Thursday, June 28, 2018

Does GE's Credit Rating Cut Matter?

It's never good news when a credit rating agency downgrades debt ratings for a company, so investors in General Electric Company (NYSE:GE)�didn't appear to have welcomed�Fitch's recent lowering of its rating on GE's debt to A from A+ the day it was announced. That said, does it really matter in the grand scheme of things? Let's take a look at the rationale for the ratings cut and whether it should concern for GE investors or not.

Fitch cuts GE's debt rating

Companies rely on debt in order to function (even if it's short-term financing for working capital needs), and a high rating tends to mean they pay less interest on that debt. So when a company's debt rating is cut by a credit rating agency, it implies bond investors will require higher rates in order to compensate them for the extra risk. Therefore, in the purest sense, Fitch's downgrade is a negative.

AC/DC converters

Power remains at the forefront of GE's problems. Image source: GE Energy Connections.

Moreover, the reasons behind the downgrade are obviously a concern. In a nutshell, Fitch's major worry is what it called "constrained" earnings and cash flow while GE deals with a number of issues due to a combination of factors:

An ongoing struggle dealing with its underperforming GE power business.� CEO John Flannery is restructuring the company through divestitures and cost-cutting. GE has a large pension deficit that it needs to fund in the future -- around $29 billion at the end of 2017.� A "weaker balance sheet at GE Capital" after the company took significant charges on GE capital businesses this year.� Don't we already know this?

Of course, these factors are already well known to the market. The problems at GE capital are known, as is the pension deficit and the restructuring plans. Moreover, the deterioration in the power segment outlook was also recently flagged by Flannery.

In case you are wondering why the power segment always attracts attention, it's because the aviation and healthcare segments are performing well, so the deciding factor in GE's earnings and cash flow performance (Fitch's major concern) will come from its power segment.

Of course, GE recently announced plans to separate the healthcare business. While this is good news from a liquidity perspective -- it will bring in cash as GE plans to monetize 20%�of the healthcare business and distribute the remaining 80% to GE shareholders -- exiting Healthcare will also reduce ongoing free cash flow generation and earnings. In addition, it means the power segment is even more important to GE's long-term prospects.�

Going back to the end of May at the Electrical Products Group (EPG) conference,�Flannery dialed back investors' expectations for the troubled power segment by claiming there would be "no quick fix" and that the end market for gas turbines (GE power's core product) would remain weak until at least 2020.�

In addition, at EPG Flannery said he aimed to get power segment margin back to above 10% (power margin was 5.6% in 2017) although he didn't give a specific time frame. This figure has now become one to watch for investors, as Fitch cited a failure to improve "segment margins in the Power business to around 10% by 2020" as a development that could lead to a negative rerating.

All told, Fitch's downgrade is pretty much a reaction to what GE has already told investors, and the credit rating agency's rationale for the rating cut shouldn't concern shareholders per se.

But the outlook should worry investors

On the other hand, it should be noted that Fitch's updated rating assumptions assume GE's free cash flow (FCF) after dividends will be around $2 billion in 2018 and will be "steady to slightly higher through the next one to two years with expectations for further improvement." Failure to reach the 2018 FCF target could lead to Fitch cutting its rating. �

Unfortunately, there are reasons to believe GE will struggle to hit Fitch's 2018 target. To put this into perspective, GE will likely pay out around $4.2 billion in dividends, so Fitch's assumption for GE's FCF is around $6.2 billion in 2018. That seems OK, after all Flannery reiterated GE's standing forecast for $6 billion to $7 billion in FCF in 2018.

But here's the thing -- or rather, the three things:

GE's EPS guidance for 2018 is $1.00-$1.07, but analyst consensus is for $0.94. GE has already lowered earnings expectations to the low end of the range so it's reasonable to assume FCF will come in at the low end of the range, too. Any further deterioration in the power segment is likely to lead to further guidance cuts for it and this will negatively impact FCF generation.

In other words, GE may well struggle to meet 2018 FCF assumptions (both its own and those of Fitch), and this could cause for another credit rating cut.

Investor Takeaway

Fitch's actions reflect the deterioration in the outlook at GE through 2018, and even though most of this is already known to the market, the credit agency's negative perspective still highlights the risk in the stock. There will surely be a time to buy GE shares at some point, but it's probably a good idea to wait until the power segment stabilizes, because only then can investors have full confidence in the company's earnings and cash flow outlook.

Monday, June 25, 2018

Boeing Grabs Another Big Widebody Order

In 2017, Boeing (NYSE:BA) saw a somewhat surprising uptick in order activity�after entering the year with modest expectations. The Boeing sales team is off to a great start in 2018, as well. By the end of May, the company had received 306 net orders for commercial jets�compared to 205 during the same period in 2017.

Recently, Boeing has been particularly successful in selling widebodies -- the larger dual-aisle aircraft that typically serve longer international routes. This is a market segment that Boeing had expected to remain weak until around 2020.

A 787-9 flying over a river

Widebody order activity has bounced back for Boeing this year. Image source: Boeing.

Last week, Boeing continued its impressive run of success in the widebody market. This time, it secured orders for 24 widebody freighters from package-delivery giant FedEx (NYSE:FDX).

Turning things around in the widebody market

Boeing currently builds four different widebody aircraft types: the four-engine 747 jumbo jet, the small 767 (mainly used as a freighter today), the large twin-engine 777, and the popular 787 Dreamliner. Across these four aircraft families, Boeing brought in more than 300 net firm orders in both 2013 and 2014, driven by new versions of the 777 and 787.

However, a combination of factors caused sales to slump after 2014. Boeing captured 180 net firm orders for widebodies in 2015 and just 118 in 2016. Sales started to pick up again in 2017, but widebody order activity remained quite low compared to the 2013-2014 boom years, with 167 net firm orders.

Boeing's widebody sales momentum has accelerated in 2018. In the first five months of the year, the company locked down 113 net firm widebody orders, including major deals with the likes of American Airlines, United Parcel Service, and Turkish Airlines. Considering that aircraft orders tend to be weighted toward the second half of the year, this puts Boeing on track for a spectacular performance in 2018.

FedEx orders up even more new planes

On Tuesday, Boeing announced an order for 24 widebody freighters from FedEx consisting of 12 767s and 12 777s. These aircraft will help FedEx replace older, less-efficient aircraft and accommodate future growth.

A rendering of a 767F and a 777F flying side-by-side in the FedEx livery

FedEx agreed to buy another 24 widebody freighters last week. Image source: Boeing.

FedEx already operates both of these aircraft types, with 57 767Fs and 34 777Fs in its fleet as of the end of May. Additionally, prior to placing this new order, FedEx already had another 70 Boeing widebody freighters scheduled for delivery in the coming years.

The additional 767s that FedEx ordered all will be delivered by May 2022. FedEx has become a big fan of the 767 over the past few years, so it's taking advantage of Boeing's decision to increase production of that aircraft type from 2.5 per month to three per month in 2020.

With the exception of two incremental 777s scheduled for delivery in fiscal 2021, all of the 777 freighters ordered last week will be delivered in fiscal 2023 and thereafter. Thus, the FedEx deal will have a limited impact on keeping the 777 line busy until production of the next-generation 777X ramps up. That said, Boeing and FedEx have routinely moved orders around in recent years. The two companies might strike a deal to accelerate some 777 deliveries, if needed.

More widebody orders could come soon

After Boeing adds the FedEx deal to its firm order book, it will have picked up 137 net firm orders in 2018 (assuming no further cancellations). That would already be more than it received in all of 2016.

Furthermore, Boeing is likely to win more widebody orders next month at the Farnborough Airshow, the largest industry trade show of the year. It already has some sizable commitments that could soon be converted into firm orders, including a deal for 40 787-10s with Emirates and a commitment for 10 787-9s from Hawaiian Holdings.

Several other airlines are mulling 787 Dreamliner orders, as well. That includes major customers such as United Continental and British Airways parent International Airlines Group, along with Saudi discount airline flynas.

Considering all of these potential deals -- plus others that may not have been reported -- Boeing could conceivably have around 250 net widebody orders for the year by the end of July. This surge in orders should give investors confidence that Boeing will be able to stick to its current production plans and continue to grow free cash flow over the next five years and beyond.

Sunday, June 24, 2018

Saudi Women Driving Is Better for Economy Than Aramco IPO

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Allowing Saudi women to drive could help the kingdom reap as much income as selling shares in Saudi Aramco.

The move, which went into effect on Sunday, could add as much as $90 billion to economic output by 2030, with the benefits extending beyond that date, according to Bloomberg Economics. Selling as much as 5 percent stake in Saudi Arabian Oil Co. -- at the most optimistic valuation -- could generate about $100 billion.

Saudi Arabia ended its status as the last country on earth to prohibit women from taking to the wheel. A handful of women drove through the still-packed streets of the capital early Sunday while others drove in convoys around Riyadh neighborhoods in celebration of the ban’s end. The decision would enable women to work without having to incur the cost of a driver or taxis.

“Lifting the ban on driving is likely to increase the number of women seeking jobs, boosting the size of the workforce and lifting overall incomes and output,” according to Ziad Daoud, Dubai-based chief Middle East economist for Bloomberg Economics.

“But it’ll take time before these gains are realized as the economy adapts to absorbing growing number of women seeking work.”

Read More: Midnight Cheers and Disbelief as Saudis End Ban on Women Driving

Ending the ban is one of the most socially-consequential reforms implemented by Saudi Arabia’s Crown Prince Mohammed bin Salman. It’s also a key part of his plan to veer the economy from its reliance on oil.

What Our Economists Say:“The participation of women in Saudi Arabia’s labor market is poor. With only 20% of females in Saudi Arabia economically active, the country even lags behind its neighbors in the Gulf, where participation averaged 42% in 2016. Recognizing this, the Saudi administration made raising the female participation rate one of its main targets in the National Vision 2030 program, designed to modernize Saudi society.”

Ziad Daoud, Bloomberg Economics. Full report here  

Read More: Why Some Saudi Women Will Keep Their Driving Licenses a Secret

Adding 1 percentage point to the Saudi participation rate every year might add about 70,000 more women a year to the labor market, according to Daoud. The larger participation of women will lift potential economic growth by as much as 0.9 percentage points a year, “depending on the proportion that chooses to work full or part-time,” he said.

Saturday, June 16, 2018

Comparing Cars.com (CARS) & Sphere 3D (ANY)

Cars.com (NYSE: CARS) and Sphere 3D (NASDAQ:ANY) are both retail/wholesale companies, but which is the better business? We will contrast the two businesses based on the strength of their valuation, dividends, analyst recommendations, risk, institutional ownership, profitability and earnings.

Analyst Recommendations

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This is a breakdown of recent ratings for Cars.com and Sphere 3D, as provided by MarketBeat.com.

Sell Ratings Hold Ratings Buy Ratings Strong Buy Ratings Rating Score
Cars.com 0 2 3 0 2.60
Sphere 3D 0 0 0 0 N/A

Cars.com currently has a consensus target price of $34.38, indicating a potential upside of 16.05%. Given Cars.com’s higher possible upside, equities research analysts clearly believe Cars.com is more favorable than Sphere 3D.

Profitability

This table compares Cars.com and Sphere 3D’s net margins, return on equity and return on assets.

Net Margins Return on Equity Return on Assets
Cars.com 31.35% 9.11% 5.63%
Sphere 3D -31.80% -84.04% -11.62%

Earnings & Valuation

This table compares Cars.com and Sphere 3D’s revenue, earnings per share and valuation.

Gross Revenue Price/Sales Ratio Net Income Earnings Per Share Price/Earnings Ratio
Cars.com $626.26 million 3.40 $224.44 million $2.28 12.99
Sphere 3D $81.52 million 0.09 -$26.18 million N/A N/A

Cars.com has higher revenue and earnings than Sphere 3D.

Institutional and Insider Ownership

6.6% of Sphere 3D shares are held by institutional investors. 0.0% of Cars.com shares are held by insiders. Comparatively, 1.1% of Sphere 3D shares are held by insiders. Strong institutional ownership is an indication that large money managers, endowments and hedge funds believe a company is poised for long-term growth.

Summary

Cars.com beats Sphere 3D on 8 of the 10 factors compared between the two stocks.

About Cars.com

Cars.com Inc., through its subsidiaries, operates as a digital automotive marketplace that connects local car dealers to consumers in the United States. The company offers a suite of digital solutions that creates connections between individuals researching cars or looking to purchase a car with car dealerships and automotive original equipment manufacturers. It also sells online subscription advertising products to car dealerships by its direct sales force, as well as through its affiliate sales channel. In addition, the company sells display advertising to national advertisers. Further, it offers online automotive marketplace service that connects buyers and sellers through Cars.com, Auto.com, DealerRater.com, NewCars.com, PickupTrucks.com, DealerInspire.com, and LaunchDigitalMarketing.com Websites. Its platform hosts approximately 4.9 million new and used vehicle listings and serves approximately 20,000 franchise and independent car dealers. Cars.com Inc. was founded in 1998 and is headquartered in Chicago, Illinois.

About Sphere 3D

Sphere 3D Corp. provides data management, and desktop and application virtualization solutions in the Americas, Europe, the Middle East, Africa, and the Asia Pacific. It enables organizations to deploy a combination of public, private, or hybrid cloud strategies through containerized applications, virtual desktops, virtual storage, and physical hyper-converged platforms. The company offers RDX removable disk systems that provide scalability, centralized management, encryption and duplication, and reliability for backup, archive, data interchange, and disaster recovery; G-Series Appliance and G-Series Cloud applications; and Glassware Open Virtual Appliance and Open Virtual Format products. It also provides HVE converged and hyper-converged Infrastructure solutions, such as HVE-STACK high density server solution; HVE-VELOCITY high availability dual enclosure storage area network solution; and HVE 3DGFX, a virtualized desktop infrastructure solution. In addition, the company offers SnapServer network attached storage solution, a platform for primary or nearline storage for integration with Windows, UNIX/Linux, and Macintosh environments; NEO tape-based backup and long-term archive solutions, including tape libraries, autoloaders, and drives, as well as linear tape file system solutions; and LTO tape drives and media products. Sphere 3D Corp. markets its products under the RDX, Glassware 2.0, SnapCLOUD, SnapServer, SnapSync, NEO, and V3 brand names. The company sells its products through its distributor and reseller network to small and medium businesses, and distributed enterprises. Sphere 3D Corp. is headquartered in Mississauga, Canada.