or how much they’re offering, but it’s serious enough for NICK to reveal that it happened. The firm has retained Janney Montgomery Scott to advise them in evaluating “strategic alternatives.”

Some of you may remember that the same thing happened to NICK in early 2011. At the time, the stock was at $10 and it soared 18% following the news. In the end, NICK shot down that offer. Again, I don’t know what the offer was, but I’m almost positive it was too low and NICK’s board did the right thing in walking away. It’s tough to turn down a buyout offer, but sometimes it’s the right thing to do. NICK’s stock is up about 50% since then, and that doesn’t include the big dividend we got in December.

This time around, I’m far more open to NICK being sold. The senior management is close to retirement age, so they may be looking for an exit as well. The difference between now and two years ago is that NICK has proved to the world that it navigated the financial crisis. Their portfolio is solid, and according to the Fed, short-term interest rates are going to stay low for a while more. This is a very good environment for NICK’s business. On Thursday, the stock got as high as $15.15. Obviously, I want as high a price as possible, but if I were a member of the board, I’d set $18 as a minimum.

Here’s the reality: In a world of zero interest rates, there’s a massive hunt going on for yield. This is one of the distortions that Bernanke and the Fed are worried about. Fund managers are looking anywhere and everywhere for higher rates without too much risk. Eventually, that led someone to NICK. Fortunately, we were there first.

Let me warn shareholders that these situations can become dramatic, and it’s largely out of our hands. If the deal is shot down or withdrawn, the shares will take a hit. But on the plus side, it’s possible that a bidding war will ensue, and the shares will be ratcheted higher. For now, I’m going to raise my Buy Below price to $16. Stay tuned for more news.

We shared the following MyStudy to illustrate that an offer in the $18 range wouldn’t be out of question.

Nick mystudy 20130321