Business services provider Cintas (CTAS) has experienced decent appreciation in their stock over the past month, essentially the up-trend started soon after they lowered guidance for the second half of their fiscal year.  As a provider of uniforms and other related business services products like fire safety equipment that help other businesses operate more smoothly, the recession and its effect on employment has been rough on Cintas.  However, since they revised guidance downward, management has said they are heartened by the slowing in job losses and can perceive a general improvement in the economy.  Apparently, the market agrees with this outlook as the stock has moved steadily higher by about 18% in just over a month.

The last quarterly results came in above the more conservative guidance, as EPS came in at $.32 and beat consensus analysts’ estimates of $.30.  Sales fell 5.2% to about $862 million, but topped Wall Street’s view of $854 million.  The market’s reaction has been a muted 1% rise, as these results would have fallen short of expectations before the downward guidance.  For the quarter ahead, management left the EPS outlook unchanged at $.30 to $.34.  Cintas is currently trading at just over 18x trailing twelve month earnings, but only 15x 1-year forward earnings per share.  Clearly, some improvement to the employment situation is baked into the forward looking estimates.

As you can see from our valuation history chart, we have rated CTAS as Undervalued for the last few years and we are reiterating that rating this week.  Given the current fundamentals, Cintas trades for about 10.1x price-to-cash earnings, while CTAS has normally traded for 11.8x to 17.1x cash earnings per share over the last ten years.  Better operating performance has enabled the company to maintain strong cash flow even while sales are down.  Furthermore, the historically normal range of price-to-sales is about 1.56x to 2.23x, but the metric for this fiscal year’s sales is well below that range at just 1.2x.  Based on the market’s historically normal valuation ranges, we think it is reasonable to believe the stock may be able to attain $32 per share before we would consider a downgrade to fairly valued.

We think that jobs will begin to return to the US economy in the next few months, but they will not soon recover to pre-recession levels.  That being said, Cintas may not be the most attractive stock in this environment, but we think it does have decent underlying value, and if the job recovery surprises to the upside CTAS would be a clear beneficiary of that trend. 

On Thursday, Palm Inc (PALM) reported results for the quarter that ended in February that were quite a disappointment to the market and one analyst in particular.  Excluding one-time charges the mobile handset maker lost $102.8 mln or $.61 cents per share, which was much wider than the $.42 cents expected by Wall Street.  The company reported unit shipments increased to 960,000, but sales did not follow through, selling only 408,000 units.  Net shipments drove revenue to come in at $350 mln, much better than Palm’s own guided range of $285 mln to $310 mln.  Clearly, this situation creates an excess inventory issue, especially in an environment where sales dropped 29% from the past quarter.  These inventory concerns have caused quite a few analysts to lower sales expectation for the next quarter.

The last quarter showed that Palm has fallen further behind the likes of RIM’s Blackberry or Apple’s iPhone in market share, and with strong emerging competition from Motorola and Google to name a few, the outlook appears fairly bleak.  The fact that Palm lacks a defining strength of the others is one serious cause for concern.  With 8.7 mln iPhones sold in the last quarter alone, Apple (AAPL) has a firm grip on the consumer market, and Blackberry (RIMM) continues to be the dominant player in enterprise market.  Motorola (MOT) has struggled over the last few years, but has a very wide range of handset products available and is making a strong push into smartphones.  And well, Google (GOOG) is Google, and the Nexus One is simply a cog in their massive operation.  Palm has a critically acclaimed WebOS and interface that it can hang its hat on, but the sales have been lackluster and are tailing off rapidly.

The analysts at Canaccord Adams have heard enough and actually lowered their price target on Palm from $4 to $0, and clearly have a Sell rating on shares.  In a note, technology analyst Peter Misek supported his bearish case,

“We believe Palm’s troubles will only accelerate as carriers and suppliers increasingly question the company’s solvency and withdraw their support…With what appears to be roughly 12 months of cash on hand, an accelerating burn rate, a complete lack of earnings visibility, and substantial debt and preferred equity, we no longer see any value in the company’s common equity.”

At Ockham, we have not been high on Palm for sometime either, and we were taken aback by the stock’s meteoric rise without strong fundamentals at all.  The stock became a darling of Wall Street on the hope that it had the next iPhone, or better yet, the perfect mix of business and pleasure in a smartphone.  The stock was a momentum play, pure and simple.  Sales have shown that the demand has not matched expectations, and we recently downgraded Palm to Overvalued from Fairly Valued a few weeks ago.  The stock is down 31% since our downgrade, but 27% of that has come today following the weak earnings and analyst reactions.  We are not as dire as Canaccord in our analysis or Palm though, because at some point we think the intellectual property may become attractive to another mobile phone company.  However, we would not be surprised if Palm continues lower before any potential buyers begin to show interest, especially as sales and earnings remain weak and the burn rate accelerates.

“There has been a lot of buzz lately that GameStop might be acquired…It reported results that blew away street estimates.” — Bloomberg TV’s In The Loop 3/18/2010

Readers of this blog by now have probably heard us beat the drum about GameStop (GME) being an extremely attractively valued stock, and today we feel somewhat vindicated and will continue to beat that drum following an impressive fiscal fourth quarter report.  The last year has been a difficult one for the video game industry, and as the world’s largest video game retailer, GameStop has clearly fallen out of favor with the market.  Same store sales dropped nearly 8% as spending on consoles was especially weak. 

Critics argue that GameStop will go the way of Blockbuster (BBI), which is teetering on the verge of bankruptcy, because video game sales will increasingly go digital.  The theory goes that bricks and mortar will be an anchor on results and it is only a matter of time.  However, as we see it, there is one extremely important difference between GameStop and Blockbuster: profit.

Recall, if you will, Blockbuster has not turned an annual profit in six long years, and the losses have widened for the last 4.  Even when Blockubster was in its heyday around the turn of the millennium, profits were hard to come by, which doesn’t speak well of management.  In contrast, GameStop reported a fiscal fourth quarter 2010 (ended Jan.) net income of $215.9 million or $1.29 per share, which is better than Wall Street estimates of $1.27 per share.  That means for the year the company earned $2.28 per share, so even after today’s 9% rally the stock trades for 9.5x trailing twelve month earnings.  The midpoint of 2011 EPS guidance comes in at $2.63, which is 15% growth in the next year.  Overall sales grew by 3.1% over the past year, which hardly warrants the catastrophic tone that some have taken towards the video game industry.  Management said they expect a decent rebound in sales growth next year, calling for growth of 4% to 6%.  The midpoint of the guided sales range would equate to $9.53 billion or $150 mln better than consensus analysts’ estimates.

Are the headwinds for GameStop? Of course.  The threat of aforementioned mentioned digital distribution may cut out distributors like GameStop completely, as game developers may connect directly to consumers.  There is growing competition particularly in used game sales from some of retail’s heaviest hitters like Walmart (WMT) and Amazon (AMZN), but as of yet GameStop has effectively managed to maintain and even grow profits in the face of competition.  At least up to this point, gamers like the feeling of physically holding a highly anticipated game purchase and GameStop instantly gives this to them while Amazon and Walmart do not. 

Will a service like Gamefly pester GameStop like Netflix (NFLX) has Blockbuster?  This one is doubtful, in my opinion; games are different from movies in that they are used repeatedly rather than a single use at a time.  One great thing about Netflix is sending a just-viewed movie back in order to get another one that you have been waiting to see.  Gamers however invest time in the game, and while Gamefly will attract some serious gamers looking to test out games for their next purchase, we think it has less appeal for the average gamer and have less of an effect on GME.

By looking at historically normal valuations, it is clear that the market has priced in a substantial amount of downside has been priced into GameStop already.  For example, GME’s price-to-cash earnings of 5.7x is well below the historically normal range of 8.3x to 19.1x.  Furthermore, price-to-sales over the last ten years has historically ranged between .46x to 1.08x, but the current multiple is .37x with sales expected rise in the year ahead.  We currently have an Undervalued rating on GME, and based on the market’s normal valuation of this stock, we think it could trade in the high-$20 without any concern over valuation give current fundamentals.

So, with strengthening fundamentals and an extremely strong balance sheet, we believe long term investors have not missed the up-trend in GameStop after today’s nice bump.  Management has delivered consistent performance and the underlying fundamentals will eventually be recognized by the market.  With the current valuation, it is no surprise to that there have been rumors in the past week of a potential private equity acquisition looming around this company.

Temple-Inland, Inc. (TIN), which makes paper, packaging and building products, was put on credit rating watch with a positive outlook by Standard & Poor’s.  The stock is up nearly 10% on the news Wednesday and it is also giving a boost to some of Temple-Inland’s competitors’ stocks.  S&P credits the company will reducing its debt load by $440 million over the last year, and said that if it can continue with its debt reduction plans it would be eligible for a credit upgrade to “BBB”.  While their efforts to reduce debt should be commended, it is a bit surprising that this announcement would be met with such enthusiasm by the market.

Temple-Inland was able to shave its debt in an environment that was certainly not hospitable to an important business segment, building products such as lumber and particle board.  Clearly, this segment is heavily correlated to the strength of US housing starts, which have been at extremely low levels over the past two years.  The company was able to utilize $175 million in alternative-fuels tax credits as well as $335 million in free cash flow in fiscal 2009, and rolled the majority of that into cutting down its debt.  What makes this especially impressive is that the company devoted these resources even though they did not have any significant amount of debt maturing until 2012.  It is clear that there were not a lot of great opportunities for TIN to invest in growth over the last year, so they were content to bide their time and strengthen their balance sheet.  This may not be the sexiest strategy for investors, but it should give them greater flexibility to pursue growth as better opportunities present themselves in the years ahead.

The company’s strong and disciplined execution over the last year as well as stabilization in economic conditions has allowed the stock to return over 400% over the last 52-weeks.  However, even after its impressive run, we are not yet concerned over its current valuation.  Aggressive cost cutting should make a quick rebound in profitability possible once housing starts do begin to pick up.  Its corrugated packaging business segment is somewhat more stabile, but it is still subject to commodity (lumber) price fluctuations which weigh heavily on margins.  An improvement in economic activity would increase the demand for Temple-Inland’s packaging products and would prove to benefit the bottom-line.

Both price-to-cash earnings and price-to-sales are currently well within their historically normal ranges, so as of yet, no red flags there.  Based on the current fundamentals, we see a price range of $18 to $26 as a reasonable to expect over the coming year, barring considerable further weakening housing environment or a double-dip hampering the US economy.  Temple-Inland has done a good job managing costs and lowering debt in a difficult environment, but after today’s appreciation the stock remains Fairly Valued.  There are certainly more attractive stocks available for value investors, but it is good to see a company getting credit for strong, conservative management in a tough market environment.

“WellPoint reaffirmed their 2010 guidance, but please note that excludes any kind of health care reform. If we get a big health care package, that would change the guidance.” — CNBC’s Squawk on the Street 3/17/2010

Healthcare investors and investors in general must pay attention to the daily news flow out of Washington because the outcome of ongoing healthcare reform will have a substantial impact on a sizable portion of the US economy.  On this blog, we aim to remove politics from the discussion and rather focus on financial matters, but in the case of healthcare the two are undeniably linked.  No sector will be more impacted by healthcare reform than insurance plan providers such as WellPoint, United Healthcare, and Aetna.

Today, one such HMO provider, WellPoint (WLP), reaffirmed its fiscal 2010 guidance, which shows fundamentally speaking the stock looks quite cheap compared to historical norms.  They expect earnings per share to come in above $6, as share repurchases will neutralize what is expected to be an 11% decline in net income.  America’s largest managed-care company by membership also forecast revenue of $59 billion which tops the consensus of Wall Street analysts’ estimates of $58.2 billion, but it does fall short of the $60.8 billion in sales last year.  A sluggish labor market is cause of a major headwind for the company, and they see a loss of around 400,000 members through the rest of the year.

As HMO’s come under fire from politicians, WellPoint anticipates raising the percentage of premiums to pay member medical costs this year to 84.3%, an increase of 1.7% over last year.  They anticipate medical costs may escalate by up to 8% this year, which will make raising premiums all but a necessity despite the political environment.  Obviously, there are very significant headwinds facing the company, even without the prospect of a healthcare overhaul.  So, it is no surprise that the uncertainty weighing on these stocks will cause a depressed valuation, but according to our methodology WLP has the most depressed valuation of the entire group.  The stock currently trades at a price-to-sales multiple of .46x, which is well below the historically normal range of .61x to .98x.  Similarly, on a price-to-cash earnings basis, WLP has normally traded for 12.1x to 19.7x, but at the current valuation the market only trades at just over 8x cash earnings.

According to our methodology, this stock could be a major benefactor should healthcare reform derail, and under normal circumstances this stock as well as many in the Health Insurance industry would be considered Undervalued.  However, betting on or against the political will in Washington is far more akin to speculation than it is to a sound long term investing strategy.  Make no mistake, there is a reason that these HMO stocks are valued the way they are, but if you think reform will not pass and can stomach the risks, WLP may be the best way to play it.