Shares of biotech firm BioCryst Pharmaceuticals (BCRX) have caught fire lately after worries over a potential Avian Flu pandemic have flooded media outlets. The stock is up 80 percent to $17.65 already this month and has tripled in the last three months, giving the company a market cap of nearly half a billion dollars.
To say this violent move to the upside is based on speculation would be a dramatic understatement. The excitement over BCRX comes from a flu vaccine that the company actually scrapped in 2002 after it failed late stage clinical trials. However, with Avian Flu worries running rampant, the company has decided to bring back the drug and test it on bird flu. Early indications show it might have some kind of positive effect, but it's way too early to conclude the drug, Peramavir, would be successful in preventing the spread of Avian Flu.
Investors, though, haven't really focused on the downside (an ineffective drug brought back into testing only to get shelved again), but rather only on what it could do, become heavily useable in case a pandemic of Avian Bird Flu does sweep the globe. What happens if Avian Bird Flu goes the way of SARS, and in several months we never hear of it again? Or what happens if BioCryst's drug shows to not work, or not work any better than drugs that have already been approved by the FDA for the flu (TamiFlu from Gilead, for instance)?
There is no doubt that BCRX shares have momentum right now as individual retail investors gobble up shares while the media hypes the potential death toll from an Avian Flu pandemic. Such momentum could drive the stock higher in the short term, with $20 or $25 very feasible. However, for BCRX to maintain its current share price for the longer term, after the hype dies down, a lot of things need to go perfectly, most of which the company and investors can't control. If that doesn't happen, remember that BCRX was a $3 stock in April of this year.
Peridot Not Alone In Buying Sears
Late Friday Sears Holdings (SHLD) announced that its board has authorized a $500 million stock buyback program. You may recall the company did the same thing exactly a month ago on September 14th. In today's press release, Sears said they have bought back $434 million of that inital amount in the last month, at an average price of $118.86 per share.
This announcement brings the total amount of the buyback to $1 billion, or roughly 5% of the company's outstanding shares, and could be completed within 60 days, start to finish. Based on these numbers, earnings per share for Sears in 2006 will be increased by nearly $0.40 per share.
Amazingly, the stock still goes down pretty much every day, and trades below the prices Sears has been paying recently. Investors won't be able to come back a year or two from now and say they didn't have a great chance to get in, that's for sure.
OXY Purchase of VPI Implies Energy Undervaluation
Late yesterday we learned that Occidental Petroleum (OXY) is buying Vintage Petroleum (VPI) for $20 cash plus 0.42 OXY shares. This represents a huge premium (33%) over yesterday's closing price and 12.5 times VPI's 2006 estimate of $4.13 per share. This deal very much backs up my contention yesterday that energy multiples are too low.
Take Plains Exploration (PXP) for example, and their 2006 consensus expectation of $4.44 in EPS. If investors put the same 12.5 multiple on PXP that OXY was willing to pay for Vintage, you get an implied buyout value of $55 per share for Plains, about 50% higher than its current share price.
Energy Selling Overdone
With the XLU down 15% from its high, you'd think energy prices were tanking. Instead we have $63 crude oil and $13 natural gas. While a warm winter would bring natural gas prices down considerably from here, earnings estimates for energy companies right now are probably based on no more than $50 oil and $7 natural gas, nowhere near where we are now.
Stocks like Chesapeake (CHK), Suncor (SU), and Plains (PXP) are trading at 8-10 times 2006 earnings. Plains is getting crushed today, in fact, on news of charges it will be taking from its hedging positions. However, that will be money well spent since it assured they could get high prices for their product in 2006.
Unless energy prices plummet from here, current earnings numbers will prove conservative. The volatility is hard to stomach, but these stocks are too cheap to ignore if you don't have your 10% position in energy yet.
Talks For AOL Partnership Heat Up
Reports indicate that talks between Time Warner (TWX) and several technology industry giants regarding an online partnership with America Online have heated up in recent days. Some are speculating that a deal could value the entire AOL division at $20 billion. So what does TWX stock do yesterday on this news? It drops 2%, which can be attributed in part to the news that Yahoo and Microsoft are linking accessibility to their instant message programs.
Time Warner itself is valued at slightly more than $80 billion, with the AOL subsidiary widely considered dead as far as online innovation is concerned. And yet, reports of a deal are indicating that AOL might be worth 25% of Time Warner's total valuation. If true, TWX's current share price hardly makes sense to me. At $17, TWX repreesnts a wonderful value in a market that has been, to borrow a Jim Cramer term, a "house of pain." If investors are looking for good deals with limited downside, Time Warner shares looks like a solid bet.
Market Action Feels Like 2001
Midway through the 8th day trading day of October, we have our 7th down day of the quarter. This market feels a lot like the painful one we experienced in late 2001. The culmination of the Nasdaq bubble bursting, the outbreak of SARS, and the 9/11 terrorist attacks led to an environment that felt as though it would go down every day and never end.
Today we have a similar scenario. Stock prices are indicating that 1) gasoline prices will remain at $3 per gallon even as refineries come back online in the coming weeks and months, 2) natural gas prices will remain high even after the winter season passes, 3) consumer spending will be poor during the holiday season and every season thereafter, and 4) the Fed will continue to raise interest rates forever. Add to it that we are in the historically poor performing month of October, and it feels like no end is in sight.
Like in 2001, today I wish I was a trader in these environments, not a long-term investor. As a trader you can just go with the trend and short this market. As a long-term value investor you need to buy stocks as they fall, knowing full well they will most likely fall further before they rebound.
However, I know that as a short-term trader I would not have been able to profit handsomely from some very contrarian bets. Shares of Royal Caribbean (RCL) fell from $30 to $8 in 2001 after leisure travel was halted in the United States. Four years later the stock closed 2004 at $54 per share, for a gain of 575 percent.
In the end, sacrificing the short-term for the good of the long-term can yield outstanding rewards. The key is stick to your convictions when it hurts the most. "No pain, no gain" rings true in the stock market as well.
Delving into the Conventional Wisdom
There are two reasons the market is down so far this year; energy and interest rates. The question we need to ask ourselves is "Are the stock market reactions we are seeing correct?" Since the market is mostly psychological, investors need to take a deep breathe and focus on reality, not simply psychology or perception.
Stocks are being held down by underperforming names in the financial services and consumer discretionary sectors. Together, those 2 areas represent 31% of the S&P 500. That's a huge chunk. Regardless of how strong energy, materials, and health care stocks act in times of higher interest rates and fears of an economic slowdown, they won't be able to carry the market on their shoulders. Why not? Energy and materials are only 13% of the market. Health care is another 13%, but that only gets us to 26%, less than the 31% of weakness we need to offset.
The weakness in financial services is real and very much warranted. Banks are going to struggle with a flat yield curve. If you were running a bank and your borrowing costs were risng faster than the lending rates you could charge, your profit margin would be squeezed. No doubt about it. Until the Fed is ready to stop, financials are not right here, so let's hope once Greenspan is gone in early 2006 that rates stabilize.
Conversely, the sell-off in consumer discretionary sectors is a little less warranted, in my opinion. As gas prices have gone from $2 a gallon to $3 a gallon, drivers will need an extra $60 per month to fill up their cars if they have a 15 gallon tank and fill up once a week. The question we need to ask is, where will that $60 come from? I don't doubt that it will be taken out of another area of one's personal budget, but where? It won't come out of every other place.
One of the conclusions I've come to is that it won't come out of food expenditures as much as the restaurant stocks are telling us. I still think the trend toward eating out, not cooking at home, is here to stay, regardless of gas prices. Families might not go out and spend a lot of money on food, but they should still eat out at a reasonable price. With major restaurant chain share prices at 52-week lows, that's an area I would strongly consider buying as prices continue falling.
Spiraling Healthcare Costs
I just got a notice in the mail from United Healthcare. My premium will be going up by 21 percent on November 1st. That's right... 21 percent in a single year. Although politicians campaigned on the issue, and Bush and Kerry continually pointed to the rising costs of healthcare as a grave concern during the 2004 presidential debates, nothing has been done about it. This is despite the fact that annual premium increases of 15 to 25 percent have been commonplace recently, with overall inflation only running 2-3 percent per year, and wages that have been flat for four years running.
All we can do really, aside from shopping around for better rates (which I'm doing), is try and make some of this money back via the healthcare portion of our investment portfolios. United Healthcare (UNH) will continue to grow earnings at double digit rates as long as Washington doesn't help us citizens out with healthcare reform. And that industry growth will persist regardless of whether gasoline is $1, $2, or $3 a gallon, or if Fed Funds are priced at 3%, 4%, or 5%.
Ugly Market Could Soon Be An Opportunity
Market psychology in October is never very good, based on what have been some pretty lousy performances in 1987 and much earlier during the Great Depression. Combine that history with the fact that markets rarely do well in the middle of earnings season, and a continuation to the downside short-term could present an excellent opportunity for investors.
The markets are jittery right now due to inflationary fears, which I think are very warranted. There is little doubt in my mind that Fed Funds rates will be at 4.25% by year-end. As far as 2006 goes, it all depends who succeeds Alan Greenspan. If an inflation hawk steps in, rates could very well go even higher if commodity prices keep rising and the government continues its insane spending.
Despite that somewhat gloomy backdrop, corporate earnings have held up okay, and estimates right now are for the S&P 500 companies to earn $85 in 2006. While that number is by no means assured given the current economic environment, the P/E on such estimates right now is only 14x.
If the recent slide continues, and we get the S&P 500 back down to its support level in the 1135-1150 area, all of the sudden the forward multiple is 13.5 times earnings. A lot of good things could happen if we see that kind of valuation (not seen in years) combined with a technical support level holding and a seasonally strong period (November through April) set to begin after we get through third quarter earnings reports. Continued weakness in crude oil prices would only help that scenario.
Is Vegas Growth Peaking?
After exhausting my own reading materials on a recent Southwest Airlines flight to Baltimore, I thumbed through the air carrier's in-flight magazine entitled Attache. What I found in its pages was very interesting. Nearly every single page of advertising (probably half the entire magazine) had something to do with Las Vegas. Either a plug for a Vegas casino, a specific show at one of the Vegas casinos, or most frequently, a new high-rise condominium project in Vegas.
The constant marketing of Vegas with each turn of the page showed me that growth in that city may very well be peaking. After all, can construction there really accelerate from here? With so much capacity being added to Las Vegas, I can't help but wonder how all of it is going to be filled. The new Wynn hotel recently opened to much fanfare, and there was even an article about MGM's new massive building project along with all of those ads. No fewer than a dozen new condo buildings are going up, with the likes of Ivana Trump gracing their colorful advertisements.
While demand may be high, I doubt so much more supply is going to be good for the city. With vacant desert land as far as the eye can see, I sure hope people keep coming to Vegas, both vacationers and new residents. If the economy were to slow down noticeably, travel would likely decrease, leaving billions in new projects at risk. Investing in Vegas now, whether it be via the companies that are building there, or directly in the local real estate market seems like a risky bet to me.
As attractive as the growth opportunities for the country's largest gaming companies are, I am having a hard time justifying Vegas-related investments at this point in time. The rapid growth could very well continue for several more years, but the downside risk is evident enough to me that I prefer looking elsewhere for my consumer discretionary holdings. In fact, I have sold all gaming related stocks aside from a hedged pair trade of long WYNN, short LVS.