Deer Consumer Products (DEER)

DEER (7-23-2010)

Current Price – $8.07, 12-Month Target Price $15.88

52-Week: $5.09-$18.97         Proj. Yield: 0.00%                   Market Cap: 268.51M                              Forward P/E: 8.3

(DEER) Deer Consumer Products http://www.deerinc.com is a designer and manufacture of home and kitchen electronics that markets their products to an established global customer.

We are initiating DEER Consumer Products with a 12-month target price of  $15.88 and a Sector Outperform rating, which implies 96% upside from the 7/23 close of $8.07.  We expect DEER to experience a sustain period of rapid top and bottom line growth through the expansion of product categories, existing channels and increased production capabilities using their strong brand reputation.

The PT is formulated utilizing the average of our $0.80 2010 and $1.05 2011 earnings per share estimates plus $2.00 per share in cash multiplied by a 15 forward multiple.

		DEER Estimates
	FY-Dec.09		Consensus		Consensus
Income Statement		Est. FY-Dec.10		Est. FY-Dec.11
Revenue	81.34	165.90	159.95	218.06	204.39
Gross Margin (%)	24.79	30.00	29.5	30.50	30.07
Net Income	12.37	26.55	25.5	34.89	32.87
Per Share Data
EPS	0.530	0.800	0.75	1.050	0.96

At the current price DEER’s shares are trading a 10x forward numbers, with an estimated 30% 5-year growth rate or PEG of .30.  Our forward estimates assume a PEG of .50, or 15x forward multiple.

Sector Outlook - From 2003-2007, China’s expenditure on food grew 40% to $276,255 (US$ mil.) and consumer electronics grew 33% to 213,832 (RMB million) despite having one of the highest national savings rates in the world and very little assistance from consumer credit. We expect this trend to continue, and believe that as disposable incomes in China grow so should their demand household products and appliances.

In China today, the average Chinese household only owns 5 home appliances vs. 30 in the US. For DEER, the growth in both the middle class and increases in expenditures should lead to acceleration in revenue growth.  China currently makes up 26.8% of revenues and emerging markets (China, Asia ex-China and Latin America) make up 64.10% of net revenues.  Deer expects mid-teen appliance growth through at least 2011 and sales in these regions to continue unabated during this secular shift.

Production: DEER’s in-house production of motors and moldings enables higher efficiencies, product quality and margins.  Their proximity to ports and major markets gives them strategic logistic advantages and their rural production facilities lend to low employee turnover.  In 2010 Management plans to double production capacity to support $320 mil in annual revenues.  In addition to DEER’s increase in production capacity management has 50 products in the pipeline and own over 90 functional and design patents.

Sales: 2009 sales consisted of Blenders (51%), Juicers (21%) & other appliances (28%) through 420 brands in 40 countries to international brands like Magic Bullet and domestic brands like Wal-Mart and Tesco. 2009 sales totaled $81.3 mil an 86% year-over-year increase.  Management projects 2010 sales of $160 mil an 87% year-over-year increase and net income to be $26 mil a  110% y-o-y increase vs. 09’ net income of $12.4 mil.  Currently, we expect a forward 5-year CARG of 30% in line with consensus.

On July 12^th management announced that they are going to report their best Q2 results in corporate history due to record product sales.  In addition, on July 15^th management updated their open $20 million share buyback program and communicated their intentions to buyback additional shares in the open market at current prices because they are valued at single digit price to earning multiples. http://www.deerinc.com/web/new20100715.asp.

http://www.deerinc.com/web/new20100712.asp.

On July 12^th, DEER closed at  $8.63.  On July 23^rd shares closed at $8.09 .  Which equates to a 6% loss in less then 10 trading days, after a very bullish announcement. We are conservatively positioned estimating $.80 for 2010, and believe the recent sell-off has given us the ability to buy shares before DEER’s official Q2 release.

Growth: We are confident in management’s growth initiatives and ability to grow market share while maintaining strong margins. Some initiatives that we expect to drive the 30% 5-year growth estimate are the expansion of their retail footprint to 20,000 locations, triple digit sales growth through e-commerce and commercial channel penetration via products for use in hotel rooms.

Profitability: DEER’s TTM ROA of 18.07% up form 14.15 in 09’ and 8.90 in 08’ is strong when compared to the 3.2% TTM ROA earned by an international competitor like Whirlpool. In addition, when compared to US peers their TTM profit margins are 16.01%, or 4x more times more profitable then US peers 4.42%.

Valuations: Utilizing a PEG valuation methodology we uncover that DEER is trading at a steep 50% discount to WHR on a PEG basis with DEER at 0.28 and WHR at 0.61 using forward consensus multiples dividend by 5-year growth expectations WHR 15.5% vs. DEER 30%. Both DEER’s strong profitability and reasonable valuation help reinforce our Sector Outperform view vs. its peer group.

Management: Management owns 41.24% of the 33.19M shares outstanding.  They have shown a commitment to shareholders via their recent share buyback and have properly communicated their operating strategy and objectives.  We are confident in their message to shareholders and future execution

Balance Sheet: At the end of Q1 DEER had $75 mil in cash ($2.31 per share) and almost no debt.  Although inventory growth has accelerated substantially year-to-date, DEER is in a high growth phase.  Their balance sheet should provide ample capital for organic growth and strategic acquisitions.

Conclusion: DEER represents a compelling growth opportunity at a reasonable price with a strong risk/reward profile vs. both their sector and the SPX.

Review of Bill Miller’s Comments utilizing the SPX, QCOM & EBAY

According to Bill Miller, Large Cap stocks like XOM and KMB represent a once in a life time opportunity and have not been this cheap since 1951.  To either refute or agree with Bill’s claim we will review a simple metric Earnings Yield.

** FCF/Enterprise Value = Cash Return** E Value = Mkt. Capt + LT Debt – Cash

At the End of Q2 the SPX P/E was 15 equaling an Earnings Yield of 6.7%

At the End of Q2 the 10-Year US Treasury Yield was 2.93%

The fixed income market is signaling deflation, but their pessimism is baked into the numbers offering investors a more than adequate return over the risk free rate.

When examining the SPX, Bill’s comments becoming increasingly more convincing, but to be more stringent in our examination we will examine the earnings yield of high quality companies QCOM & EBAY.

Earnings Yield EBAY – 10.68%

Earnings Yield QCOM – 9.3%

QCOM – Is trading at 14.95x it trailing 3-year P/E (($39-$7 per share in cash)/ ($2.16)) vs. a historical multiple of 21x.  They have no debt; pay a 2% dividend yield (which has grown 18% per year over the past 5-years), an open $3 billion share repurchasing plan, and an industry leading patent protected portfolio of products.

EBAY – IS trading at 17.09x it trailing 3-year P/E vs. a historical multiple of 30x.  They have no debt, have grown the BV/per share y 26% the past 5 years and excess cash for share repurchases, investing in operations or acquisitions.

Conclusion – It is typically, very difficult to find cash returns above 10%.  In the current environment QCOMs and EBAY earning yield uncover just how reasonable high quality shares are selling for vs. a 10-year Treasury yield of 2.93%.

Quick Update on QCOM earnings.

QCOM – reported adjusted earnings of $0.57 EPS on revenues of $2.71 billion vs. Thomson estimates of $0.54 EPS and $2.63 billion in revenues.

They raised full year guidance to $2.33 to $2.37 EPS and $10.7 to $11.0 billion in revenues vs. Thomson estimates of $2.31 EPS and $10.72 billion in revenues.

QCOM – Decent beat and raise.  Outlook confirms July 9th review, 2H should see top and bottom line acceleration.  More after the earnings call.

QCOM Update

QCOM Update – When we first recommended QCOM at $39 on 2/2/2010, we thought the shares were a steal.  Since the shares have fallen 16%.  To reaffirm our buy thesis will attempt to uncover why the shares have underperformed, and why we believe they will outperform in the future.

Why Underperformance? (I) ASPs (averaging selling prices) are under pressure.  QCOM has been selling more of their lower priced chips ( none 3G and none smart phone) as the demand for 3G and smart phones has been slower than expected in the Emerging Markets. Management believes this to be a temporary phenomenon and I believe their assessment to be true.  In addition, when this trend reverses (I expect this to occur in the 2H 2010), QCOM’s top and bottom line should accelerate at a faster rate then estimate by both the street and our numbers at prudentstockinvesting (resulting in a far larger forward multiple). (II) An inconsistent message from management. I recently spoke to a growth manager that sold the shares.  Their reason was plain and simple, management. A positive preannounce had the street excited that higher margin sales were accelerating,  however; their schedule eps announcement resulted in a completely different message,  resulting in a  big selloff  (management announced inline forward guidance).   For the most part, there is no defense here and the street voice their opinion by dumping shares aggressively.  Management has been wrong, but I remain comfortable holding the shares because historically QCOM has been able to fend of competitors using the same playbook they are today.

Why Out Performance in the Future?  First I must address a recent announcement,
On 6/14/2010 QCOM agreed to pay $1.045 billion to acquire wireless broadband spectrum in 4 regions in India.  As per management, this was done to manage 4G network deployment in India.  The deal put some of QCOM large cash position to work and should set them up nicely to reap the benefits from 4G chip sales and higher royalty rates via the adoption of smart phones.

I am leaving my esp. estimates unchanged and reaffirming my buy rating on the stock ($2.30 in 10’, $2.58 in 11’ & $2.90 in 12’) because QCOM’s competitive landscape remains the same and they have a number of positive catalyst approaching. (I) QCOM has a number of Snapdragon phones coming to market, which is their high end chipset, (II) I expect a pick up in EM adoption to 3G and high margin Smartphone’s & (III) a possible release of a CDMA iphone on the Verizon network.

On a valuation basis the shares are a steal, trading at 9.9X 2011 & 8.84X 2012 my eps estimates base on today’s close of $32.65 and subtracting $7 in cash per share.  In addition, at current prices QCOM shares offer a compelling risk reward.

QCOM Update

Since our latest report we have some positive news to share on our 1^st buy list candidate QCOM.

QCOM – The quarter was a disappointment and shares sold off.  I am not going to get into much of the technicals, because my philosophy has not changed since my 2/2 post and  my estimates are exactly the same, but despite momentum investors scrambling to the exits, believe it or not I get the sense that wall street analyst have quietly turned positive on the stock after the earnings call, with a reported Median 12-month Price Target of $49 (Thomsons), implying 31.37% upside from our current price. (next eps release is 7/21/10)

On the quarter, plain and simple, the acceleration in 3G growth in emerging market China and India have been slower then anticipated.  Thus, uncertainty-surrounding the3G emerging market ramp up caused management to be cautious (which they almost always are) and analyst to cut their forward 12-month numbers because forward guidance was weak.  I will repeat, QCOM runs a near monopoly business and it is not a matter or if, but when the 3G uptake in emerging markets begins to accelerate.  Finally, Research in Motion (RIMM), the maker of Blackberry that run using QCOM’s technology, in their latest quarterly conference call pointed to none other then the emerging markets as their next driver of growth, so it may not be that far away.

Before the Quarterly earning announcement QCOM also did two things that typically reinforce my comfort in an investment. Return of capital to shareholders via a 12% dividend increase and a new announced $3.0 billion stock repurchase program due to the recently complete $2 billion stock repurchase program.  I know one thing, management typically knows more then the public, and if they want to purchase shares at these levels to increase owner’s equity, then so do I! ( Just and FYI, QCOM unlike many companies does not implement a share buyback program to hide excessive option awards to management)

Please read my 2/2/10 post at www.prudentstockinvesting.wordpress.com for additional information.

Note:  I posted an example below, and in my About Me Link summarizing my investment philosophy. At heart I am an improvised “Graham” value investor who utilizes a thesis that concentrates on buying wide moat companies that the market “hates” because the risk/reward is better.

Investment Process & Example Using New Buy, EBAY

My process begins by examining underperformers and companies significantly lagging their peers (I love stocks selling just off their 52-week lows).  If the business is not broken, I then consider valuations, profitability and closely scrutinize the balance sheets to ensure it can support the hiccup in earnings growth.

An investment group I love is a wide moat company making a small organization change to better their competitive position in the long-term.  Since Wall Street is so focused on a companies forward 12-month earnings growth (their annual pay is closely tie to this), they will typically underestimate future earning growth in their modeling for the “slow growers” due to uncertainty and lack of growth vs. their peers.  This typically, betters an investor’s risk/reward if the analysis is done correctly, because it depresses the shares forward multiple as if the company will never be an earnings grower again (it also helps that most momentum investor will be no where near the shares).

Hopefully, the EBAY example can provide you with a real example.

In most instances it is hard to identify price dislocations in widely covered stocks by the analyst community, however; in EBAY’s case there are TWO!

EBAY is a wide moat stock.  They are transitioning their auction business to a buy-it-now model, similar to that of Amazon (AMZN). Unlike AMZN, EBAY’s revenue growth on the auction business has stalled, making EBAY’s core business and share price trade at a fraction of the multiple of AMZN, despite having similar business models.

EBAY also owns PayPal, an online payment system.  PayPal functions much in the same way as Visa (V) & MasterCard (MA) except their business is online (they almost have as many customer accounts as AXP). PayPal like EBAY’s auction businesses also trades steep discount to it peers group V & MA, despite having recently reported strong earning growth in their latest quarter and strong earnings potential.

In the EBAY Auction business vs. AMZN Wall Street is pricing EBAY like they will never grow again.  With Paypal Wall Street is over looking their earning potential vs. a similar peer payment-processing group.  To boot, EBAY’s strong free-cash-flow generation, operating margins, balance sheet and earnings yield are all positive.

EBAY is our second strong buy.  ( I will do a detail analysis with price targets, a DCF and more after EBAY’s Q2 eps announcement).

QCOM – OUR FIRST, STRONG BUY

Qualcomm (2-2-2010)

Current Price – $39.80, 12-Month Target Price $48.40

52-Week: $32.64-$49.80                   Proj. Yield: 1.74%

Market Cap: 63.8 bil.                            Forward P/E: 14.9

The 15% sell-off in the shares of QCOM after this weeks earnings report have given us the opportunity to examine a high-quality growth stock selling at an attractive acquisition price.

Business Overview: QCOM is a diversified technology company that has a number of future growth drivers.  They are the leader in the wireless chip space for global handsets with 27% market share and earn royalties via their CDMA, WCDMA & ASPA technologies.  QCOM generates a 3.5% royalty fee on these technologies, and as of the Dec. Qtr. the technologies made up 146.5 million units or 44% of global handsets units.  Their revenue breakdown is 60% CDMA, 34% licensing & 5% Wireless/Internet Group.

Earnings Summary: On Jan. 28 QCOM announced earnings and revised guidance for 2010.  They beat on the bottom line, but 2010 Revenue guidance of $10.4-11.5 billion was below street estimates and previously announced guidance.  In addition disappointing (I) price erosion on 3G handsets (II) pricing on 3G chipsets and (III) lackluster 3G growth in emerging markets added to the selling pressure of QCOM’s shares.

The street was expecting a beat and raise, resulting in a run up in the shares before the report date, but an unexpected decline in ASPs (average selling prices per unit) and weak guidance moved the shares lower.  Although this news was negative, the announcement uncovered no structural issues with their business model, and management reassured investors that the fall in ASPs should not be a continuous trend.  The sell-off appears unwarranted and revenue shortcomings look like a short-term hiccup opening the window for an accumulation of shares.

Sector Outlook: Smart Phone growth by industry analyst is expect to growth at a mid- double digits the next 3-5 years. Wall Street estimates expect a similar path for shares of QCOM, currently estimating 5-year growth to be 17.5% and the sector growth to be 17.9% vs. an estimated growth rate for the S&P500 at 10%.  In 07’ & 08’ despite and ailing global economy smart phone sales growth averaged 18%.  Finally, the strong uptake in Smartphone’s has predominately occurred in North America and the Euro-zone the past 5-years.  Like management, we believe the acceleration of emerging market 3G and data growth the next 3-5 years is the next growth catalyst.

Growth: Chipset design wins, strong industry trends and being well positioned to capitalize on the transition on from 3G to 4G networks will all help to drive sales growth in the high single digits the next 5-years.

Profitability: QCOM 5-year Net Profit Margins were 32.72% & Operating Profit Margins 40.20%.  Their margins have been very strong on a historical basis, driven by its IP licensing business and royalty business.  Despite, weak ASP’s this quarter, QCOM should generate Op. Margins in excess of 30% over the next 5 years.

Balance Sheet: QCOM balance sheet is excellent.  As of the Jan. 28 earning report QCOM had no debt and $18 billion of cash and marketable securities ($11 per/share).  Their excellent financial condition enables management the flexibility to propose future dividend increases, a share buy back programs and pursue attractive bolt on acquisitions to further diversify their business.  Their investment portfolio has consistently added to revenues since 2004, and is on pace to add as much as 0.30 per/Share in 2012.

Valuation: (I) P/E (II) A 10-year DCF Model & (III) Earnings Yield.  Model assumptions will use the data points below, in addition to assuming a 7% 5-year sales growth rate, 3.5% terminal growth rate & a 12% 5-year growth rate in EPS driven by strong sales trends and reduce share count via a share buy back program.

(I)   P/E – Historically, QCOM has trade at 20-23x its forward 1-year multiple.  EPS growth assumptions are 12%, thus the following EPS growth has been modeled: $2.30 in 10’, $2.58 in 11’ & $2.90 in 12’.   Using a $2.30 2010 EPS assumption our 1-year price Target would be $53 = ((20 * $2.30) +($7)).  A $53 1-Year Price Target is by no mean overly optimistic considering our 2010 EPS estimate is at the high end of QCOM conservative 2010 guidance, however; the streets expectations are now diffused and a slight discount to the market multiple is probably more accurate for the next 6-12 months, thus our conservative PT/fair-value estimate is $48.40, using a forward multiple of 18x, plus $7 per/share in cash.

(II) 10-Year DCF – Using a 10-year DCF fair-value is $53.13.  In the DCF model the following assumptions were utilized:  Shares outstanding would fall from 1,679 mil. to 1,600 mil., this is equivalent to purchasing $3.5 billion in shares.  2010 FCF to be 4,600 mil., or a 7% year-over-year increase to 2009 FCF generation. A Perpetuity Rate of 3% inline with normalized inflation.   A discount rate of 10%, and a long-term 7 years growth rate of 7%.

(III) Earnings yield, or FCF/Enterprise Value = Cash Return is compared to the 10-year risk free rate of return, or in this assumption a 10-year AA Corp bond.  Utilizing the following assumptions: FCF of 4,295 mil., a Mkt. Cap. of 63,800 mil., LT debt 0 and Cash 11,000 mil., QCOM has an earnings yield of 8.14%.  Compared to a 10-year Treasury 3.65%: & AA Corp Bond: 4.98% QCOM earning yield is strong and compensates for the risk premium in equities.

Conclusion: QCOM is a BUY at current levels and can be accumulated going into their Q2 report.  A conservative near-term price target of $48.40 plus $0.67 per share in dividends implies a 1-year return of 23%, and long-term price target of $53.13 implies a return of 33%.  Excellent free cash flow generation and a strong balance provide a strong foundation for QCOM to defend its competitive position in the wireless sector.

QCOM Data Points

Before I completed my review of the CELG & GENZ, I will turn my attention to QCOM after a 1-week sell off in the market of 16.22% vs. the Spider Technology ETF (XLK) of 3.24%.  Like most companies I intend to highlight on this blog, QCOM is of the highest quality with an exceptional balance and formidable operating strategy.  Below I have listed some of the data points I intend to refer to in my post on QCOM.

QCOM –

Data –

52-Week Range: $32.64-$49.80

Proj. Yield: 1.74%

Market Cap: 63.8 bil.

Avg. Volume: 18.6 mil

Forward P/E: 14.9

Wall Street Estimates:

2010: Mean EPS 2.25

2011: Mean EPS 2.52

5-year Growth Forecast: 15.5%

Analyst Opinion: 1.2

Number of Analyst Covering: 37 ( 28 rated QCOM a Buy)

Other ( all data on a TTM basis)

Sales: 10,569

Op Income: 2,360

EPS/share: 1.25

Dividends/ Share: 0.67

Total Shares: 1,679

Cash Flow ($mil) TTM

Op. CF: 4910

Cap. Spending: 615

Free Cash Flow: 4295

Balance Sheet ( $mil)

Assets:                                                                        Liabilities

Cash: 3,660                                                            Current: 2,048

Other Current: 9,914                                                Long-Term: 4,602

Long-Term Assets: 15329                                    Share Holder Equity: 21,353

Total: 28,903                                                            Total: 28,903

*  Data point numbers were found @ www.morningstar.com