A One for One Ratio is a Good SignMay 31, 2005 | Comments : 0 Recommended this article: (0)
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First quarter 2005 earnings season is almost over. Over 96% of the companies in the S&P 500 have released results. Of the companies that have reported, 80% have met or exceeded their estimates. The average earnings gain has been 17% from last years first quarter. The expectation for the companies that have reported was for 12%. When all companies report, we expect final first quarter 2005 earnings growth of 16% for the S&P 500.
Earnings guidance over the past thirty days remains relatively positive. Roughly one company is raising guidance for every company lowering it. Typically, this ratio has run at three companies warning for every company raising guidance over the past five years. Thus, the early indication is that second quarter earnings estimates will most likely be exceeded. However, there will certainly be more companies preannouncing in the upcoming weeks and we will closely monitor their guidance.
The current Zacks consensus second quarter 2005 earnings growth estimate for the S&P 500 currently stands at 9%. At this time, we believe that is a very achievable figure. Our best estimate is for second quarter earnings growth of 12-14% for the S&P 500. Our current view is based on the recent guidance given by companies.
Zacks industry rankings are provided toward the back of this report. The rankings are based on a quantitative model developed by Zacks that focuses on past earnings trends and forward earnings revisions from Wall Street analysts. The model has an excellent track record of outperforming the market. Therefore, the Zacks industry rankings should provide a great starting point for your equity research.
Companies in the spotlight
In this section, we focus on two stocks that our independent equity analysts feel you should be buying or selling. Our analysts start with the quantitative Zacks model and build their final buy/sell decision by performing additional fundamental analysis on the company. To view the entire report on each of these spotlight companies or to gain access to our detailed analysis on over 1,150 companies, log on to:www.zacks.com.
In 2004, 90% and 10% of LENDs new loans were originated through the companys wholesale and retail channels, respectively. Its wholesale loans were originated through seven division offices and a network of around 7,000 brokers. The top 10 brokers account for only 6% or so of originations, so the sources of loan production are diversified. The company finances its loans under one of eight secured warehouse facilities (adding diversification at the financing level). As of March 31, these facilities provided it with approximately $4 billion in credit capacity. Last week the company announced the formation of a commercial paper conduit, allowing it to access additional financing in a relatively direct manner, adding to financing flexibility and diversification, and potentially decreasing its funding costs over time. During 2004, net interest income was 42% of net revenues (defined as net interest revenue plus all non-interest revenue), while gain-on-sale revenue was 56%. This is becoming a relatively well balanced business model, and continues to move in that direction (net interest income was 31% in 2003, 23% in 2002, 12% in 2001, and only 5% in 2000). Further, even the still-significant gain-on-sale income is less risky than for some peers, as LEND sells whole loans for cash, avoiding accounting issues which add risk to revenue streams for the peer universe overall.
LEND continues to post strong growth. Mortgage origination volumes for 2004 increased by 56% to $12.4 billion, and Q1 originations were $3.2 Bn even in a seasonally weak quarter. This is further evidence that the downswing of the refinance boom will have less impact on LEND, since they benefited less from the upswing. In a typical quarter 40-50% of their originations are purchase loans, and the refinance loans typically have a high component of debt consolidation loans (as opposed to rate- or term-oriented refinancing). Most importantly (in our view), the companys on-balance sheet portfolio continues to grow dramatically, increasing by 93% in 2004 to $6.5 billion, and by another 11% in Q1 to $7.2 Bn. This is the key to LENDs story. As the company moves to a portfolio-based model from a gain-on-sale model, we believe the market should reward it with a higher multiple. This is due to the fact that earnings will become more stable and predictable as a greater percentage of net revenue is comprised of net interest income compared to gains on the sale of loans.
Along with the Q1 earnings release, management guided toward Q2 EPS of $1.80 per share and reaffirmed fiscal year 2005 guidance of $6.90 per diluted share, also reaffirming that it expects to increase EPS at an annual rate of 15% over the next three to five years. Our Q2 estimate falls below both consensus and management guidance, but we are not hung up on a few pennies. It is frankly very difficult to forecast earnings with such a large gain-on-sale component (which is why mortgage bankers tend to receive such low multiples), and probably the smart thing to do would be to move our number closer to guidance. What is important is that we remain very comfortable with the overall growth rates implied in the numbers. Using any likely outcome, valuation looks compelling. Even if $1.43 were the run-rate, LEND would be trading at 7.0 times 2005 earnings, which would still be a 14% discount to the peer group median.
Earlier capital-adequacy concerns (including the fear that the company might be forced to raise equity capital at depressed levels) have been substantially addressed. A year ago LEND formed Accredited Mortgage Loan REIT Trust a REIT subsidiary of Accredited Home Lenders, Inc., the operating subsidiary of LEND. The REIT subsidiary provides more flexibility in structuring securitizations and should thereby reduce long-term funding costs. To-date, LEND has raised more than $100 million in capital by selling preferred shares through its REIT subsidiary.
LENDs management team has developed incentive programs, technology tools, and business processes that seek to reward employees for originating non-prime mortgage loans with characteristics that generate the highest profits for the company. We believe this profit-centric approach will help the company maintain disciplined growth in terms of both volumes and profits in the future.
Buy Accredited Home Lenders Holding Company (Ticker: LEND)
Accredited Home Lenders Holding Company, headquartered in San Diego, was incorporated in 1990 and went public in February 2003. Accredited operates as a mortgage banking company across the United States. It specializes in non-prime loans secured by residential real estate. We believe that LEND suffers from guilt by association due to its focus, which is why the shares trade at such a low multiple. Its clientele include borrowers who have defaulted on loans in the past, who have limited credit histories, or whose borrowing capacity is limited for reasons such as documentation requirements or debt-to-income-ratios. This can be a risky business. However, LEND does this very well, and in the right manner, which we think argues for a much higher multiple than the share price currently reflects.
Sell Citizens Communications Company (Ticker: CZN)
Citizens Communications Company is a Stamford, Connecticut-based telecommunications service provider operating both as an incumbent local exchange carrier (ILEC) and a competitive local exchange carrier (CLEC). The companys ILEC operations are provided under the Frontier brand (Citizens acquired Frontier Communications from Global Crossing in June 2001) and span 24 states, serving roughly 2.3 million mostly rural and suburban customers. The largest ILEC market is Rochester, New York. Citizens also operates as a competitive local exchange carrier (CLEC), providing communications services to business customers and other telecom carriers in certain metropolitan areas, mainly in the western U.S. under the Electric Lightwave brand. The company previously operated as a multi-service public utility, distributing natural gas and electricity in Vermont, Hawaii and Arizona. Management completed the sale of most of its electric and gas operations in 2003. The sale of Vermont Electric, its last remaining utility property, closed in April 2004.
Citizens Communications has become a pure-play telecom service provider following the divestiture of its electric and gas utility operations. We believe these asset sales will help the company to focus on its core telecom businesses. To its credit, management has used a good portion of the proceeds from these divestitures to begin to reduce its enormous debt burden. Nevertheless, the net debt to EBITDA ratio remains well above most other companies, at approximately 3.7x.
Because Citizens offers telecom services mostly in rural and suburban areas, it faces less competition than telecom carriers that operate in densely populated areas. However, we expect the competitive environment to become more challenging over time, mostly due to the availability of newer technologies, such as Voice-over-Internet protocol (VoIP). In particular, we are concerned about the growing presence of Time Warner Cables Voice-over-Internet protocol (VoIP) rollout in Rochester, which accounts for approximately 25% of CZNs total access lines.
Furthermore, the company relies on the Federal Universal Service Fund (which provides subsidies for lower income and rural consumers) for over 7% of its revenue. Following changes in the way phone companies are reimbursed, CZNs USF revenue is expected to drop in 2004 and 2005, and it could fall further, if regulatory support for the rural local exchange carriers wanes.
After considering various alternatives (in consultation with its financial advisors) CZN has adopted an aggressive dividend policy. The $1.00 annual dividend rate equates to a 7.7% yield, one of the highest of any company in the telecom sector and S&P 500. Given CZNs strong and relatively stable cash flow, the high dividend payout (at approximately two-thirds of free cash flow per share) appears sustainable, at least over the near-term. Whats more, this approach has been well received by investors, as evidenced by the relatively strong stock price performance recently. However, we believe it represents an admission by the companys management that CZNs long-term growth prospects are mediocre, at best.
While it is generating decent growth from its DSL businesses, CZNs core local phone business has slowed significantly, as access lines have been declining at about a 2% - 3% annual rate. This is mainly due to three factors: the loss of second lines to DSL, soft economic conditions in the companys service territory, and displacement of traditional wireline telephone services by wireless and other competitive services.
We believe CZNs fundamental strengths are more than offset by the companys limited growth prospects and the potential for the regulatory/competitive environment to take a turn for the worse. While we do not see large downside risk for the stock, we would steer clear for now.
1Q 2005 EARNINGS SCORECARD S&P 500
67% (of the companies) exceeded estimates
13% matched estimates
20% missed estimates
1Q 2005 SECTOR SCORECARD S&P 500
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|Sector||EPS Growth||Sales Growth||Total||Reported||% Reported|
Note: EPS and sales growth compare current quarterly results vs. prior year ago quarter
S&P 500 COMPANIES THAT REPORTED EARNINGS LAST WEEK
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|Company||Ticker||Actual||Estimate||EPS Surprise %||Report Date|
|Heinz (Hj) Co||HNZ||0.63||0.62||1.61||26-May|
THIS WEEK IN EARNINGS
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Below is a list of key companies that should report this week. To view the entire list of companies reporting on a given day,check out the Zacks earnings calendar.
KEY COMPANIES REPORTING THIS WEEK
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|Company||Ticker||Zacks EPS Estimate||Expected Report Date|
INDUSTRIES RANKED BY ZACKS (1= STRONG BUY, 5 = STRONG SELL)
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|Industry||Zacks Rank||P/E 2005E||Next 3-5 Yr Est EPS Growth|
|STEEL-PIPE & TUBES||1.20||10.93||11.33|
|OIL & GAS-DRILLNG||1.79||21.86||32.45|
|OIL & GAS-U S ROYALTY TR||2.00||12.24||N/A|
|OIL & GAS-CDN INTEGRATED||2.00||18.48||8.50|
|OIL & GAS-INTL SPECIALTY||2.00||14.52||12.23|
|OIL & GAS-U S INTEGRATED||2.00||12.23||6.03|
|CONSUMER PROD-MISC DISCRECTN||2.17||23.40||14.21|
|WIRE & CABLE PRODUCTS||2.29||20.99||15.11|
|OIL & GAS-FIELD SERVICES||2.36||23.19||25.44|
|OIL FIELD MACH & EQUIP||2.39||20.82||24.45|
|BLDG PROD-AIR COND/HEAT||2.40||15.73||12.55|
|BLDG PROD-LIGHTING FIXT||2.40||27.31||16.13|
|OIL & GAS-INTL INTEGRATED||2.47||9.42||9.74|
|MEDICAL-HLTH MAINT ORG||2.50||18.44||15.39|
|RETAIL-MAJOR DEPT STRS||2.50||18.16||9.39|
|REAL ESTATE DEVELOPMENT||2.60||22.96||9.64|
|INSURANCE-ACC & HEALTH||2.63||15.61||14.88|
|OIL REFINING & MARKETING||2.72||22.90||6.10|
|HOTELS & MOTELS||2.75||27.64||14.31|
|SOAP & CLNG PREPARATNS||2.75||20.33||10.01|
|FUNERAL SVCS & REL||2.80||25.74||8.67|
|MACHINE-TOOLS & REL PROD||2.80||14.93||11.57|
|OIL & GAS-U S EXPLO & PROD||2.82||15.95||13.46|
|BLDG-MAINTENANCE & SVC||2.83||23.86||13.70|
|SHOES & REL APPAREL||2.83||15.05||14.53|
|FINANCE-PUBLIC TD INV FD||2.86||17.83||18.23|
|OIL & GAS-CDN EXP & PROD||2.86||31.34||6.25|
|RETAIL-MAIL ORDER & DIRECT||2.86||23.22||18.89|
|RUBBER & PLASTIC PRODUCTS||2.86||14.78||11.57|
|BUSINESS INFORMATION SERVICES||2.86||28.36||15.05|
|REAL ESTATE OPERATIONS||2.88||18.17||12.86|
|TRANSPORTATION-EQP & LSNG||2.88||17.51||12.50|
|MEDICAL INFORMATION SYSTEMS||2.88||84.23||22.87|
|FINANCE-MRTG & REL SVC||2.93||10.16||10.42|
|RETAIL-FOOD & RESTAURANTS||2.96||29.75||15.85|
|AUDIO/VIDEO HOME PROD||3.00||59.17||18.29|
|FOOD-SUGAR & REFINING||3.00||11.21||10.00|
|LINEN SUPPLY & RELATED||3.00||23.25||13.09|
|PAINTS & ALLIED PRODUCTS||3.00||13.83||8.42|
|LEISURE & RECREATION-GAMING||3.03||54.93||18.70|
|LEISURE & RECREATION SVCS||3.06||23.26||11.10|
|METAL PROC & FABRICATION||3.07||16.19||15.12|
|OIL & GAS-PROD/PIPELINE||3.07||18.60||7.46|
|FINANCE-SAVINGS & LOAN||3.10||16.55||11.91|
|FINANCE-SBIC & COMMRCL||3.10||13.47||11.50|
|BLDG & CONST PROD-MISC||3.11||23.91||15.90|
|CONSUMER PROD-MISC STAPLES||3.13||18.84||12.83|
|COSMETICS & TOILETRIES||3.14||18.92||9.76|
|POLLUTION CONTROL EQ & SVS||3.22||29.16||13.68|
|OFFICE SUPPLIES & FORMS||3.29||16.13||9.66|
|PAPER & PAPER PRODUCTS||3.29||20.64||7.73|
|RETAIL-REGNL DEPT STRS||3.29||20.42||11.67|
|RETAIL-DISCOUNT & VARIETY||3.31||19.18||14.43|
|ELEC MEASRNG INSTRUMENTS||3.35||24.10||14.93|
|OFFICE AUTOMATION & EQP||3.40||14.93||15.33|
|ELECTRONIC PARTS DISTRIB||3.43||18.60||14.08|
|PROTECTION-SFTY EQ & SVC||3.47||37.99||17.32|
|LEISURE & RECREATION PROD||3.53||18.56||14.86|
|BLDG-MOBILE/MFG & RV||3.71||21.11||13.44|
|FOOD-FLOUR & GRAIN||4.50||18.53||18.67|
|PHOTO EQUIPMENT & SUP||4.50||14.61||6.17|
EARNINGS AND SALES GROWTH - ACTUAL AND ESTIMATED FOR THE S&P 500
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|EPS Growth||Sales Growth|
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