After looking at the details of AutoNation's AN third-quarter financial results, we're maintaining our fair value estimate for the company's shares at $21. During the quarter, revenues rose 5% to $5.2 billion while operating income grew by 13% to $220 million compared with the same period last year. AutoNation benefited from widely publicized manufacturers' incentives, which increased store traffic and resulted in solid same-store sales growth in each of AutoNation's business segments. Higher sales volumes helped AutoNation leverage its cost structure, boosting operating margins by about 300 basis points to 4.2%. The end of "employee discount" pricing and the recent Florida hurricanes, which disrupted business at about 20% of the company's stores, could wreak havoc with AutoNation's operating results over the next few quarters. Nonetheless, we think AutoNation will continue to deliver steady longer-term growth in operating earnings and cash flow as it realizes further economies of scale and increases sales of high-margin parts and services. In addition, AutoNation's balance sheet appears strong, providing the flexibility to make additional acquisitions while returning cash to shareholders through dividends or share repurchases.
CapitalSource CSE reported third-quarter results and declared a $2.50 special dividend in anticipation of becoming a real estate investment trust in early 2006. Our fair value estimate stands at $28 per share. The $2.50 dividend is payable in late January to shareholders owning the stock on Nov. 23. Since this special dividend is considered a return of capital--analogous to a partial liquidation--our fair value estimate will decrease by $2.50 on that day. Third-quarter results declined from the year-ago quarter, thanks to a change in how the firm accounts for its provisions for loan losses. Aside from that, the fundamentals of the business looked good, with nothing to change our view of the company. We were happy to see that more than 22% of the recent secondary share offering was purchased by members of management and other insiders, along with some additional open-market purchases of CapitalSource stock outside the new offering. We like to see insiders with skin in the game and think this is a good sign that management, like us, believes CapitalSource shares are undervalued. However, because there may be hiccups in the conversion to REIT status, and given this firm's above-average risk rating, we'd wait for a large margin of safety before we invest.
Chiron CHIR announced that it has accepted Novartis' NVS $45 per share cash acquisition offer. We believe that Chiron shareholders are getting a good deal, and we are removing our rating for the shares. The agreement comes after Novartis' failed takeover attempt in September, when the Chiron board rejected the pharmaceutical firm's offer of $40 per share. Chiron, which has a strong hold on the vaccine and blood-testing markets, has encountered difficulties with a weak drug pipeline and problems with its flu vaccine business that led to the closure of a large manufacturing plant last year. The firm missed out on last year's entire flu season, worth about $415 million in sales, and has struggled to get the business back on track. With Novartis' expansive resources, Chiron has an opportunity to get back on its feet.
Colgate's CL hefty advertising spending appears to be paying off, as the company reported strong third-quarter results. Our fair value estimate for the shares remains $60. In our opinion, record advertising spending of $327.9 million helped drive total revenue growth of 8.0% from the year-ago period, to $2.91 billion. This advertising expenditure was funded by improvements in gross margins from Colgate's restructuring initiatives and cost controls, which also helped offset rising raw-material costs. Excluding restructuring and other charges, operating profits increased 7.0% in the face of the 15.0% increase in advertising spending. We think the firm is doing a good job of generating healthy sales volume in all of its geographies as well as continued market share growth. We're also glad to see that Colgate is reinvesting its savings in advertising, though we would like to see more funds directed at new product initiatives. Strong new products, in our view, create a longer-term foundation for growth than does advertising spending, and Colgate's new product initiatives have lagged those of competitors. We would require a narrow discount to our fair value estimate before we'd find Colgate shares attractive.
Honda's HMC fiscal second-quarter results proved the firm isn't immune to the cost pressures affecting the global auto industry. The slump in operating income was consistent with our expectations, and we are maintaining our $23 fair value estimate. Excluding benefits from currency effects, Honda's revenue increased 9.6% to $21 billion while operating income declined 17% to about $1.4 billion compared with the same period last year. Auto sales, which account for 80% of total revenue, increased about 12% to $17 billion, but auto operating income declined 16% to $909 million as Honda spent more on incentives and battled higher raw-material costs. We think the next several months could be volatile for all automakers as high gas prices, broader economic uncertainty, and the hangover from this summer's incentive-fueled buying binge conspire to hurt demand. Nonetheless, Honda is introducing new small-car models that should do better than the industry at large, given their lower prices and higher gas mileage. In addition, we're confident Honda can manage the rising costs that pressured results this quarter.
IAC/InterActiveCorp's IACI post-Expedia EXPE life is off to a great start, as the company turned in a topnotch third quarter. We are maintaining our $42 fair value estimate. Strength was broad-based, but we were particularly impressed by the performance at Ticketmaster, LendingTree, and Match.com. Overall revenue surged 55%, thanks largely to the acquisitions of Cornerstone Brands and Ask Jeeves. Ask's decision last quarter to significantly reduce the number of paid links on its site hurt growth, as expected (on a pro forma basis, Ask's revenue grew 15% year over year, compared with its normalized 20%-plus rate). However, search queries started to pick up in September, and we expect Ask's growth to accelerate in upcoming quarters. The scalability of IAC's operations was once again on full display. Margins on operating income before amortization swelled to 10.5% in the quarter, up from 8% in the prior year, despite the inclusion of lower-margin Cornerstone. This operating leverage is a core part of our IAC investment thesis, so we are encouraged by these results.
Level
3 LVLT
announced plans to acquire WilTel from Leucadia National LUK. We are
placing our Level 3 fair value estimate under review while we evaluate the deal, though we
don't expect our overall view of the company to change much. At first glance, we think
this transaction makes a lot of sense. Both companies have followed similar strategies,
offering similar services to similar customers, so the merger will eliminate a competitor.
Level 3 has had success with similar acquisitions in the past, notably Genuity. Still,
this industry is likely to remain very competitive. As with any acquisition, we'll be
taking a close look at the assets Level 3 is buying relative to the price paid. Level 3
will issue 115 million shares and pay $370 million for WilTel. The agreement includes
WilTel's Vyvx video transmission business.
Marsh
& McLennan MMC reported
third-quarter results that were largely in line with our expectations. We don't anticipate
making a significant adjustment to our $36 fair value estimate. Revenue growth was
essentially flat through the first nine months of the year, as continued strong growth in
the Kroll and Mercer consulting units offset declining revenue in the insurance brokerage
unit. As we had expected, Marsh's operating margin declined about 8 percentage points
through Sept. 30, thanks to higher employee-retention expense. We continue to believe that
Marsh's road to recovery will be bumpy, and we would advocate a reasonable margin of
safety to our fair value estimate before investing.
Procter & Gamble's PG first-quarter results were in line with our expectations, and we are maintaining our fair value estimate of $58 per share. The firm delivered strong revenue growth of 7.6% from the year-ago quarter, for total sales of $14.79 billion. Sales and earnings growth was strong in all of P&G's segments, excluding the snacks and coffee business, where manufacturing operations were disrupted by Hurricane Katrina. P&G appears to be doing a solid job of delivering top-line growth with new product innovations, such Tide Coldwater and Tide with Febreze, and with expansion in developing markets. We think this healthy top-line growth is key to offsetting raw-material cost increases, which hurt gross margins by about 100 basis points during the quarter. We believe sales leverage and cost savings helped gross margins improve about 20 basis points and operating profits increase a robust 10%. P&G closed its acquisition of Gillette shortly after the end of the first quarter, so we're looking forward to second-quarter results and the runup to Gillette's new five-blade Fusion razor launch. We would seek a narrow discount to our fair value estimate before we'd find P&G shares attractive.
Viacom VIA.B reported third-quarter results that were about as we expected. We are not changing our fair value estimate at this time. Year-to-date sales increased 8.6% from the year-ago period. We forecast a sales gain of 8.9% for the full year. Strong performances in the cable network and entertainment units offset slower growth in the television, radio, outdoor, and parks/publishing segments. The year-to-date operating margin was 23%, compared with our full-year 23.6% projection. The radio and cable network units posted the highest operating margins, with television in the middle and entertainment, parks/publishing, and outdoor at the low end. The company now expects to complete its split (into the new Viacom and CBS Corp.) by year-end instead of the first quarter of 2006. We recommend purchase of Viacom shares at a moderate discount to our fair value estimate.
- Stock
Analyst Reports
After Doral Financial
DRL revealed
some new potential problems with its accounting, and following our recent discussions with
the company, our long-term outlook for the firm has soured, and we're slashing our fair
value estimate to $15 per share.
Nissan NSANY reported
mixed first-half results as rising raw-material costs and heavy price discounting in North
America offset benefits from higher sales. Over the long term, however, we think Nissan remains
well-positioned.
We are increasing our fair value estimate for Reynolds American RAI to $76 per share following the release of third-quarter earnings, which, despite the company's lowering of earnings guidance for the year, had a few positive notes.
- Fund
Analyst Reports
There's
really no reason to own Fidelity Select Natural Gas
FSNGX. It
concentrates on a very narrow segment of the market, its performance is closely linked
with volatile natural-gas prices, and it courts considerable stock-specific
risk.
The
management team at Hartford Global Health
HGHAX employs
a valuation discipline in the health-care sector, scouring the globe in search of stocks
trading at attractive valuations. The fund's approach has
driven stellar results so far, and we think they will continue.
Vanguard Financials VIPERs VFH probably won't turn in category-killing results, but it shouldn't dramatically underperform either, and it is helped by its 0.25% expense ratio. We think this ETF's middle-of-the-road approach holds appeal for investors seeking no-nonsense financials exposure.
Jodye Deal, Owner
Gazelle Associates
Phone: (202) 257-1350
Fax: (202) 478-0943
www.GazelleAssociates.com
Please read important disclosures at the bottom of this document.
- This report is based on data obtained from sources we believe to be reliable, but
is not guaranteed as to accuracy and does not purport to be complete. Because of
individual client objectives, this report should not be construed as advice designed to
meet the particular investment needs of any investor. Any opinions express herein
are subject to change. This report is not to be construed as an offer or the
solicitation of an offer to buy or sell the securities herein mentioned. From time
to time, this firm, and/or their respective officers, employees, and members of their
immediate families may have a long or short position in the securities mentioned in this
report. This publication has been issued and approved by Gazelle Associates under
compliance routine approved by Gazelle Associates for distribution.
October
2005, Gazelle Associates