For Immediate Release
Chicago, IL –August 02, 2010 – Zacks Equity Research highlights: Jabil Circuit (JBL) as the Bull of the Day and Quest Diagnostics (DGX) as the Bear of the Day. In addition, Zacks Equity Research provides analysis on Ford (F), Toyota (TM) and Chesapeake Energy (CHK).
Here is a synopsis of all five stocks:
Jabil Circuit's (JBL) results continued to improve in each of the last four quarters. Estimates for the fourth quarter and full-year 2010 have soared following the company's strong third quarter 2010 results that beat the Zacks Consensus Estimate.
Third quarter 2010 revenues and earnings both jumped on a year-over-year and sequential basis, attributable to a significant operating margin expansion and growth across end markets. Despite substantial European exposure, Jabil provided upbeat fourth quarter guidance, well above the Consensus Estimate. We have raised our 2010 revenue estimate by 6.3% and earnings per share estimate by 15.2%.
We expect Jabil to witness strong revenue, margins and earnings growth by the end of fiscal 2010 and in 2011 on account of new business wins from major OEMs, an increase in customer orders, recovery in end market demand and resurgence in IT enterprise spending. We are upgrading the stock to Outperform and raise our price target to $18.00.
Quest Diagnostics (DGX) second-quarter EPS of $0.89 beats the Zacks Consensus Estimate by a penny and the year-ago quarter s by 7 cents. However, revenues declined 1.4% to $1.9 billion, driven by a decline in both volume and pricing. Meanwhile, the company proactively negotiated contracts with some MCOs at reduced prices. Although this gives more visibility, revenue per requisition was affected in the near term. Quest is adopting strategies such as suitable acquisitions, increased sales force and targeting additional geographies to drive its top line. However, we believe in the near term volume and pricing outlook will continue to remain under pressure unless the economic scenario improves. As a result, we lower our estimates for the company and downgrade it to Underperform.
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In-Depth: 2nd Quarter GDP Growth
Without a doubt, growth has been slowing from the 5.0% rate in the fourth quarter to 3.7% in the first quarter to the current estimate of 2.4% in the second quarter. However, the quality of the growth has been improving. In the second quarter, 1.05 points of growth came from the change in inventories (non-fixed investment), down from 2.64 points in the first quarter and 2.83 points in the fourth quarter.
The biggest part of the economy by far is consumption, accounting for 70.4% of total GDP in the 2Q. In the 2Q, Personal Consumption Expenditures (PCE added 1.15 points of growth down from 1.33 points in the 1Q but up from the 0.69 point addition in the 4Q.
People spend on both Goods and Services, and goods are further broken down into durable goods such as cars and furniture, and non-durable goods like food and clothing (although the government clearly has not looked in my closet; I think I still have some clothing that dates back to the Reagan Administration).
In total, goods added 0.79 points to growth in the 2Q down from 1.29 points in the 1Q but up from 0.42 points in the 4Q. Of that, durable goods added 0.53 points versus 0.62 points in the 1Q but up from a 0.07 point subtraction from growth in the 4Q. Spending on durable goods was 7.36% of the entire economy in the 2Q.
By the very nature of being durable, spending on durable goods tends to be easy to postpone when times get tight. Instead of going out and buying a new car from Ford (F) or Toyota (TM), when people are worried that they might get laid off in the near future they simply drive the old clunker a little longer.
That demand then gets pent up (you get tired of driving that old thing, or the repair bills start to mount) and when good times return, the spending on durable goods tends to jump. Thus, durable goods tend to “punch above their weight” when it comes to determining if the economy is in a recession or is booming.
Spending on non-durable goods is a much bigger part of the economy at 15.77%. However, non-durable goods spending tends to be much more stable than spending on durable goods. In the 2Q, non-durable goods consumption added 0.25 points to growth, versus 0.67 points in the 1Q and 0.49 points in the 4Q.
Most of consumer spending though is not on stuff, it is on services -- accounting for 47.24% of the whole economy. Despite its huge size services added just 0.36% in the 2Q up from just 0.03 points in the 1Q and 0.27 points in the 4Q. Services tend to be performed in real time, and cannot be stored, thus they tend to be a more stable part of the economy.
Investment is Key
The part of the economy that really punches above its weight is Investment. Gross Private Domestic Investment (GDPI) is really the thing that makes the difference between boom and bust. It is broken down into fixed and non-fixed investment, with non-fixed being the change in inventories I discussed above. Inventory investment is considered low-quality growth since if factories are making something that is simply piling up on store shelves, it means that they will have to cut back production in the future.
Fixed Investment
Fixed investment, on the other hand, is a bet on the future of the country, and for the most part adds to the country’s productive capacity. In total, GDPI makes up just 12.66% of the overall economy, but it was responsible for 3.14 points of growth in the 2Q up from 3.04 points in the 1Q and 2.70 points in the 4Q. The change in fixed investment is even more dramatic, with fixed investment adding 2.09 points in the 2Q up from 0.39 points in the 1Q and an actual subtraction of 0.12 points in the 4Q.
Fixed investment is further broken down into residential (Home building and improvements) and non-residential. Non-residential investment was 9.62% of the economy in the 2Q and added 1.50 points to growth, up from 0.71 points in the 1Q and a subtraction of 0.10 points in the 4Q. It is further broken down into investment in structures, such as the building of new office buildings and shopping centers, and into investment in equipment and software (E&S).
Spending on structures added 0.14 points to growth, but that is a big positive swing from the subtraction of 0.53 points in the 1Q and a 1.10 point subtraction in the 4Q. That improvement is a major surprise, and I would not expect it to last. There are simply too many vacant office buildings and empty stores in the country for it to make sense to be building a lot of new ones.
However, the increase in spending on structures of 5.2% comes on the heels of seven straight quarters of it being a drag on growth. Spending on non-residential structures has fallen by 33.7% over the last two years, and in the process it has declined from 4.04% of the whole economy to just 2.65% of the economy.
Investment in E&S added 1.36 points to growth, up from 1.24 points in the 1Q and 0.91 points in the 4Q. E&S spending increased by 21.9% and now represents 6.97% of the whole economy. That is up at a 21.9% rate and E&S investment is now 6.97% of the economy up from 6.43% a year ago. This is a very encouraging development, suggesting that businesses are starting to deploy some of the massive cash hoard they have amassed.
Despite all the whining you hear on CNBC about uncertainty regarding taxes and regulation, the animal spirits are starting to rise. The sharp increase in E&S spending is all the more surprising since manufacturing capacity utilization is only at 71.4%, which is an extremely depressed level; the long-term average is 79.2%. If businesses are investing even when they have factories sitting idle, it means that they must be getting more confident about the future.
On the other hand, it is partly a reflection of the sharp decline in E&S spending that happened during the recession. Even with the sharp increase, E&S spending is still 8.7% below where it was two years ago.
Residential Investment
The other side of fixed investment is residential investment (RI). It added 0.59 points to growth, but I would not expect that to last either. Mostly it is due to the homebuyer tax credit, which drew demand into the 2Q from the 3Q and 4Q. RI jumped at an annual rate of 27.9% in the 2Q.
However, there is a huge overhang of existing homes for sale, especially when one counts the shadow inventory of homes where the owners are far behind on their mortgages and are likely to go into foreclosure (or which are already in the foreclosure process).
RI has been a perpetual thorn in the side of the economy, having subtracted from GDP growth in 13 of the previous 14 quarters. Since the peak of the housing bubble, RI has fallen from 6.43% of GDP down to just 2.46% in the 2Q, even with the big (and artificial) jump in the 2Q. While eventually RI should return to a more normal level of about 4.2% of the economy, I don’t think that the rise in the 2Q is the start of that process.
Historically, RI has made a huge difference in determining if the economy is booming or is in a bust. Housing is in some ways the ultimate durable good, as a house will last a lot longer than a car, and used houses are even better substitutes for new houses than used cars are for new cars. Recent data on building permits and housing starts indicate that residential investment will again be a drag on growth in the 3Q, and quite possibly 4Q as well.
G for Government
Government spending was responsible for 0.88 points of growth in the 2Q, a big swing from the 0.32 point subtraction from growth in the 1Q and the 0.28 point drag in the 4Q. The Federal Government was responsible for 0.72 of that, up from a contribution of 0.15 points in the 1Q and a 0.01 point contribution in the 4Q. Most of the swing has come from spending for Defense, which added 0.40 points after adding just 0.02 points in the 1Q and being a 0.13 point drag in the 4Q. Non-defense spending added 0.33 points in the 2Q, up from a contribution of 0.13 points in the 1Q and adding 0.14 points in the 4Q.
Government spending for calculating GDP is very different from the government budget, since it excludes transfer payments like Social Security. That spending is part of Consumption, and is counted when Grandma spends her Social Security check.
In total, government spending was 20.51% of the economy in the 2Q, and of that only 8.26% is Federal Government spending. Defense spending was 5.57% and non-defense federal spending was 2.70% of GDP. State and local governments added 0.16 points of growth in the 2Q a big swing from the 0.48 point drag in the 1Q and the 0.29 point drag in the 4Q.
State and local governments are generally not allowed to run deficits for operations (they can float bonds for capital improvements like roads and sewage systems). Since most are facing very large deficits due to falling tax revenues, they will have to cut spending sharply in the coming quarters, and will once again be a significant drag on the economy. If instead of cutting spending they raise taxes to balance their budgets, they are likely to reduce either Consumption or Investment spending (or both). State and local government spending was 12.24% of the whole economy in the 2Q.
Net exports were a huge drag on the economy in the 2Q, subtracting 2.78 points from growth. In the 1Q they subtracted just 0.31 points and in the 4Q they added 1.90 points. In other words, if we had a closed economy, with no imports or exports, the overall pattern of GDP growth would look very different, with growth of 5.18% in the 2Q, versus growth of 3.39% in the 1Q and 3.10% growth in the 4Q. The problem is not on the export side, which grew by 10.3% in the 2Q and added 1.22 points to growth, after adding 1.30 points in the 1Q and 2.56 points in the 4Q.
Imports Remains the Big Issue
The problem is on the import side, and increasing imports are a subtraction from GDP growth. After all, imports are things that we consume here, but which we don’t make here. Imports surged 28.8% in the 2Q and subtracted 4.00 points from growth, after subtracting 1.61 points in the 1Q and 0.66 points in the 4Q.
This is a reason for serious concern. It is the trade deficit that drives our indebtedness to foreign countries, not the budget deficit. After all, the budget deficits during WWII were far larger than the current budget deficits as a share of GDP, but when the war was over, we were by far the world's largest creditor, rather than being the biggest debtor as we are now.
About half of our trade deficit is due to our oil addiction. We need to reduce our oil imports and have to do it soon -- they are a cancer eating away at the economy. To do so, we need to both use energy more efficiently and to move to other sources of energy. We simply no longer have the oil reserves (2.1% of the world’s total in 2009) for “drill baby drill” to be a reasonable answer -- not when we are already the third largest oil producer on the planet, accounting for 9.0% of total production already (that’s more than Iran and Iraq, combined).
The problem is that we consume 21.7% of the world’s oil. The disaster in the Gulf shows that there are substantial risks to trying to increase our production, although clearly we will need that deepwater resource. The oil has been sitting there for millions of years, and is not going anywhere, so taking some time to make sure we are extracting it in the safest possible way make sense.
Fortunately, we have ample supplies of natural gas, thanks to the emerging shale gas plays. Natural gas is also cheap relative to the price of oil on a per-BTU basis, and it contributes far less CO2 per BTU than does oil (or coal, for that matter).
Oil is primarily used as a transportation fuel, but the technology does exist to run cars on compressed natural gas and is widely used outside the country. Moving towards more use of natural gas as a transportation fuel would do wonders for improving our trade deficit, and as we do that we would improve GDP growth. Revenues that now flow to Saudi Aramco would flow to companies like Chesapeake Energy (CHK).
Moving more of our freight by rail rather than truck (or rail for the long-haul portion, with the containers loaded onto trucks for the last 50 miles or so) would also greatly reduce our consumption of oil and thus improve the trade deficit. Climate change is a VERY good reason to reduce our oil consumption, but it is far from the only one.
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