Tachibana Eletech, Pfizer and IEH Corp Report Solid Earnings

Earnings season is in full swing. And my holdings are doing well.

Tachibana Eletech (TSE:8159), a small cap factory automation company reported a great start with 1Q 2013. The company reported EPS of 34 yen, a 60% increase yoy. Revenue increased 10% yoy. I presume that the yen's recent drop contributed to the company's results. Management projects 134.75 yen EPS for the year. Which translates to a PE of 7x! In addition, this is a netnet company (see previous post).

The only disappointment with the company is the paltry 20 yen annual dividend (2% dividend yield).

Pfizer reported Q2 adjusted EPS of $0.56. This adjusted EPS leaves out special items such as the Zoetis share sale. For the year, the company projects adjusted EPS of $2.10 - $2.20 and actual EPS $3.07 - $3.22. This is all not surprising. With shares trading at around $30, Pfizer has a healthy P/E in the low teens (adjusted earnings). Recently, I have sold some shares in my tax-sheltered account. But, I'll leave the rest alone. Pfizer is one of those solid stocks in a great industry that you can just leave alone without worry.

IEH Corp (IEHC) reported full year earnings of $0.40 vs $0.48 a year ago. That is a PE of 7x also. Total revenue for the last two years were almost identical. So, it seems margins slipped a bit. IEHC is also a netnet (see previous post).

IEHC is a tiny company with a market cap of $8M. They only do one thing, electrical connectors, and they do it well.  The company has very few customers. The company sells 31% to the corporate world, 63% to the military. All this is little changed from last year.

Why I'll Pass on the Pfizer-Zoetis Exchange

I am an Pfizer (PFE) shareholder and the company is making an interesting tender offer of its animal meds division call Zoetis (ZTS).

Zoetis up until a year ago was a wholly owned division of PFE. Then it IPO'ed this year. PFE tendered 20% of its shares in ZTS, so it still owns 80%. Then PFE realized that the market was strong and this is the time to unload all of its remaining stake in ZTS. It is doing this via a exchange offering to PFE shareholders.

The exchange offering expires June 19. It gives the PFE shareholder the right to get ZTS at roughly a 7% discount to the ZTS market price. To get the ZTS shares, however he must exchange his PFE shares. This is a non-cash exchange. So the discount gets reflected in the exchange ratio between ZTS and PFE. Suppose the market price of ZTS and PFE are equal, then the PFE shareholder can get 107 shares of ZTS for each 100 PFE shares tendered.

The market price for the exchange is considered to be the average of the two stock's trading price in the three days before and including June 19.

The Pfizer shareholder has the right to get up to 0.9898 ZTS shares for each PFE shares owned. The number of shares that Pfizer will actually exchange may be different from what the shareholder asked for because ZTS is a much smaller company than PFE. If PFE shareholders oversubscribe (i.e., there wouldn't be enough ZTS shares to go around) the ZTS shares will be distributed proportionally to the number of PFE shares tendered.

So, the amount of benefit to a PFE shareholder is dependent on how much other PFE shareholders tender. If plotted on a graph this would be a straight-line relationship. I didn't bother plotting a graph but instead calculated the benefit at the endpoints if I tender to exchange $100 worth of PFE shares. The endpoints are the least and most favourable cases.

In the least favourable case, we all subscribe all our shares. The market cap of PFE and ZTS are $204.8B and $15.6B, respectively. And PFE is putting up 80% of ZTS shares. So the ratio is $204.8:$12.4, or $100:$6.05. Then to get $6.05 worth in ZTS shares I must exchange about $6.05 &divide 1.0752 = $5.63 worth of PFE. And in the end for each $100 PFE I had before exchange, I would have $94.37 worth of PFE and $6.05 of ZTS, for a $0.42 gain in the least favourable case.

In the most favourable case, few people beside myself subscribe. Then for each $100 of PFE I would get about $100 * 0.9898 * 1.0752 = $106.42 worth of ZTS. And in the end for each $100 PFE I had before exchange, I would have $1.02 worth of PFE and $106.42 ZTS, for a $7.44 gain in the most favourable case.

So, it is a guessing game between PFE shareholders; the payoff is a possible 7.44% gain. The more people exchange thinking they can get the 7% the more likely they will end up closer to 1%. The more people give up and think it isn't worth the trouble, the more likely that those who do exchange will get 7%. This is a arbitrage situation. I am sure someone in some hedge fund must be dreaming of a way to make a small gain. But one major downside is the transaction cost of executing such a trade. I don't want to do such a thing because of the small gains involved. The other reason for exchanging could be because I want to own ZTS long term. But again, I don't want to because Zoetis trades at a PE of more than 30. I wouldn't own such a stock with such a tiny discount.

So I will keep my PFE shares. Tell me what you think.

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Disclaimer: please look at the disclaimer section on the right column. If in doubt about what to do, please consult a qualified financial advisor.

Why I Sold Intel, Microsoft and Pfizer

Recently, I noticed that people have read my old bullish posts on my holdings, for example, Intel. So, I want to update folks about my recent sells.

I closed my Intel position. I sold Intel in part because it was languishing in the low twenties, and near term I don't see any reason for the stock to move in either direction. Their recent earnings point to a P/E of just a bit over 10. But I was shocked to hear the recent news that PC sales are down 13.9% year over year. I generally don't heed the sensational headlines, like tablets are replacing PCs. But this statistic is a wake up call. I just don't see Intel as that attractive an investment. I bought it at about $20 a year ago. I made about 12%.

I reduced my position in Microsoft because of the aforementioned PC situation. Also, I don't see Windows 8 or their tablet push or their partnership with Nokia working that well. On the other hand, I still think Microsoft is a worthwhile investment.

I reduced my Pfizer position because it has doubled for me in the past four years. I was lucky to get a bunch during the financial crisis. Pfizer had a lot of headline problems due to patent expirations. But that headline risk is gone now, it being such a large cap stock, I don't see how it can grow profits much. I still have some left, but only because I want to avoid capital gains tax.

So, a lot of these sells are because I am in the process of changing my investment style. I want to invest in less large cap stocks. I still do own large caps but my positions will be much more concentrated.

Pfizer, PMI and Cisco Report Solid Earnings

Pfizer reported GAAP earnings of $0.43 per share in the most recent quarter. GAAP is the benchmark I feel we should use GAAP as a starting point for understanding a company's earnings performance. But a lot of companies have factors that would skew this result. Pfizer is one such example because the company acquired several large companies, most notably Wyeth in 2009. Acquisitions affects the company's earnings because of the marked value of inventories from acquired companies. Pfizer explains away such purchase accounting with a adjusted income value. Pfizer's adjusted income is $0.53 a share. I give Pfizer the benefit of the doubt and use this figure for Pfizer's income. I then estimate Pfizer trades at a PE of 13 (current price divided by adjust income). In addition, Pfizer has saved more than $7 billion in each of the last two years due to synergies from their acquisitions. Pfizer's report does not state how much it can save in the future but I hope that these savings can bring the company's PE close to 10 in the next two years. So to summarize, PFE is nothing too fancy, just a solid performer in a lucrative industry. I have a long term hold on it.

Philip Morris International (PM) recently announced that it earned $5.17 per share for the most recent year. This is an increase of 7% over a year earlier. The company has a 3.7% dividend yield. But as it trades at $91, it's PE is getting close to 20. And to me that is getting close to overvalued territory. As I mentioned before this is a sea change in opinion from a little more than a decade ago, when the market thought tobacco companies were getting sued to oblivion. I have sold a bit here and there as PM rose above 60. I will sell more if it goes above $100.

Cisco is another stock that has experienced a sea change of opinion in the last decade. The market once made it the most valuable company in the world. Now, the company just announced that it earned $1.49 GAAP per share last year. This gives it a PE of 14 with and a net-net of $4 per share. I consider it a value investment at this price. Cisco is my fifth largest holding mainly because of legacy positions and recent purchase as a value play. I would like to close my position however if it gets from $21 today to around $25; I generally do not like tech investments.

Why I Own PFE

PFE is the largest pharmaceutical company in the world with $70 B in annual sales. I have owned PFE (off and on) since 2005. Back then stock was depressed because of the headlines regarding the patent cliff of 2010's. The patent cliff is a series of major patent expiration starting in 2010 which was supposed to dramatically reduce the company's sales. The company's sales are tied to around a dozen blockbuster drugs. Here I define blockbuster drugs as those with over a billion annual sales. As an example, Lipitor (a cholesterol drug) was a $10 B drug until its patent expiration in the US in 2011.

Just in 2010-2012, PFE has lost exclusivity in six billion dollar drugs (Lipitor, Geodon, Aricept, Viagra, Xalatan, Detrol). However, PFE is not alone, the entire drug industry is going through the patent cliff together. And I feel the patent cliff headlines have made all pharmaceuticals undervalued. PFE has tackled the patent cliff with consolidation and cost reductions. In 2009 they bought Wyeth, another major pharmaceutical company. This merger was to diversify PFE's sales, and mitigate the patent expirations. And fortunately, the patent expirations will start tapering off, with no major expirations in 2013 and only one (Celebrex) in 2014.

PFE now has almost $70B revenue. The stock trades at $25 and generates $2.20 per share of free cash flow. The stock's dividend yield is 4%. I bought most of my current shares below $20 during the financial crises of 2008-2009. When then as the market tanked, I was looking to buy stocks because of the overall market valuation. Which particular stock didn't matter so much as long as it was not at risk of bankruptcy. Defensive sectors such as health care fit this bill.

From the depths of the financial crises to now, PFE has roughly kept pace with the overall market. Now the PFE stock is a decent investment based on the cash flow alone. The company's R&D pipeline is said to be quite deep. Future products from R&D should at least maintain their cash flow. Furthermore, as the Wyeth merger matures, the synergies will add further to cash flow.

I don't delve into the specifics of the R&D aspects of PFE. The pharmaceutical industry is very leading edge like high tech. And I feel my analysis or opinion will add little to the general knowledge. Instead, I just admit the specifics of PFE's future is unknowable, but the market dynamics are very much in the industry's favour. The pharmaceuticals are a $1 trillion industry worldwide. As countries look to improve living standards, a key goal would be to improve health standards while reining in costs. That means the focus should not be in churning out more and more doctors, who are highly paid, but in using technology to make cheap and decent health care to the masses.

In the US, for example, the coming health care bill called Obamacare will increase health coverage for tens of millions of people. To do so, cost per person will have to go down, so the industry will do anything it can to save money. That appears to be bad for the managed care organizations (MCOs). I disagree. The MCOs cut of the health care bill is small. Cutting MCO profits will do little to dent the overall rising costs. Instead, if MCOs can improve efficiencies in delivery and trim waste, then they will reduce the overall health care cost and make a good profit at the same time.

And as for pharmaceuticals, the increase in people with coverage means more demand for medicine. More demand means more money for the R&D of new medicines. Pharma companies are driven by the profit motive. If governments trim costs by starving them of profits, then they simply cannot afford research.

So overall, the entire health care industry is a large portion of the world economy with lots of room for growth. And I am a low-risk diversified investor. That is the main reason I have held two large cap health care stocks for a while now: PFE and Wellpoint.