CI Outlook - Archives

September 2012

Some time ago we bought Caterpillar and Baker Hughes as beaten down value stocks whose fortunes should improve with improving perceptions of the world economy.  With that same idea in mind we recently added Joy Global to many portfolios in which it was appropriate.  Joy Global is a preeminent manufacturer of mining equipment.  It and Caterpillar are very cyclical and therefore quite sensitive to the “China Trade”.  Today China announced a $157 billion infrastructure build out program.  We believe the scale and magnitude of the program vindicates our long held view that China will do what is necessary to support a reasonable rate of growth for their economy.  That is the reasoning behind owning construction and mining stocks.  Today’s news is causing other investors to come around to this line of reasoning and they are purchasing those cyclical stocks likely to benefit from large scale construction in China.  Caterpillar and Joy lead that pack.  We are very interested to see how the market will react to China’s announcement this Sunday of last quarter’s economic results.  Most observers are already braced for terrible news so there will probably be no negative surprises.

The newest addition to our portfolio is NXP.  It is not a China story.  The real story for NXP is strength in semiconductors.  That industry is currently at about mid-cycle in its expansion phase.  NXP stumbled earlier this year but now seems to be on track for a large expansion in gross profit margins going forward.  If they are successful, street analysts expect earnings to go from an estimated $1.78 this year to $2.77 in 2013.  That expansion will be accomplished not merely by rising sales volume but continued aggressive paying down of their debt.  Since they were spun out by Phillips they have reduced debt from nearly $5 billion to under $3 billion.  According to analysts at Credit Suisse they may well reduce debt to under $2 billion by fiscal 2013.  That combined with current cash on the balance sheet of nearly $900 million gives them the balance sheet strength and expanded margins to command and industry P/E.  According to Credit Suisse that level should be 15% higher from here.  Last but not least is the sizzle that comes with all good fundamental stock stories.  NXP is the recognized leader in NFC identity applications.  These are the chips that are going into most new smart phones, and power such things as electronic wallet apps.  Google used NXP’s designs in its wallet and Apple is announcing its iPhone 5 soon.  Although NFC identity is currently only 20% of NXP’s business NXP controls a majority of the NFC patents.  Early investors in QUALCOMM will remember it controlled most of the CDMA patents and will easily see the value in NXP’s patents.  Based on that sort of analysis Credit Suisse believes NXP is worth at least $33 in the next 12 months.  Deutsche Bank recommended the stock on September 5th and we believe others will follow.  We are excited to be back in the stock and look forward to further news on it. 

Although the current rally is exhilarating we remain vigilant to signs of trouble.  The election outcome this year and the possibility of further political gridlock leading us over the edge of the “fiscal cliff” will remain the short term clouds on the horizon.  We hope to stay a step ahead of the news and will act accordingly. 

Thank you for your patronage.  Please call with any questions or comments.

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