Weekly Commentary & Outlook
McIntyre, Freedman & Flynn
November 1, 2010
This is Tom McIntyre with another client only update as of
Monday morning the 1st of November 2010
The stock market continues to be supported by strong earnings and the prospect for political change. As a result, last week saw the market consolidate this good news.
As the charts above illustrate, the Dow Jones Industrial Average was flat last week while the NASDAQ Composite tacked on another one percent gain.
The Markets & Economy
Friday’s report that the growth rate in the 3rd quarter was just 2% drove home the peculiarity of this market. As everyone understands, this sort of growth rate is simply not going to create the generation of jobs sufficient to lower the unemployment rate anytime soon. At the same time the earnings reports and other corporate actions such as mergers, buybacks and buyouts are supporting stock prices at a time when the Fed wants stock prices to rise at all costs.
Thus while the economy is largely a disappointment and the political fallout will be felt tomorrow, the stock market is having a stealth rally based upon the attractiveness of the global economy and the lack of a better investment alternative.
Clearly, real estate is not something that investors are interested in and bonds have been chased to the point where the return is not attractive. Accordingly stocks are emerging out of this morass as the investment along with commodities that investors continue to favor.
The question is how far and how long can this rally continue to last? With interest rates near zero and the Federal Reserve printing money in an attempt to raise asset prices, the near-term seems to be in good shape. Typically the last couple of months of the year are quite good for stocks and the twelve months after a mid-term election have proven quite strong for stocks as well.
Longer-term the question is how can this Country get back into shape in terms of the size and scope of government? Additionally, how can this country get back to being the job creator that it has been over the course of history? Only time will tell, but tomorrow’s election results and the continuing policy debate over the next two years will go a long way toward answering these questions.
What to Expect This Week
Put simply, this is going to be a news-dominated week. The aforementioned mid-term election results will be announced and the policy implications noted by the markets. In addition, on Wednesday the Federal Reserve will announce its specific intentions concerning “quantitative easing”. This too will be scrutinized carefully by all concerned.
Finally, on Friday the unemployment report for October will be revealed with the rate expected to be once again near 10%. No real improvement here.
Overall, the market has anticipated much of this week’s events and so the possibility exists that some break in the rally could ensue. I doubt it will last long. The race to the end of the year is upon us and barring a terrorist event - the easiest path for stock prices, for now, is higher.
Biogen Idec reported better than expected third quarter earnings results last week and the shares rallied to new multi-year highs. The Company earned $1.35, which was 13 cents better than consensus estimates. Revenues also came in better than expected at $1.2 billion. Management stuck with their guidance for the remainder of the year, which we believe will prove conservative.
Although some investors have been worrying about increased competition in the multiple sclerosis sector, the MS division performed much better than expected. For the first time since 2004, unit sales of Avonex grew for the second straight quarter. Sales were 11 percent higher from the previous year, and we believe the trend is sustainable. Avonex more than made up for some slight weakness of Tysabri sales during the quarter.
The management of Biogen has been aggressively buying back stock this year and the share count has been decreasing. During 2010 the Company has repurchased 40.3 million shares for about $2.1 billion and experienced higher earnings per share because of the reduced share count. We believe that management of Biogen has to keep the share price higher or the Company will likely be taken over. There is definitely a stronger commitment to enhancing shareholder value than before at the Company.
Shares of Biogen have been performing well and the strength of this report did catapult the share price higher. We believe the news flow from the Company will continue to remain positive and expect more consolidation in the biotech industry. We believe the shares of Biogen will reach $75 within the next 12 months.
Shares of Netgear rallied sharply following the better than expected third quarter earnings results last week. Strong back to school shopping drove sales 20 percent higher than the previous quarter to $236 million, which was about $15 million more than expected. The Company also earned $0.45 per share, which was seven cents better than consensus. Management remained conservative with its fourth quarter earnings guidance, although we expect they won’t have a problem exceeding expectations again.
The Company experienced robust demand for their products and continue to take market share from Cisco. Netgear now leads the North American retail market with 32 percent compared to just 27 percent for Cisco. We expect these market share gains will continue as the Company launches at least 20 new products this quarter. We believe the new product launches will be the key to the Company’s success over the next 18 months.
Even though Netgear has rallied more than 50 percent the last couple of months, the shares are still conservatively valued. The Company has nearly $7 per share in cash on their balance sheet and a growing profitable business. We expect the Company will have no problem earning $2.25 per share next year.
We believe that Company’s product pipeline will drive earnings and revenue expectations much higher over the next couple of quarters. The shares of Netgear are still undervalued, in our opinion, and the market share gains should continue. We believe that shares of Netgear will reach $40 by the end of next year.
Flextronics reported better than expected second quarter earnings results last week, as demand for smartphones continues to be underestimated by Wall Street. The Company experienced 27 percent sales growth during the quarter and easily beat consensus estimates. Earnings per share came in at $0.23, which was 3 cents better than expected. Management also slightly raised the earnings and sales guidance for the remainder of the year.
Strong demand for several of its key products and easing component shortages led to the excellent performance. We do believe that smartphones and the tablet markets will lead to increased activity for the Company over the next 18 months. Management also indicated that they have nearly $2 billion in cash and will look to do some more acquisitions in coming quarters.
Shares of Flextronics are cheap, although they will likely always be cheap given its low operating margins. The shares did rally nearly 12 percent following the release of this report and we expect the positive trend to continue. We believe the shares will reach $9 in the next 12 months, and if the shares come close to our target we will likely move the money into a more exciting investment opportunity.