These Stock Losses May Be Misleading
Is a stock market that rewards the good--and trashes the bad--a troubled market?
Sounds like the way capitalism ought to work. But Wall Street bears argue that the breakdown of some big-name stocks in recent months, while the Dow Jones industrial index has gone to new highs, is a sign that this market surge is phony.
Charles LaLoggia, a veteran market strategist who writes the Special Situation Report newsletter from Rochester, N.Y., says the plunge of such key stocks as AT&T;, J. C. Penney, Citicorp and Boise Cascade shows that there is “tremendous damage taking place under the guise of a rising Dow.”
LaLoggia believes that the troubles encountered by those companies are warnings of trouble ahead for the economy, and thus for the broad market.
The counter to that argument, however, is that the hammered stocks deserve what they got--because their earnings are lousy, for individual reasons. The stocks that have soared in this rally, meanwhile, are attracting money because their earnings are strong. In any market, some stocks are going up while others are falling. That’s not exactly a strange concept.
The undercurrent to LaLoggia’s message is that there’s something wrong with the way investors have flocked to “recession-proof” growth stocks, such as Wal-Mart and Waste Management, while ignoring many cyclical industrial companies, such as Boise, Dow Chemical and Panhandle Eastern.
But investors have simply been searching for stocks whose earnings appear fairly certain. For now, in a slow economy, industrial companies don’t offer that kind of earnings confidence. So the divergence isn’t surprising. It has happened before; in 1986, as the economy slowed, many industrial stocks and high-tech stocks were dumped, while Wal-Mart, Waste Management and other growth names kept climbing.
The danger is not in the divergence between growth and cyclical stocks, but rather in how long it goes on. “At some point it reaches an unsustainable level,” notes Robert Urquhart, partner at RCM Capital Management in San Francisco. In other words, the market can’t forever value growth stocks at 25 times earnings per share and industrial stocks at just five times earnings per share, he says.
The bulls see the industrial stocks catching up to growth stocks later this year. The bears see recession and a market collapse. One side is bound to be right.
Mixed Marks for Modtech: Perris, Calif.-based Modtech Inc. is scheduled to make its initial public offering of stock at $9 to $11 a share today, and demand could be hot. But a few items noted in the stock’s prospectus might cause some potential shareholders to shy away from the issue.
Modtech is a play on California’s booming school-age population: The 8-year-old company is the largest manufacturer of modular classrooms for the state’s public schools.
Since 1986, the state has mandated that at least 30% of all new classrooms built with state funds be relocatable, for ease of meeting changing enrollment patterns. And in 1988, the state ordered that all classrooms meet certain earthquake safety codes. School districts have until September, 1993, to meet the codes. Modtech estimates that more than 4,500 trailers now in use as classrooms don’t meet the codes and will have to be replaced.
Last year, about $175 million was spent on modular classrooms in California. Modtech’s sales totaled $41 million. The firm earned $2.02 million on those sales, or 55 cents a share, based on 3.7 million shares to be outstanding after today.
Modtech has all the makings of a growth company, based on expected demand for relocatable classrooms in the 1990s. State enrollment in grades kindergarten through 12 should rise 35% in the 10 years ending in 1998, the state Department of Education estimates.
Last year, Modtech’s sales rose 68% from 1988, and net income rose 31%. Total sales were boosted further by the company’s acquisition of competitor Del-Tec in April, 1989. The Del-Tec deal gave Modtech a foothold in Northern California and also helped cement Modtech’s strategy of vertical integration: the company fabricates many of its classroom parts itself, helping to keep costs down. In fact, the company bills itself as one of the lowest-cost producers of modular classrooms in the state. That’s important because contracts for the classrooms are almost always awarded to the lowest bidder--and Modtech faces a large number of competitors.
Modtech is selling 1 million shares in the stock offering today, which is being handled by L.A.-based Seider Amdec Securities. The proceeds will be used to repay debt and to boost working capital so that Modtech presents a stronger financial face to the state and to local school districts that the company must woo.
The only questionable aspect of Modtech’s offering is the “golden parachute” its senior officers are demanding up front. Each of the three top officers is guaranteed 36 months’ worth of salary, to be paid in a lump sum, if the company terminates their employment other than for cause. Some L.A. investment bankers say that’s a big parachute for a small company to guarantee.
Likewise, it struck some local observers as odd that Modtech is guaranteeing an annual bonus of at least $150,000 for President James Goldenetz and an annual bonus of at least $40,000 for CEO Evan Gruber. Plus, their annual salaries, as well as the salary of Chairman Gerald Bashaw, are guaranteed to increase at least as much as the inflation rate.
Modtech’s public shareholders might naturally prefer that the executives be paid well if the company performs--but that bonuses be withheld if the company fails to perform.
Still, Glenn Cutler, editor of Market Mania newsletter in Pacifica, rates Modtech a B+ as an attractive new stock--if you can get it for $11 or less, he says. The shares will trade over-the-counter.
Magnetic Attraction? Applied Magnetics, the Goleta-based maker of magnetic recording heads for the computer industry, didn’t make its earnings target for the quarter ended June 30. But Wall Street decided to give the company a reprieve.
The June 30 report, released Monday morning, showed the firm recorded sales of $94.9 million in the quarter, up 28% from a year earlier. However, net income from operations totaled just 7 cents a share. That was up from 3 cents a year earlier but down from the 13 cents that Wall Street had expected. Total profit was 19 cents a share ($3.06 million) only because of a one-time gain.
The stock lost $1.50 to $11.50 Monday in New York Stock Exchange trading. It recovered 50 cents to $12 Tuesday. Investors’ optimism despite the bad news stems from the belief that Applied Magnetics has solved its recent labor problems in South Korea. Labor strife in the quarter, related to overtime hours, wreaked havoc with the firm’s costs. But CEO Ben Newitt says the firm concluded new agreements with workers a few weeks ago.
“Now, productivity is up, and if it holds up, we should have a very good quarter,” he said.
Another problem in the recent quarter: costs related to new production facilities in Malaysia. Those start-up expenses could still pressure margins in the current quarter, says analyst Todd Bakar at Hambrecht & Quist in San Francisco.
Still, Bakar expects Applied Magnetics to earn 45 cents a share in the year ending Sept. 30, and $1.45 the following year. The problem isn’t demand, Bakar says--it’s execution. Newitt agrees. Demand for the company’s parts--integral to computers--remains “very strong,” he said.
BREAKDOWN STOCKS Some of the major stocks that have been crumbling while the Dow Jones index goes on to new highs:
52-week Tues. Pct. change Stock high/low close from high Lowe’s Corp. $49 5/8-$25 $41 3/8 -17% AT&T; 47-36 1/4 37 -21% J.C. Penney 75 5/8-57 1/8 59 1/4 -22% Dow Chemical 75 3/4-55 3/8 59 3/8 -22% Boise Cascade 48-31 1/2 31 5/8 -34% Citicorp 35 1/2-21 1/8 21 7/8 -38% Panhandle Eastern 30 3/4-17 5/8 18 -41%
