Zacks Analyst Blog Highlights: Berkshire Hathaway, Verizon, AT&T, iShares Dow Jones US Utilities and iShares Dow Jones U.S. Transportation Index Fund
Posted on March 09, 2011 at 09:30 AM EST
CHICAGO, March 9, 2011 /PRNewswire/ -- Zacks.com Analyst Blog features: Berkshire Hathaway (NYSE: BRK.B), Verizon (NYSE: VZ), AT&T (NYSE: T), iShares Dow Jones US Utilities: (NYSE: IDU) and iShares Dow Jones U.S. Transportation Index Fund (NYSE: IYT).
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Here are highlights from Tuesday's Analyst Blog:
Sector Watch: Financials, Utilities, Transportation
Financials (100% in)
This is a huge sector, expected to account for 18.09% of all S&P 500 earnings in 2011, up from 17.34% in 2010. The earnings share of the sector has been extremely volatile in recent years. It was over 30% in 2007, before becoming negative in 2008 (i.e. the sector as a whole lost money), and it is now in the process of staging an extremely strong recovery. In 2009, the sector earned 5.97% of all the net income of the S&P 500.
Ample help from the government both direct through the TARP processes, and even more importantly indirectly through a super-steep yield curve engineered by the Fed, have certainly aided the recovery. If you believe the numbers, earnings growth has been absolutely spectacular, although very lumpy.
In the fourth quarter, total net income for the sector was 205.6% higher than in the fourth quarter of 2009. That is a huge acceleration from the 33.9% growth in the third quarter. In fact, if the Financials are excluded, total net income growth in the fourth quarter for the S&P 500 as a whole would be just 19.9%, not the 30.5% reported. For 2010 as a whole, earnings rose an astounding 320.0%, but is expected to slow to a still above the index level of 19.9% in 2011 and 14.8% in 2012.
Revenues in the Financials are different from other companies, as low interest rates cause revenues to fall, but also cause interest expense to fall. This can cause some big distortions, and is the reason that in the earnings trends reports, the revenue and net margin tables are shown both for the total S&P 500 and excluding the Financials. Revenue growth for the sector is very poor as a result, with total revenues declining by 0.2% in 2010, and then expected to fall by 20.39% in 2011 before growing 4.96% in 2012.
However, in the Financial sector that is much less of a worry than it is in any other sector. Most of the higher earnings in 2010 were from lower loan loss provisions, something that does not affect revenues. Massive growth in the bottom line and a shrinking top line can only mean one thing, massive growth in net margins. Net margins were actually negative in 2008 but recovered to 2.51% in 2009, and jumped to 17.34% in 2010. The net margin party is not over for the Financials as they are expected to grow to 18.09% in 2011 and 18.96% in 2012.
Why did I say, "if you believe the numbers?" Because early last year, under significant political pressure, the Financial Accounting Standards Board (FASB) suspended the mark-to-market accounting rules for the Financials. Honestly, I do not know if I should classify the books values of the Financials under fiction or non-fiction because of this. While that is focused on the balance sheet, it does flow through to the income statement as well.
Estimate momentum has been positive over the last month, but also a little bit weaker than for the rest of the market, with a revisions ratio of 1.45 for FY1 and just 1.47 for FY2. This suggests that there are probably better opportunities elsewhere for short term trading gains, but this is a very big sector, not just by total earnings but by number of firms as well with 78 firms in it, so there are plenty of opportunities for short-term trading if you want to play in this sandbox.
Valuations in the sector are quite reasonable (again if you trust the numbers) with the sector trading at just 14.7x 2010 and 12.3x 2011 earnings. If you are willing to look out to 2012 earnings, the P/E drops down to 10.3x, the lowest of any sector except Autos. These numbers suggest that you should be massively overweighted in the sector, but I simply can't bring myself to make an overweight call, simply because I don't trust the numbers.
Let me be clear, I'm not questioning the competence of the analysts making the forecasts, or of our data collection. The analysts (and the companies) follow the FASB rules, and those are what I have an issue with. Still, this is a sector that you simply can't go naked in, like say the construction sector, it's just too big and important. I would stick to firms where balance sheet integrity is less of an issue, such as Berkshire Hathaway (NYSE: BRK.B).
In general, those issues are going to be less of a big deal for the insurance companies than the banks. If you want banking exposure, I would suggest looking North to some of the Canadian banks, where the banks are better regulated (the new Financial Regulation law was a good step in the right direction, but did not go anywhere far enough in my opinion).
On the other hand, I will admit that if I am wrong about the soundness of the banks' balance sheets (and I'm more uncertain about them than certain that they are bad, a few years of good earnings and not paying out dividends or buying back stock can do wonders for bringing down the excessive leverage they had) that some of the big banks, especially the too big to fail ones, could be huge winners. Hey - no guts no glory, but your guts are also not likely to be in a pile outside your body either). Thus, I would market weight the sector.
Utilities (100% in)
Earnings growth in this sector -- which includes the telecom companies like Verizon (NYSE: VZ) and AT&T (NYSE: T), not just the electric utilities -- rose an anemic 0.9% in the fourth quarter, down from an already low 6.4% in the third quarter. Things are expected to continue to deteriorate in the first quarter, with total net income falling 2.0% from the first quarter of 2010. For all of 2010, total net income was down 0.82%.
The sector holds the dubious distinction of being the only one to earn less in 2010 than in 2009. Analysts are only a little bit of a turnaround, with 3.84% growth in 2011 and 5.44% in 2012. Then again, it has been a long time since Utilities were a big growth sector (they were in the 1920's when Sam Insull was playing his games, but not so much since then.) They tend to be "Steady Eddie" performers and pay nice fat dividends.
For that reason, they are often considered to be bond substitutes. I'm not a big fan of bonds at the current level of interest rates, and that extends to the utilities. Net margins are slightly below average for 2010 a 7.85%. The sector was one where the net margins for 2010 were lower than in 2009 when they were 8.11%. Only a slight recovery to 7.81% is expected for 2011, with an expansion to 7.99% expected for 2012.
As with the bottom line, top line growth is anemic, up just 2.38% in 2010 and picking up to 4.41% in 2011 before accelerating to 13.19% in 2012. From a short-term trading point of view the sector looks downright unattractive, with more cuts than increases for FY1 (ratio of 0.61) and for FY2 (ratio of 0.53). Based on 2010 earnings the P/E of 14.6x for the sector is below that of the overall index. However, others are passing it by in terms of earnings, so the 2011 multiple only falls to 14.1x, and that is above the overall multiple for the index in 2011.
It becomes relatively more expensive if you look out to 2012 earnings, when the P/E is 13.4x, well above the 12.3x for the S&P 500 as a whole. This is a mid-sized sector, expected to account for 5.71% of total S&P 500 earnings in 2011, but that is down from 6.32% in 2010, and 9.21% in 2009 and is expected to drop to 5.31% in 2012. Unless you really need the income, I would be inclined to underweight the sector. Even then, there are probably better income stocks around.
iShares Dow Jones US Utilities: (NYSE: IDU)
Transportation (100% in)
This is a small but growing sector, with its earnings share expected to grow from 1.49% in 2010 to 1.55% in 2011 and 1.62% in 2012. In the fourth quarter total net income rose 30.7%, down from a scorching 65.2% in the third quarter, but still slightly better than the index as a whole.
For all of 2010 earnings were up 44.2%, slowing to a still better than market 20.4% in 2011 and 18.2% in 2012. Much of that growth is expected to come from margin expansion, but not all of it. Total revenues climbed 10.83% in 2010. Analysts expect slowing to 10.07% in 2011 and 8.06% in 2012. For all three years, that is better than is expected for the overall market. Net margins rose from 5.84% in 2009 to 7.60% in 2010, and are expected to expand to 8.30% in 2011 and 9.08% in 2012.
The estimate revisions picture is mixed, at a well-below market revisions ratio of 0.43 for FY1, but a healthy 1.94 for FY2. The sample size is extremely small, so take those numbers with a grain of salt. There is a big variation in estimate momentum between the different industries that make up the sector. Airlines have been very weak, as have the Truckers (more so when you look outside the S&P 500 index than inside it) but railroads have been holding up well. That probably has to do with how much more fuel efficient rails are versus planes and trucks.
Valuations are on the high side with a P/E of 20.0x on 2010 earnings, but falling to 16.6x for 2011 and 14.0x if you are willing to look out to 2012. As far as making long-term investments is concerned, it really matters what part of the sector you are looking at. I have always felt that Airline stocks are ones that you rent, not own. Good for the occasional trade, but dangerous to your wealth if you try to hold them long-term.
The railroads could be solid long-term winners, though, especially if I am right about the long-term trend in energy prices being higher. Railroads are just super-efficient in moving stuff when it comes to energy consumption. The greatest investor ever, Warren Buffet, seemed to agree when he bought all of Burlington Northern last year. I like the growth prospects of the sector, but some of that at least looks priced in. I would go with a modest overweight to market weighting in the sector.
iShares Dow Jones U.S. Transportation Index Fund (NYSE: IYT)
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