Tuesday, May 25, 2010

CASE SHILLER/Spanish Banks/CPB VZ T MDT/MBC/Bought 50 OSM at 15.74

May 2010 is starting to be a faint echo of October 2008, at least as measured by the decline in my portfolio, and I am conservatively positioned for this kind of turmoil. I was encouraged that the S & P 500 managed a small gain today. When I left HQ to deal with a problem involving my parent's 1987 Mercedes, the DJIA was down over 200 points. I remembered what Louise Yamada had said in a recent interview about the importance of staying above 9800. (Yamada Interview) For now, it looks like the market successfully retested that low from February.

The rally off the March 2009 low was a short duration cyclical bull rally within the confines of a long term secular bear market starting in October 1997, typical for a counter move response to a catastrophic bottom which occurs in every long term bear market. More on 1982 or 1974 1974 or 1982: Start of Cyclical Bull in a Long Term Secular Bear Market or the Start of Secular Bull Market? The VIX did give excellent warning signals of the pending end of the short duration cyclical bull cycle (summarized in an earlier post: Continuation of the Long Term Secular Bear Market Pattern).

Some would quibble with my terminology and simply call the dismal action in May as a correction in that bull cycle. For now, I am saying that the short duration cyclical bull which started in March 2009 is kaput. Hopefully, the market can stabilize at the current level, meander around the low 10,000 area in the DJIA until most people realize that the fears about Europe are overblown. The 1 trillion dollar rescue package does buy Europe enough time to get its fiscal house in order. The PIIGS are starting to implement some fiscal restraint. Now, what about the U.S.?

I was not exactly reassured today when the St. Louis Fed President, James Bullard, opined that the European crisis would "probably" fall short of sending the world into another recession. St. Louis Fed | Newsroom | James Bullard | Speeches & Presentations Personally, I think using the word "crisis" to describe what is happening in Europe now is overly dramatic. It does represent another warning shot across the bow of western governments about the levels of government spending and debt.

A number of stocks have already reached valuations that are hard to justify. I noticed the Exxon hit a 52 week low today and has now fallen below its low reached in early March 2009: Exxon Mobil Corporation Common Share Price Chart | XOM The current price is around 10 times 2010 estimated earnings.

1. Campbell Soup (owned): Campbell reported adjusted earnings of 54 cents for its fiscal third quarter, beating the consensus estimate of 51 cents , on an increase in revenues to 1.802 billion. U.S. soup sales rose 2%. CPB forecasted that its adjusted E.P.S. for fiscal 2010 will be at the upper end of its targeted range of $2.41 to $2.45. U.S. soup sales increased 2%.

2. AT & T and Verizon (own senior bonds and AT & T common): Eric Savitz summarized in his daily Tech Trader column the analyst reports on AT & T and Verizon published by Davenport & Company analyst Drake Johnstone. This analyst downgraded VZ to neutral based on concerns that Verizon will not be able to grow its dividend when it has to start paying 45% of the cash flow from Verizon Wireless to Vodafone, which he contends will happen sometime in the next two years. Barrons.com The same analyst cut his rating on AT & T to neutral based on his estimate that as many as 40% of the AT & T's IPhone customers may defect to VZ once AT & T's exclusivity with Apple ends and VZ is able to offer the IPhone on its network. I did note that AT & T raised its early termination fee to $325 from $175 on the smart phones. CNET News

I would simply note that VZ is yielding almost 7% at its current price. I suspect most investors would be satisfied with that yield even without a dividend raise, at least for a few years.

It is my understanding that Verizon can use the Verizon Wireless cash flow to repay inter-company debt owed to VZ, but that debt will be repaid sometime in mid 2010. Seeking Alpha VOD has not received a dividend from Verizon Wireless since 2005. Verizon Wireless had free cash flow of 14.77 billion in 2009 according to the WSJ. The argument made by the Davenport analyst may be more supportive of a purchase of VOD shares than a downgrade of VZ at its current price.

3. Spanish Banks: Okay, who has ever heard of Cajastur, Caja de Ahorros del Mediterraneo, Caja Extremadura and Caja Cantabria. There is a growing recognition that some of Spain's banks have not exactly come to grips with their problem real estate loans. These four Spanish savings banks announced plans to merge on Tuesday to "strengthen solvency". It does not appear that the market is buying the strengthen or the solvency part of that phrase. Spain bailed out another savings bank on Monday with a $691 million bailout. This problem has been brewing for a long time. Bloomberg ran an article last October about the Spanish banks efforts to avoid recognizing losses on their soured real estate loans. Apparently, there was a belief in Spain that refusing to recognize their problems is tantamount to solving them. But recognizing that you have a problem is the first step toward recovery. Reuters

4. Spit as Weapon: The NYT had an article on the front page today about NYC taking extended paid leaves after allegedly being spat upon by a passenger. A total of 51 drivers took an average of 64 paid days off from work after claiming about such an incident, apparently a very traumatic event in their lives. One driver spent 191 days. The transit authority is facing a budget shortfall of 400 million. While I have never read about or heard of such an incident in my neck of the woods, I would not question that some of these incidents actually occurred in NYC. How many paid days can be justified even if such an event actually happened? I would say none, and it is time for politicians to exercise some backbone in dealing with public unions.

5. Case Shiller Index: This was a disturbing report. Home prices fell .5% March compared to February in the Case Shiller 20 city index, notwithstanding the home purchase tax credit which expired at the end of April. This was on an unadjusted basis. The seasonal adjustment resulted in no change between February and March. CNBC

6. Medtronic (owned): Medtronic reported adjusted earnings of 89 cents per share for its fiscal 4th quarter, 1 cent better than the consensus expectation, on revenues of 4.196 billion. MDT forecasts an E.P.S. of $3.45 to $3.55 for fiscal 2011 which includes 5 cents of share dilution due to the acquisition of Invatec and the pending deal to acquire ATS Medical. The 4th quarter cash flow from operations was 1.237 billion. For MDT's fiscal 2010, international revenue grew 13% in constant currency terms and those revenues constituted 41% of total revenues for that year.

7. Record Low Yield for the 2 Year Note: What can you say? The treasury held the auction for the 2 year note today. The yield was the lowest in history at .769%. www.treasurydirect.gov pdf Such a low yield is a manifestation of palpable fear, so thick that you can cut with a knife. Obviously, people are more concerned about the return of their money than the return on their money. It is almost impossible to believe, but the treasury sold almost 43 billion in 2 year notes at that measly yield. This is a link to the Federal Reserve's data on the 2 year note yields since 1976. There was a story at CNBC that this auction had weak demand. I would not characterize the successful sell of 43 billion in 2 years notes to yield .769% as anything resembling weak.

8. MBC (owned): I mentioned that MBC was ex dividend for its annual distribution today. I knew that this principal protected note with a $10 par value would pay its guarantee of 3%, rather than an amount tied to the increase in the ^RUT due to a maximum level violation during the first annual coupon period. The first period ended on May 21, 2010 with the Russell 2000 at 649.29. This will be the Starting Value for the second annual coupon period which will end on 5/20/2011. Final Pricing Supplement MBC will pay the greater of 3% or the percentage gain in the Russell 2000 from the Starting Value to the closing date, but only up to 30%. And, as previously discussed, there will be a reversion to 3% irrespective of the increase if the Russell 2000 has just one closing day above a 30% increase from the Starting Value of 649.29. Such a reversion occurred in the first annual coupon period. Bought 100 MDC at 9.84 This places the maximum level at 844.077 in the Russell 2000 index.

9. Bought 50 OSM at 15.74 (see Disclaimer): This purchase brings me up to 200 shares. OSM is a $25 par value senior note issued by SLM (known as Sallie Mae) that matures in March 2017. The return on this note would be good just with the profit realized on the shares at maturity, assuming SLM survives to pay value. I have discussed this note several times in the past. It pays interest monthly based on a 2% spread over a CPI computation, which uses a 12 month period with a 3 month lag. The calculation will use the non-seasonal CPI numbers that can be found at research.stlouisfed.org. The April CPI number was released in May, and it will be relevant in the calculation for the August monthly interest payment. This is how it is computed:

April 2010 Non-Seasonal CPI 218.009
April 2009 Non-Seasonal CPI 213.240
Difference=4.769
Divide 4.769 by 213.240= .02236 +.02 Spread= .04236
Multiply .04236 x $25 par value= $1.059 (annualize rate for the month)
Multiply $1.059 x. 31/365= $.08994 penny rate for August 15th monthly payment

The computation for July was done in an earlier post as follows:

March 2010 217.631
March 2009 212.709
Difference=4.922
Divided by 212.709=.02314
Add .02 Spread=.04314
Multiply by $25=$1.0785
Divide by 30/365=$ .0886 for July

The penny rate for the next payment on June 15th is $.088.

February 2010 216.741
February 2009 212.193
Difference=4.548
Divided by 212.193=.02143
Add the Spread (02% for OSM; .024% for PFK)= .04143% for OSM
Multiply .04123% by $25 par value=$1.03575
Multiply $1.03575 x 31/365= $.08796 rounded to $.088.

Prospectus: www.sec.gov

So that is how it is done. It is going to vary by the month and there is a built in lag of 3 months. I just work off the assumption that a decent guess for the average annual inflation rate over the next six years would be 2.5%. Adding the 2% spread to 2.5% gives me an average coupon rate of 4.5%. Multiply 4.5% by the $25 par value and I arrive at an average annual penny rate of $1.125. Divided that number by a total cost per share of $15.74 and I arrive at 7.147%. That is just an assumption based on a 2.5% annualized inflation rate. It could turn out to be higher or lower of course. That does not entice me given the risk of a SLM note. I am interested in the yield to maturity number. If I plug in a 4.5% coupon into the Morningstar Bond Calculator, a $25 par value, a $15.74 cost, and a maturity on 3/15/2017, I arrive at a YTM of 13.08%, That is the number that is worth taking the risk connected with SLM's survival.

Some earlier posts on this note include these posts from 2008: CPI FLoaters PFK AND OSM CPI and CPI Floaters-OSM CPI FLOATER: OSM OSM is discussed in this recent Seeking Alpha article (the author incorrectly calls OSM a preferred stock however, so I left a comment).

The government will be ending soon its subsides to SLM for originating student loans. Anyone interested in SLM notes needs to read some analyst reports on how this company will likely cope with the government becoming the primary originator of student loans. SLM will service loans originated by the government, and it has a large book of loans outstanding that will run off in the coming years. QuantumOnline.com (free site with registration) has the Moody's rating of OSM at Ba1 and the S & P rating at BBB- . Ratings and trading information about SLM bonds can be found at FINRA.

I am willing to take only a small risk on OSM. If and when the bond starts trading over $20, I will assess then whether or not it would be prudent to continue taking the risk or to harvest the profit that I now have in those 200 shares.

No comments:

Post a Comment