Abandon All Hope

By Dr. Duru written for One-Twenty

February 7, 2008

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"Abandon all hope all ye who enter this house..." This is the phrase that came to mind when I read the simple warning from Toll Brothers's (TOL) earning report yesterday: "Robert I. Toll, chairman and chief executive officer, stated: 'The housing market remains very weak in most areas. Based on current traffic and deposits, we are not yet seeing much light at the end of the tunnel.'" Apparently, there is good reason for this despair. I believe this is TOL's seventh consecutive quarter of revenue declines. It is amazing to see such large double-digit declines almost three years into the deflation of the housing bubble: "Gross signed contracts for FY 2008ís first quarter of approximately $573.2 million and 904 homes declined 46% and 38%, respectively, versus FY 2007ís same period totals of $1.07 billion and 1,463 homes." The steady decline in sentiment and increase in despair amongst the homebuilder executives have matched the steady decline in their stocks. I think there must be some analogy here to the five stages of mourning or grief: denial (what bubble? Our business remains strong and we see no headwinds ahead), anger (the market continues to undervalue our stock), bargaining (if only consumer psychology would improve, business would be fine. And the Fed needs to cut rates back to 1% too), depression (see Toll above!), and acceptance (we probably witnessed this stage BEFORE depression).

I noted earlier that homebuilder stocks have been top performers for 2008. The ETF for the homebuilders, XHB, finally broke a portracted downtrend. I also stated that the behavior of these stocks on the next pullback would determine whether it is "safe" to start nibbling. Well, the market has sold the homebuilder stocks on bad news; that is no good. But the XHB is maintaining its breakout. The first real test will be around the 50 DMA where the XHB would equal $19 - only a 5% decline from current levels. Regardless of what happens, I still think shorts should be looking to lock in profits here unless they are really convinced they have identified the homebuilders that are headed to bankruptcy. Besides, there are so many former high-flying growth stocks that are imploding which should provide much juicier targets.

Speaking of which...Google (GOOG) is now back to the $500 level. Hopefully, you took my pre-earnings warning seriously. Baidu.com (BIDU) is headed for $200 - still amost twice where it was in 2007, but it has clearly broken down below the 200 DMA (I finally read in the Wall Street Journal a description of how BIDU makes its money - the bggest attraction seems to be the facillitation of illegal music downloads!). Cisco (CSCO) is trading below $21 in the pre-market after disappointing investors with "only" a 10% revenue growth forecast. If CSCO closes at $21, it will be down 23% from the beginning of 2007. CSCO is yet another example of why I am skeptical of any stock that has not yet priced in recession. Going into earnings, all I kept hearing about CSCO was how great the growth story is, how CSCO must be good since Juniper Networks (JNPR) reported good numbers (nevermind that the stock is down since those earnings), how CSCO's business should be fine since it is much more reliant on its global business, etc... This is the chatter of sentiment that has not yet accepted the likely impact of an economic slowdown. Sure CSCO is cheap, but as TraderMike always reminds me, "the cheap often get cheaper." And notice, CSCO is not selling off because its business is contracting, it just is not growing as fast as it once was or as fast as expected. Similarly, the economy does not need to go into recession for the stock market to enter and remain in a bear market. All it takes is a significant slowdown. And slowdown is where we are now.

This morning, Citigroup provided the kind of commentary I want to see before even considering buying a growth stock in this environment. From briefing.com: "Citigroup discusses their recession scenario analysis, saying RIMM faces double-barreled risk: high North American exposure combined with a high P/E multiple. They think in a worst-case, global recession, RIMM likely has downside to $63; in a more decoupled macro environment (US-only recession) they think the downside is to $75..." RIMM may never get to these prices. Who knows, right? (Duly note that RIMM is STILL double 2007 prices and trades at a forward P/E of 25. With a PEG ratio of 0.99, we know that growth expectations remain robust). But at least you finally know that negative sentiment may soon get priced in.

I leave you with notes from the conference call for rental car company Dollar Thrifty (DTG). The stock dropped an ugly 37% in one day after reporting awful earnings. It seems everything but the kitchen sink hit this company. I have often wondered why car rental companies are even publicly traded. Renting cars is NOT a growth industry. Margins are low and competition is fierce. To wit, Hertz (HTZ) is now below it's IPO opening day price in 2007. Avis Budget (CAR) has hit 10-year lows and should hit 15-year lows in no time. DTG is back to 5-year lows after a almost doubling in about 2 years. Anyway, the quote below says a lot. I took particular interest in it because this is one of the rare times you see a company suspend a stock repurhcase program. Clearly, management had no clue just how bad things could get for the business and now it is signalling that things will likely get even worse. Be careful out there!

From briefing.com:
DTG Dollar Thrifty lowers FY07 EPS below consensus; sees 2008 EPS below consensus; co suspended repurchasing shares under its share repurchase program.
Co lowers FY07 Non-GAAP EPS to $1.22-1.27, excluding $0.32 charge, vs. $1.82 consensus, down from $1.75-1.85. Co issues downside guidance; co sees FY08 Non-GAAP EPS of $1.00-1.50 vs $1.82 consensus. Co notes that FY08 results include an increase in both revenue per day and rental day volume of ~2%. Co says, "During Q4, the Co experienced a number of items that were not included in the Co's previous guidance range of $1.75-1.85... In Q4 we experienced progressively weaker industry demand in the travel market, excess fleet capacity in the industry, and a weakening used car market. The demand over the Thanksgiving and Christmas holidays was much weaker than we had originally expected. Lower than expected revenue drivers including a decline in consumer demand and lower revenue per day impacted Q4 results by $0.40-0.45 per diluted share versus previous guidance." Lower fleet utilization and higher fleet costs due to lower consumer demand and the disruption caused by the disorderly delivery of vehicles into December by our primary fleet supplier impacted financial results by ~$0.15 per diluted share. This is in addition to the $0.15 per diluted share impact previously disclosed related to vehicle shipping disruptions in the September / October time frame. The Co experienced increased vehicle depreciation expense through greater vehicle disposal losses related to the weaker used car market of ~$0.10 per diluted share. The Co also encountered similar challenging conditions in Canada including weak used car sales, soft consumer demand and weak pricing. These issues impacted Q4 results by ~$0.25 per diluted share versus original expectations. Canadian results have a greater impact on EPS as the Co does not record an income tax benefit from these losses. The Co has implemented plans for restructuring Canadian operations which include cost cutting measures and is considering other alternatives as well in an effort to improve operating results. Due to weaker economic and industry conditions, the Co suspended repurchasing shares under its share repurchase program. The Co spent $11.4 mln repurchasing shares in Q4."

© DR. DURU®, 2008