BEN GIVES INVESTORS A HALLMARK MOMENT / BARRON´S MAGAZINE ( A MUST READ )

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The Trader

SATURDAY, AUGUST 25, 2012

Ben Gives Investors a Hallmark Moment

By VITO J. RACANELLI

The Fed chief's letter raises hopes of easing, and the market takes immediate solace. But the dependency is a little troubling.

 

Sometimes, all it takes is a nice card to make investors feel better. It just has to come from Federal Reserve Chairman Ben Bernanke.



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Though the stock market fell last week, a respectable recovery Friday pared the weekly loss to 0.5% from a 1% drop at one point Thursday. The bounce came right after published reports Friday of a Bernanke missive to Congressman Darrell Issa, a California Republican, that said there's scope for the central bank to ease financial conditions and strengthen the recovery.

"Many economists believe that the Fed can't do a whole lot more," says John Manley, chief equity strategist at Wells Fargo Funds. "But the letter gives Wall Street a little more hope that he will do it and that it might have some impact."




The Dow Jones Industrial average lost 0.88%, or 117 points, on the week, to finish at 13,157.97, and the Standard & Poor's 500 fell 0.5%, or seven points, to 1411.13. The broad market index wasn't able to close above the 2012 high of 1419.04, though it rose above it intraday on Tuesday. The Nasdaq Composite gave up seven points, or 0.22%, to 3069.79, and the Russell 2000 small-cap index dropped 1.3% to 809.19.




The Dow's drop was mainly due to Hewlett-Packard (ticker: HPQ), the worst performer in the average last week. HP saw its stock fall 10% to $17.58. On Thursday the company reported a 5% drop in fiscal third-quarter revenue to $29.7 billion, below expectations. It posted a loss of $4.49 per share and lowered guidance for fiscal 2012 earnings.





Among last week's economic data, home-sales news continued to be positive, but jobless benefit claims rose unexpectedly, and the August HSBC Flash Chinese purchasing managers index fell.




The Bernanke watch continues this week, but the focus will move from the written word to the spoken word. The Fed chairman will give an important address at the annual Kansas City Fed conference this Friday, held in Jackson Hole, Wyo.




Wells Fargo's Manley says that "to the degree Bernanke can keep the waters fairly calm, it's a good thing but I'm a little perturbed about the market's fixation on [Fed] monetary policy. It's putting a lot in the Bernanke basket."




The Fed seemed to play ping pong with investors last week, notes one trader. On Thursday, the market turned down almost exactly on comments from St. Louis Fed President James Bullard. Bullard pointed out that U.S. economic data have been somewhat better since the July 31-Aug. 1 Fed meeting; his comments tempered expectations of Fed action.




From a technical point of view, many market participants will be closely watching for a battle at about the 1420 level—just above the 2012 high—on the S&P 500 over the next few weeks, says Jeff Saut, chief investment strategist at Raymond James Financial. Should the market decisively move through the old high, it could be "the tipping point" upward, he says. This is a hated rally and a lot of institutions are not participating, he adds.

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Concerns about lock-up expirations have hit several Internet stocks like Facebook (FB), Groupon (GRPN), and Zynga (ZNGA) over the past few weeks. So this week, keep an eye on trading in Yelp (YELP), the local-listings and online-rating Website.




On Wed., Aug. 29, the lock-up expires on 52.7 million in class B Yelp common shares, according to SEC filings. That's about 87% of shares outstanding. According to financial-information provider Markit, Yelp is the most shorted Website stock, with about 30% of the current 8.2 million share float sold short.




Earlier this month, the company reported a narrower-than-expected second quarter loss and raised its full-year revenue outlook. The stock has slid to $19.48 from a high of $26 following the report.





UNLIKE CRUDE-OIL PRICES, the price of natural gas—which is not as easy to transport—has heretofore been set locally. So disparities like this are common: Gas in North America, where we are awash with new shale discoveries, can be had for $2.80 per million British Thermal Units, not much above the decade lows. In Europe, however, prices are as much as four times higher and in Asia, six times more.




Natural gas has growing appeal. It's a cleaner-burning hydrocarbon, and the world's demand for energy soldiers on. Around the globe, there are a number of liquefied natural gas (LNG) facilities in the works that will help bring gas from places where it's cheap to places where it's dear. These giant plants turn the gas into liquid form to make it easier to transport on ships, and then the LNG is returned to the gas state at another LNG plant at the point of importation.





Around the world, there are something like 25 to 35 such large projects in various stages of planning or construction, capable of generating about $200 billion in revenue, says James McAree, a co-portfolio manager of the Neuberger Berman Intrinsic Value Fund.

He's a fan of KBR (KBR), a mid-cap firm that specializes in energy and petrochemicals engineering and construction. It should be a big beneficiary of the expected build-out of LNG infrastructure around the world, the money manager says. KBR shares closed Friday at $27.05, down about 30% from 2012 highs of $38. The fund has a stake in KBR and has been adding lately.




LNG facilities are expensive to build, but the lucrative arbitrage between regions has folks planning more. Earlier this month, for example, Golden Pass Products, a joint venture between ExxonMobil (XOM) and Qatar Petroleum, asked federal authorities for permission to export U.S.-sourced LNG from a terminal in Texas. Cheniere Energy (LNG), which built an LNG importation plant in Louisiana years ago when North American gas was much more expensive, has spent a bunch of cash to make it capable of gas exportation.




KBR stock has dropped this year on some lumpy earnings and an expected decline in its once-important logistics business, mostly with the U.S. Defense Department. In the first half, for example, total revenue fell to $4.1 billion from $4.8 billion, and earnings decreased to $195 million, or $1.31 per share, from $205 million, or $1.35. The company is winding down a logistics contract, called Logcap, with the Army that generates single-digit margins, as armed forces are removed from Iraq.
The stock's drop on unimpressive first-half earnings and worry about the defense contracts could present an opportunity for long-term investors, however.




Lazard Capital Markets analyst Will Gabrielski upgraded his rating of the stock to Buy from Neutral on Aug. 13. Logcap has gone from 70% of revenue in 2006 to less than 10%, he points out. KBR's $15 billion backlog reflects much more its hydrocarbons businesses, like LNG construction.




Earnings visibility will improve next year, and a catalyst, he says, could come as early as the first quarter when KBR starts to recognize profits from its Ichthys LNG project in Australia. That should help 2013 operating margins top 10% from 9% this year. Another potential catalyst is the awarding of contracts, perhaps by the end of this year, for the Kitimat LNG export terminal in Canada, where KBR is expected to participate.






The drop in the stock makes KBR cheap, adds McAree. It trades at about 10 times consensus analysts' earnings estimates of $2.68 for this year. That compares with 13.5 times both for its historical median and its peer average. Analyst Gabrielski has a $35 per-share target for KBR, using a multiple of 12 on his 2013 profit estimate of $2.95.





KBR has other attractive attributes, such as a recently instituted 20 cents per share dividend, for a 0.7% yield. The Houston-based firm, spun off from Halliburton (HAL) in 2006, also sports a strong balance sheet and some $5 per share in cash.



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The caveat is that KBR's stock gyrates at times based on worries about global growth and the price of oil. Still, the growing popularity of LNG facilities looks like a meaningful secular improvement for KBR.






INVESTORS HOLDING STOCKS of companies with large pension-plan deficits can give a temporary sigh of relief. In effect, they've been handed a wad of cash by Congress and the Internal Revenue Service.




On Jan. 16, as year-end pension-plan reporting documents began to trickle out, this column sounded the alarm about some potentially large and risky pension deficits at several publicly traded firms.
But the cavalry has appeared. On Aug. 17, the IRS, as directed in the pension-funding relief law passed by Congress midsummer, published the new discount rates to be used beginning with the 2012 plan year. These rates are much higher and have the effect of shrinking the pension obligation on a present-value basis. That makes the plan appear healthier and in need of less funding.




The new rates are based on high-grade bond yields averaged over 25 years. Since yields were much higher long ago, the new discount rates are higher, too.




Depending on the firm and the size of its pension deficit, the higher discount rates have the potential, according to a recent Credit Suisse report, of turning a plan that was only 77% funded into one that's fully funded.





With this accounting legerdemain, the expected aggregate 2013 contributions from S&P 500 companies could drop about 90% to $8 billion from $78 billion. Companies in the industrial sector would save the most, Credit Suisse analyst David Zion says. It's based on the 2012 plan year so the savings will be felt in 2013, he adds.



All the companies Barron's singled out as having dangerously underfunded pension plans in that report—like AK Steel Holdings (AKS), ITT (ITT), Goodyear (GT), U.S. Steel (X), and Sears Holdings (SHLD), among others—have gotten the equivalent of a government reprieve.





Congress, however, is only kicking the can down the road. It's temporary relief because the underlying pension obligation hasn't changed at all, only the rate at which the company must fund it. That could be important for companies facing a liquidity crunch. Changes in the health of the pension plan can affect the sponsor's cash flows, balance sheet, and stock price. And smaller pension contributions also help the federal government, because these payments are tax deductible.




Yet reducing the funding requirements in the short term could result in larger required pension contributions and more pension risk long-term. Congress has given companies with big pension deficits some breathing room but pension holes must eventually be made whole.

 

 

Not Enough

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Despite a nice rebound Friday, the Dow fell almost 1% last week on a 10% drop in Hewlett-Packard shares. Kraft rose 3.4%.