Chain Bridge Investing: Financial and Stock Investing News 11-4-09

November 4, 2009 by cb · Leave a Comment

Good morning, investors and traders! You are reading the Daily Download (”Daily DL”), which includes summaries and links to the day’s selected economic and stock investing news. The Daily DL is maintained by Chain Bridge Investing, which is a financial blog at www.chainbridgeinvesting.com. Chain Bridge Investing is constantly improving and adding new financial and investing content to the website. Please let us know if you have any suggestions.

Upcoming Economic Data for the Day (all times EST)

7:00 AM MBA Purchase Applications

7:30 AM Challenger Job-Cut Report

8:15 AM ADP Employment Report

9:00 AM Treasury Refunding Announcement

10:00 AM ISM Non-Mfg Index

10:30 AM EIA Petroleum Status Report

2:15 PM FOMC Meeting Announcement

Initial Public Offerings for the Week of November 2 -6, 2009

11-03-09 Aviv REIT – REIT for healthcare properties (”AVI”)

11-04-09 Ancestry.com – Online services for genealogy. (”ACOM”)

11-05-09 Plains Capital – Banking services (”PCB”).

11-05-09 Duoyan Printing – Provides printing equipment (”DYP”)

11-05-09 STR Holdings – Solar power module manufacturer (”STRI”)

Source: WSJ Market Data Group.

For Daily Market Performance Data, Please Visit the Daily Market Sheet

List of Selected Companies with Third-Quarter Earnings for 11-4-09

News

Buffett Bets Big on Railroad – The Wall Street Journal

Summary: On Tuesday, Warren Buffett stated that Berkshire Hathaway will purchase the 77% of Burlington Northern Santa Fe (”BNI”) that it doesn’t own in a deal valued at $26.3 billion with a 31% premium. The payment of the deal will be transacted with approximately 60% cash and the remaining 40% will be done with Berkshire’s Class B shares, which will undergo a 50-1 split. Buffett’s reasons for the deal are the following: (1) he expects higher future fuel costs, which indicates railroads will outperform trucking; (2) he believes the economy in the long-term will more than recover; (3) the railroads are relatively unaffected by the competitive pressures from low-wage economies; and (4) the railroads’ ability to maintain pricing power during the recession. However, some analysts believe that, given the price Berkshire paid for BNI, this investment could take years to create the returns necessary to justify the investment. Investors should note that recently railroads have enjoyed a comeback after decades of decline primarily due to: (1) rising fuel prices; (2) road congestion; and (3) pricing wars in trucking. Berkshire expects to have $20 billion of cash remaining on its balance sheet after the deal closes in the first quarter of 2010.

CB: As many probably expect this deal has been analyzed all over the Internet by now. The deal garners more interest than most due to the involvement of Buffett and the investors who carefully track his moves. These Buffett followers may be responsible for rises in the prices of other railroads in the near future. Sadly, Buffett has stated that BNI is the only railroad he will buy controlling ownership in. While CB does not claim to be a railroad expert, CB did a quick analysis of BNI when the deal was announced and CB cannot, at this time justify, the price spent on BNI. Quick mathematical calculations reveal that BNI would have to not only recover from its current low sales and profit levels, but it would have to grow significantly in the future to justify the Buffett price. BNI’s highest level of operation was achieved in fiscal year 2008, but the Company is currently operating with sales down 18% and profit down 15% from 2008. CB does believe railroads will benefit from the economic recovery, however, these companies are not very cheap at this time. This deal relies much more on various future growth opportunities than on the company’s current value. For Buffett to gain a proper return on this deal the following must occur: (1) BNI must take market share; (2) the market itself will have to grow, but how much of the current trucking market can BNI realistically capture – trucks will not disappear; (3) coal will have to continue to be supported by the government throughout the current climate-change discussions; (4) China will have to continue to import natural resources from the U.S.; and (5) the U.S. dollar will have to stabilize at some point. Yes, Buffett states that he is viewing this investment with a 10 to 20 year investment horizon, and in that situation this investment will likely earn a proper return. Nevertheless, many investors don’t have the luxury of a significant fortune to wait 10 to 20 years for an investment to pay off. CB believes there may have been better yielding investment opportunities Berkshire could have invested in for the future, but then again CB doesn’t have to worry about how to invest billions of dollars in cash. Basically, on the surface, many variables have to occur to ensure the investment a proper return. Investors should note that Buffett’s price for BNI may not represent a pure financial premium as there are possible synergies with Berkshire’s current power generation holdings in the Midwest. Yet, as always, Buffett gets the benefit of the doubt until the future is revealed.

Rail Deal is Bet on Obama’s Infrastructure, Climate Policies – The Wall Steet Journal

Summary: Some observers believe that Warren Buffett’s purchase of BNI might have been influenced by the policies being pushed by the current administration. At present, the Obama administration is working on the following to improve railroad infrastructure: (1) $8 billion in the economic-recovery act has been reserved to improve passenger railroads, which benefits the freight railroads as they own most of the lines used by commuter-rail operators; (2) $1.5 billion of stimulus is expected to finance new rail projects that are expected to reduce congestion; and (3) Obama has stated that he wants to establish a national infrastructure bank to provide financing for projects like rail improvements. Furthermore, railroads are expected to benefit from the government’s increased focus on climate change. A recent government study reported that trains are nearly 5.5 times more fuel-efficient than trucks when carrying goods. Finally, observers believe Buffett can improve the railroads’ influence in Washington, D.C. due his relationships and the respect many have for him.

FHA Digging Out After Loans Sour – The Wall Street Journal

Summary: From late 2007 into early 2008, thousands of marginal-credit borrowers were able to refinance their mortgages through the government-insured Federal Housing Administration (”FHA”). The FHA was expected to fill the gap in the mortgage market created by the exit of many private lenders. Nevertheless, the agency now projects default rates of 24% and 20% for those loans insured in 2007 and 2008, respectively. Furthermore, the FHA’s annual audit, which will be release during November, will indicate that the FHA may need taxpayer support as the value of the agency’s reserves is below the federally mandated level. Yet, the FHA maintains that is has enough capital to withstand the losses. Currently, the FHA is guaranteeing approximately half of all home-purchase loans in the worst housing markets, which may make the agency vulnerable if home prices begin to decline again.

CB: The FHA’s situation described above illustrates one of the many weaknesses in the current economic recovery. The government is trying with all its resources to support housing prices and sales. If it fails to support the home prices and sales, then values around the nation will have a high probability of declining thus causing more defaults. This recovery is fragile. A few wrong maneuvers and the consequences are felt throughout the system. This fact alone would not give CB much confidence in any projections based on economic assumptions at this time. Furthermore, not included in the article is the fact that the projected default rates probably represent a base or average case scenario. The public is not provided with the range of default rates representing various economic scenarios that were used to establish the rates reported in the article.

In October, Signs of Life at Retailers – The New York Times

Summary: As major retail categories witnessed sales growth, October was the best month for American retailers since last fall. Yet, the October sales numbers are being compared to the terrible sales figures from last year. As one expert stated, the industry’s sales are better than last year but worse than two years ago. According to the MasterCard Advisors report released on Tuesday, retailers were able to drive sales in October without deep margin-eroding discounts. Furthermore, there appears to be more stabilization in the California market, which was one of the hardest hit. Bill Dreher of Deutsche Bank Securities believes that predictions of flat-to-down Christmas sales are incorrect, in fact, he expects sales to rise 1% to 2% for the holiday season. According to the Master Card Advisors report, the results for the various sectors were as follows: (1) apparel sales increased 3.4% from last year, (2) luxury goods increased 6.5% from last year; (3) jewelry increased 7.2% from last year; and (4) department store sales dropped 1.5% from last year. Meanwhile, E-commerce increased 18.7% primarily driven strong sales of small, low-priced goods.

CB: The data tells part of the story. The categories mentioned in the article are only a small sampling of total retail and actually raise more questions. For instance, what drove the department store sales to drop? More important, why is the U.S. witnessing these increases in sales? Given the current economic environment with unemployment and the tightening of consumer credit, one would not expect these increases. Was last year’s spending freeze so bad that it represented a decrease in spending that would occur in much worst times than those currently being experienced? Are consumers not adjusting to the current economic situation? Or are these consumers shifting their spending to retail items by forgoing other larger purchases? Regarding the holiday season, it is hard to tell what will happen without some insight to the questions just listed. The projections that expect increases this year will be constrained by (1) fewer retailers than in previous years as well as (2) the limited inventory the retailers have decided to stock for the holiday season.

Johnson & Johnson Plans Cuts – The New York Times

Summary: On Tuesday, Johnson & Johnson stated that it will eliminated between 7,000 to 8,200 jobs throughout. With consolidation and legislation uncertainties combining with the general declining economy, companies throughout the drug industry are feeling pressure on their operational health. Many of these companies are responding to the pressure through cutting of staff in research and development, manufacturing, and marketing operations. Consequently, less people are being asked to handle additional responsibility.

Gold hits Record High on India Purchase – Financial Times

Summary: With India’s central bank purchasing 200 tonnes of gold on Tuesday, gold prices surged to an all-time high. India’s finance minister stated that the bank was swapping cash for gold as he believes the economies of the U.S. and Europe had collapsed. Market participants believe this is a strong signal that the Asian economies could be moving away from the U.S. dollar.

More Links of Note

The Mystery of the Rising Stock Market – Slate

John Paulson Once had Self-Doubts – Dealbreaker

Burlington… not so Buffett-Like – Rolfe Winkler

James Chanos: 10 Lessons From the Financial Crisis

6 Reasons Credit Suisse Sees the S&P at 1150 – PragCap

Sphere: Related Content

Filed under Finance News · Tagged with BNI, Buffett, Defaults, FHA, Gold, India, Johnson & Johnson, Loans, Obama, Rail, Railroads, Retail, Trucking