Thursday, May 31, 2012

The End of the PC Era?

The CEO of chip giant Intel (Nasdaq: INTC), Paul Otellini, recently stated that “there's a golden age ahead of us [Intel]”. He made this statement based on his belief that the age of “cannibalization” of PCs – consumers choosing tablets over laptops – would be replaced by age of “reverse cannibalization” as new Windows 8 laptops come out with touchscreens later this year. Windows is, of course, the new operating system soon to be brought out by Microsoft (Nasdaq: MSFT).

Intel and Microsoft are not the only companies hoping Windows 8 is a runaway success. Others in the PC world need it to be a success in order to turn their fortunes around.

Take Dell Computer (Nasdaq: DELL) for one. Its stock recently fell by a fifth in one day on the back of poor results. According to its chief financial officer, Brian Gladden, the PC market has turned into a low-growth ghetto. And this past week Hewlett Packard (NYSE: HPQ) took a $1.2 billion write-off on its decade-old acquisition, Compaq Computer. Its CEO, Meg Whitman came right out and said “We are betting heavily on Windows 8”.

These companies are facing a steep uphill climb against the competition - smartphones and tablet computers. Smartphone sales exceeded PC sales for the first time ever last year, with 427 million sold versus 353 million PCs sold. According to technology research firm Gartner, smartphone sales will be twice as big by 2013. Tablets, led by the iPad from Apple (Nasdaq: AAPL), looks like the next device which will capture a global mass market, with some in the industry predicting sales could rival those of PCs within three years.

As a whole, the number of “smart” devices sold annually will double between now and 2016, reaching 1.84 billion according to research firm IDC. In that period, traditional PCs are forecast to shrink from 36 percent to 25 percent of the total number of smartphones, tablets and PCs. Hardly a golden age.

Part of the decline is due to shifting consumer tastes. The emergence of web-based services has made software applications less relevant to consumers. For example, music lovers today are much more likely to turn to streaming service such as the iCloud where there favorite tunes are stored on Apple servers. The same can be said with regard to personal data too.

Intel and others are banking on consumer acceptance of hybrid PCs (which Apple thinks will never be viable) thanks to Windows 8. But these type of devices failed miserably in the past. Take Dell's Inspiron Duo which was launched to much hype in 2010. Consumers thought it was too heavy, the screen and battery life were poor and it did not even come close to the touchscreen experience of the iPad.

Windows 8, however, does seem to be the best offering from Microsoft since Windows 95. It will have an user interface, called Metro Style, that is based on colored tiles operated by touch and which is currently being used on Windows phones. Microsoft is also using a programming model that enables developers to create apps easily and computing architecture and operating system that will run tablets. The architecture is required for devices that run low-powered chips (which expands battery life) designed by the UK's Arm Holdings.

Microsoft's Windows 8 should give PC companies an opening to pull customers back into the PC universe. But that window may close rather quickly, leaving others like Samsung and Apple to further gain market share.
This article was originally written for the Motley Fool Blog Network. Make sure to read of my daily articles for the Motley Fool at

Tuesday, May 29, 2012

Asset Sales Galore Coming for Chesapeake

Despite having some of the best assets in the natural gas business, Chesapeake Energy (NYSE: CHK) has become the poster child for the type of company that investors should give a wide berth. Among the problems which ail Chesapeake are very questionable corporate governance, large amounts of debt both on and off the balance sheet, strained liquidity and murky accounting. No surprise then that the company's stock has fallen roughly 45 percent in the past six months.

Chesapeake Energy, the second-biggest natural gas producer in the United States, now has one choice to will have to liquidate some of the juiciest energy assets in the country. That is where this story gets interesting for investors in the sector as its rivals look to scoop up some of Chesapeake's prime assets at a good price. In fact, industry analysts believe there are at least $25 billion in valuable acreage that Chesapeake owns which should find eager buyers.

The company's principal assets are oil and gas leases covering roughly 15 million acres in key areas all across the country including Texas, Louisiana, Oklahoma and Pennsylvania. Chesapeake is the largest or second-largest leaseholder in many of the most promising in the US for producing shale gas and oil that have been opened by advances in drilling technology.

Even before the recent problems came to a head, the company had planned to make some assets sales as it has done the past several years. The biggest planned deal is the sale of 1.5 million acres of leases in the Permain Basin oil fields of west Texas and eastern New Mexico. It is believed this sale should fetch the company at least $6 billion since these fields hold much more oil than they do gas.

The most obvious possible buyer for these assets is Anadarko Petroleum (NYSE: APC) which is Chesapeake's partner in many wells in the Permian Basin. Its CEO Al Walker has publicly stated Anadarko plans to “take a look” at those assets. Another possible buyer for these assets is Occidental Petroleum (NYSE: OXY). This company is the biggest oil producer in the Permian Basin. In the past, it showed interest in these assets, offering Chesapeake about $3.5 billion for it (the offer was rejected).

The second planned disposal is a joint venture for its 2 million acres in the Mississippi Line region of Oklahoma and Kansas. This acreage, like many of Chesapeake' other assets, requires significant capital spending to bring it into full fruition. The company's capital spending has exceeded cash flow each quarter since October 2003, according to Bloomberg. This is the one of the main reasons behind the company's high debt burden and why ratings agency Fitch recently said Chesapeake's cash flow shortfall this year may reach $10 billion.

With much capital required, buyers of Chesapeake's assets are going to have to be some deep-pocketed companies. One such company which comes to mind immediately is Chevron (NYSE: CHV). Unlike some of its peers in the industry like ExxonMobil, it has been very slow in acquiring US shale reserves and has to date nearly missed the shale revolution occurring in the United States. Chevron's pockets are even deep enough for it to catch up quick and acquire the whole of Chesapeake Energy if it so desires.

Another possibility is an overseas natural resources company with a strong interest in US energy assets. That company is BHP Billiton ADR (NYSE: BHP). Its management has been trying to shift the company away from a reliance on metals mining and more towards a focus on energy assets around the globe. BHP recently announced a reduction in its capital spending on mining projects. Investors will recall that BHP, which had already bought some US energy assets, spent $12.1 billion to acquire Petrohawk Energy in July 2011. The acquisition of Petrohawk's shale assets in Texas and Louisiana moved BHP into the top 10 of oil and gas companies and it is looking to expand even more in the US.

What will happen to Chesapeake? It could try a piecemeal approach – both selling and buying assets. But this strategy will do the company little will be just running in place with a heavy debt load tied around its neck. Despite its reluctance, management will likely have to put the whole company up for sale sooner or later.

This article was originally written for the Motley Fool Blog Network. Make sure to read my daily articles for the Motley Fool at

Thursday, May 24, 2012

Pharmas Need Pain Relief

Investors who have paid any attention at all over the past few years to the pharmaceutical industry are well aware of the so-called patent cliff that nearly every company in the sector faces. The patent cliff refers to the expiration of patents on pharmaceutical firms blockbuster drugs, opening them up to competition from cheaper, generic versions of the medicines. It is this patent cliff which has pushed the drug companies into a flurry of action over the past couple of years, ranging from licensing deals to acquisitions.

This is not new news to savvy investors. But here is what is different...the problems due to patent expiries are set to become much worse in 2012. The list of patents on blockbuster drugs set to expire in 2012 include Actos, Diovan, Geodan, Lexapro, Plavix, Seroquel, Singulair and Tricor among others. Among the major pharmaceutical companies affected are Pfizer (NYSE: PFE), Abbott Laboratories (NYSE: ABT), Sanofi ADR (NYSE: SNY), Astra Zeneca PLC ADR (NYSE: AZN) and Novartis ADR (NYSE: NVS) among others.

The pharmaceuticals analyst with Bernstein, Tim Anderson, said “Nothing like this has ever been seen before. In years past, the rates of erosion were substantially less.” Mr. Anderson is likely correct. Unlike prior patent expiry cycles, this one is so much larger. That means that sales from a single drug, even a blockbuster, will not be sufficient to make up for the series of expiring drug patents.

This fact may threaten the very business model that pharmaceutical firms have used for years to conduct business. Unlike other sectors like technology, the pharma industry faces stringent regulations on authorization and marketing of drugs by the US Food and Drug Administration. This results in higher costs and longer lead times to develop new medicines, making the companies highly reliant on patent monopolies lasting years to recoup their costs.

Now the pharma companies face an unpleasant cocktail of conditions – a patent abyss, stiff competition from generic firms like Teva Pharmaceutical Industries and pressure from insurance companies and governments to lower the price of their drugs. This combination may force drug companies to take their entire current business model and throw it out the window and develop new plans for survival.

One such change is already occurring. Due to the rising cost and falling productivity of research and development, some pharma companies are cutting way back on such research. They are simply farming out the research to specialist firms or plan to just buy promising drugs from the biotechnology companies which developed them.

This approach seems to meet with shareholder approval since companies such as Astra Zeneca and Eli Lilly which have remained focused on internal research efforts are trading at the lowest multiples in the pharmaceutical sector.

Another strategy which seems to be gaining approval among shareholders is diversification. The outperformers in the sector are companies like Novartis and Sanofi which moved into others sectors including generic drugs, medical devices, consumer health products and animal health. The question here remains whether these diversification efforts will pay off in the long term. For now investors seem to think they will.

This article was originally written for the Motley Fool Blog Network. Make sure to read all of my daily articles for the Motley Fool at

Tuesday, May 22, 2012

New Global Food Crisis Looms

Most investors are well aware of rising oil prices and often try to figure ways to profit from this trend. Now another, perhaps bigger, risky trend is underway around the world – a repeat of the 2007-08 spike in food prices. It is not an area investors should ignore or underestimate since profits can also be easily made from rising prices for grains such as corn and soybeans along with meats.

What is causing the rise in prices? Mainly a lot of bad weather around the world coupled with very strong demand for grains coming from China.

The good news, when compared to the crisis of a few years ago is that the gains are less broad-based and are more concentrated in oilseeds including soybeans, rapeseed, canola and corn. Oilseeds are a source of cooking oil globally, but are also the main source of protein-rich feed meal used to fatten livestock (corn also is key in feed meal). This rise in feed costs in turn is already pushing up the price of meats globally.

The price of soybeans is already up more than 20 percent since the start of the year and is trading near $15 a bushel. Many in the industry believe that the price will challenge the all-time high of $16.63 a bushel set in mid-2008. Soybean production is down sharply in many of the crucial growing areas in Latin America including Brazil, the world's second biggest producer, thanks to La Nina causing hot and dry weather in the region.

This is a key point for investors to take in since Latin America produces more than 55 percent of the world's exports of soybeans. Add to that the fact that US farmers are planting less soybeans this season and it should come as no surprise that the US Department of Agriculture now estimates that global soybean production in the current growing season will suffer its biggest annual drop since record keeping began in 1965. This output drop comes at a crucial time too since Chinese imports of soybeans increased 20 percent in the first quarter of this year.

The situation for the global corn crop is not as dire since US farmers are increasing their planting of the crop. However corn prices are hovering at about $6 a bushel, triple the level they were just a decade ago and poised to move even higher.

China, which is not normally an importer of corn, is in the market. Expectations in the industry are for China to place its largest orders for corn in the 2011-12 and 2012-13 crop seasons since records began in 1965. It is believed that with appetite for meat rising in the country that China needs the corn for animal feed.

So how can investors play these rising food costs? One obvious way is to own the companies that trade grains globally like Bunge or Archer Daniels Midland.

A better way is to own companies that produces seeds for farmers – Syngenta AG ADR (NYSE: SYT) and Monsanto (NYSE: MON). Syngenta makes corn and soybean seeds while Monsanto produces genetically modified versions of corn, canola and soybean seeds. Monsanto forecasts that demand for corn is expected to rise to 2.5 billion bushels from 1 billion, while demand for soybeans will jump to 1 billion bushels from 200 million bushels in just the next five years. Syngenta has a similar forecast.

Of course, exchange traded funds offer investors a quick and easy way to invest into this agricultural trend. The most liquid and broad-based ETF is the PowerShares DB Agriculture Fund (AMEX: DBA). It is composed of futures contracts on various agricultural commodities. Right now, it has over 13 percent in soybean futures, nearly 12 percent in corn futures, 7 percent in hog futures and over 17 percent in cattle futures (remember those rising meat prices).

If investors want to invest specifically in corn and soybeans, there are two funds available. These are the Teucrium Corn Fund (AMEX: CORN) and the Teucrium Soybean Fund (AMEX: SOYB). Both these funds have positions in crop futures traded on the Chicago Board of Trade – corn and soybeans respectively.

This is a trend that should stay in place for the foreseeable future. According to Richard Feltes, vice-president at commodities broker RJ O'Brien in Chicago, the market is “not going to see food inflation abating in the next 18 months to two years.” In the meantime, investors should be able to eat up some profits from these rising prices.

This article was originally written for the Motley Fool Blog Network. Make sure to read my daily articles for the Motley Fool at

Thursday, May 17, 2012

Bank Bears Reawaken

Until late last week, the group which led the S&P 500 in gains for the year so far was the financial sector. This group of stocks was up nearly 15 percent for the year, nearly double the gain made by the broader market. But financial stocks fell sharply on Friday after JPMorgan (NYSE: JPM) stated it had made “egregious mistakes” and incurred significant ($2 billion) mark-to-market losses in credit derivatives since the end of March. And the company warned the losses “could get worse”.

This was terrible news for the shareholders of any of the investment banks as worries spread across the sector about the strength of banks' balance sheets and Wall Street's business model. Other stocks to suffer in the selloff include the investment bank poster child Goldman Sachs (NYSE: GS), Citigroup (NYSE: C), Morgan Stanley (NYSE: MS) and Bank of America (NYSE: BAC).

Broad investor sentiment to the JPMorgan announcement was summed up by Oliver Pursche, portfolio manager at Gary Goldberg Financial Services, “It is a reminder that when it comes to the financial sector, investors still have to be very guarded. There are still just too many uncertainties, way too many gimmicks within those balance sheets.”

Mr. Pursche is likely correct. Look at JPMorgan's $2 billion loss. Its 'chief investment office' is just a fancy name for a proprietary trading desk for the company. Since it is located in London, a question should immediately pop into investors' mind...was JPMorgan trading with their money or customers' money?

London is the place to be if you want to use other people's money to make money for yourself. Just think back to the MF Global scandal. They used a process called 're-hypothecation', which occurs when banks re-use the collateral posted by clients such as hedge funds to back the bank's own trades and borrowing. London is the center of re-hypothecated trades on the planet since there is no limit on the amount of client assets that can be re-hypothecated even if the client had an agreement with the bank that includes a ban on such practices.

Moving away from the murky world of shadow banking, the investment banks have another and more immediate worry on their hands – credit downgrades from the rating agencies.

Late on Friday, Fitch Ratings did downgrade JPMorgan's rating from AA- down to A+ and placed the bank on 'rating watch negative'. Standard & Poor's followed up by changing its outlook on the bank to 'negative' also.

A major talking point on Wall Street among the investment banks has been the recently announced Moody's upcoming review of the banks which is scheduled to be issued in June. Moody's had already put Morgan Stanley and several other banks on review for a downgrade in February. It is believed that JPMorgen may face as much as a three notch slide in its ratings while other banks including Citigroup and Goldman Sachs have a two-notch slide looming over them. Bank of America has the potential for a one-notch slide in its rating.

Morgan Stanley said last Monday that if such an event occurs, it would have to pony up another $7.2 billion in collateral if its rating was changed by Moody's and Standard and Poor's. That is more than an 50 percent increase from its last estimate. Other investment banks, if downgraded, will also face raised borrowing costs and increases in required collateral.

For a long time, the stock market has ignored the problems with the major banks which never really went away from the 2008 financial crisis. But that may be changing now. It looks as if the good times for the banks and their investors are over and it may turn out to be a long, hot summer for the sector.

This article was originally writtern for the Motley Fool Blog Network. Be sure to read my daily articles for the Motley Fool at

Tuesday, May 15, 2012

The Cola War Is Over for Pepsi

One of the world's most familiar food and beverage companies is PepsiCo (NYSE: PEP). Its brands are known all across the globe including Frito-Lay, Gatorade, Tropicana, Quaker and, of course, the iconic cola brand Pepsi.

Pepsi is also famous for the decades-long battle to be the top-selling carbonated beverage with its bitter rival, Coca Cola (NYSE: KO). The conflict between the two rivals raged back and forth for years across the country's grocery shelves. Coke usually held the upper hand but, at times, Pepsi would put its nose in front as smarter and more aggressive advertising campaigns worked their magic.

But then with the arrival of former management consultant Indira Nooyi in 2006 as CEO, the game changed. She decided to not fight Coke directly, but to try and redefine the playing field by making a push into healthier snack foods and drinks among other initiatives.

And she is still trying to redefine the playing field. The latest move by Ms. Nooyi involved asking Wall Street analysts and investors to look at Pepsi in a different way. She wants everyone to see the company's overall beverage portfolio – the “total liquid refreshment” market – rather than just looking at its carbonated soft drinks business.

Many investors remain unconvinced, as evidenced by its poor stock performance over the past few years, as Pepsi basically ignored the core of the company – the carbonated soft drink market – in favor of other endeavors. Investors holding Pepsi stock for the past five years are still underwater.

Pressure from disgruntled shareholders did force Pepsi management to announce in February a restructuring plan which cut costs while reinvesting $500-$600 hundred million into 12 core megabrands like Pepsi Cola. The plan is being implemented as just this week the company launched its first global advertising campaign for its flagship cola. Pepsi is also, for the first time ever, integrating its snacks and beverage marketing. Its Frito-Lay business needs help too with North American sales slowing due to strong competitive headwinds.

Pepsi has to act and soon because its rival Coke is not sitting by idly. Take the total liquid refreshment market that Ms. Nooyi is fond of speaking about. Rumors are that Coca Cola is eying a major move there and contemplating an acquisition of the energy drinks company, Monster Beverage (Nasdaq: MNST), formerly known as Hansen Natural. Coke already distributes the company's drinks across the nation. The only question is whether it is willing to pay the steep price necessary to take over the company.

Monster definitely has attractions to entice Coca Cola. The energy drinks category of beverages is especially popular among younger people looking for that extra jolt of caffeine. Last year Monster Beverage had net income of $286 million on net sales of $1.7 billion. According to data from Beverage Digest, the company in 2011 accounted for 1.2 percent of total carbonated drink sales. However, sales volumes for the company jumped by 15 percent while the rest of the carbonated drinks categories declined or were flat.

Against increasing pressure from Coke and other rivals, what should Pepsi do?

It should not do what some analysts believe it plans to do...sell its PepsiCo Americas Beverage business and lose exposure to the emerging markets of Latin America. It is believed that Anheuser-Busch InBev ADR (NYSE: BUD) is eager to take the business off Pepsi's hands. BUD is looking to achieve greater soft drink and beer penetration into the fast-growing Latin American market. And BUD has the necessary size and expertise in Latin American markets to make the needed investments into the business.

Perhaps the best move for Pepsi, if it does not want to continue the cola wars, is to simply break the company along the lines that Kraft Foods (NYSE: KFT) is planning to do. Kraft will split into two world class companies later in 2012. The North American grocery company, with roughly $18 billion in sales, will retain the Kraft Foods name. The global snacks business, with about $35 billion in sales, will be called Mondelez International and will trade under the symbol MDLZ.

Pepsi split into two companies – a beverage company and a snacks company – would likely be worth more than the company is right now. That would be a welcome reward for increasingly impatient PepsiCo stockholders.

This article was originally written for the Motley Fool Blog Network. Make sure to read my daily articles for the Motley Fool at

Friday, May 11, 2012

China Is the Key to Apple's Future Growth

Any investor that hasn't been under a rock in the last few weeks is aware that Apple (Nasdaq: AAPL) once again topped Wall Street forecasts for its performance in the second quarter of 2012.

Behind the latest surge in Apple's results was the news that the company had sold 35 million iPhones during the quarter, ahead of most estimates. Sales of the iPad came in ahead of estimates also at 11.8 million, 150 percent ahead of the year ago period.

Apple itself stated that the surge in iPhone sales was due largely to strong performances in international markets. And there is the key for Apple investors. Apple's future fortunes lie in overseas markets and most importantly in China.

Consider this bit of information which came out of the recent Apple earnings conference call. Sales in greater China during so far this fiscal year came to $12.4 billion, compared to sales of $13.3 billion for the whole of the 2011 fiscal year! Sales of the iPhone in the second quarter were more than 5 times higher than during the same period last year.

And it's not just the iPhone and iPad which are flying off store shelves in China. Even Mac computer sales were up more than 60 percent in the country, well above the 6 percent growth rate for the personal computer market there and the 7 percent growth for Mac worldwide. The “cult” of Apple seems to be growing there, amazing even CEO Tim Cook who said on the conference call “It is mind-boggling that we could do this well [in China].”

China already is the second biggest market for Apple in terms of sales, trailing only the United States. The company's second quarter China sales came in $7.9 billion, accounting for a chunky 20 percent of Apple's total second quarter sales of $39.2 billion. These sales in the second quarter of 2012 pushed the Asia Pacific region to surpass the European region for the first ever in terms of revenues to Apple.

The good news for its investors is that Apple has barely scratched the surface in China. The number of point of sales in China is only 11,000 for iPhones, 2,500 for iPads and just 1,800 for Mac. Consider also that its stores in China are among Apple's most heavily trafficked in the world. No wonder that Tim Cook thinks that Apple's strong results in the country are just the tip of the iceberg.

He and Apple look to be right. Apple's success in China underscores the depth of the country's fast-growing upper middle class. As Mr. Cook said, “I've never seen so many people rise into the middle class who aspire to buy Apple products.” It is this large number of aspirational, upwardly mobile Chinese citizens that likely hold the key to Apple's future growth and success as a company.

Wednesday, May 9, 2012

Intel and Arm Holdings Jockey for Position

Semiconductor giant Intel (Nasdaq: INTC) recently forecast that its second quarter revenues would come in ahead of Wall Street expectations at $13.6 billion. The company's optimism is due to the fact that new products would be launched in this quarter which would feature its new processors, including Intel's first to appear in smartphones.

In effect, Intel is betting on a combination of good sales results this year from new markets (smartphones and tablets) for Intel along with the launch of the new Windows 8 operating system from Microsoft (Nasdaq: MSFT), creating excitement in the mature market of PCs where it dominates. But in both areas, Intel will be going head-to-head against chips designed by the UK firm, ARM Holdings PLC ADR (Nasdaq: ARMH). Intel chips have traditionally been faster than Arm chips but are power guzzlers when compared to battery-saving Arm processors.

Windows 8 will be the first operating system from Microsoft that will be compatible with Arm-designed processors. Microsoft expects that factor to help increase sales of Windows 8 markedly. Intel is coming out with its third generation of Core microprocessors, called Ivy Bridge, with which it intends to defend its territory from competitors who will be using manufacturing Arm-designed chips for PCs. Circuit widths in these Intel microprocessors are shrunk from 32 to 22 nanometers (billionths of a meter), offering improved performance.

But perhaps the most interesting part of this growing conflict between Intel and Arm will be to see how well Intel does in areas where Arm is currently dominant, like smartphones and tablet computers. Intel has launched a major advertising campaign aimed at promoting its Ultrabook concept of thin, light laptop computers (as opposed to Apple's MacBook Air) and has plans to supply chips for the tablet computer market soon.

Smartphones are developing into an even more competitive segment. Just this week, the first smartphone powered by Intel-designed Atom microprocessors went on sale. The Xolo X900, from little-known Lava, went on sale in India for $423. The new phone has a single-core 32 nanometer Atom processor now, but a double-core 22 nanometer Atom processor will replace it later this year.

That won't do much for Intel, but the good news is that major companies including Lenovo Group Ltd. ADR (OTC: LNVGY) and Motorola Mobility Holdings (NYSE: MMI) have plans to come out with Intel-based smartphones soon. However, the Lenovo Android phone – the K800 – will only be available in China, so Motorola will be the key partner for Intel's global hopes for its latest version of its Atom processor, Medfield. In January, Motorola did announce a multi-year, multi-device partnership with Intel for Atom-powered phones would kick off this summer.

Intel does have an opening against Arm-based chips, at least temporarily. Rivals like Qualcomm (Nasdaq: QCOM) generally rely on Asian foundries like Taiwan Semiconductor to manufacture their chips. Qualcomm did recently warn that it was having trouble getting enough 28 nanometer chips from its partners in Asia.

Over the long term, one key for success may lie in Intel's ability to shrink its chips further. According to analysts at the research firm ISI Group, sometime at the end of 2013 Intel should be manufacturing 14 nanometer microprocessors for smartphones, giving it a distinct advantage. It remains to be seen if this advantage pans out. After all, ARM will not be sitting by idly.
This article was originally written for the Motley Fool Blog Network. Make sure to read all my daily article for the Motley Fool at

Tuesday, May 8, 2012

US Railroads and the Coal Slump

The US railroad industry has always been the heart of the nation's industrial economy. If the country's major railroads – Union Pacific (NYSE: UNP), Norfolk Southern (NYSE: NSC), CSX (NYSE: CSX) and BNSF, owned by Berkshire Hathaway (NYSE: BRK.B) – were in robust health, it meant good things for the economy.

But does that still hold true today? It may not, thanks to the impact that increased government environmental regulations and decade-low natural gas prices are having on the domestic coal industry.

The US railroad industry traditionally has gotten roughly 20 percent of its volumes from transporting coal, mainly to power utilities, across the country. Overall coal traffic on the rails in the first quarter of 2012 dropped by 14 percent from the year ago period, with revenues derived from coal traffic falling by 5 percent to $832 million. The only thing keeping things from getting worse was a 19 percent rise in coal exports from the first quarter a year ago.

This is significant because of the impact it will have on earnings at the rail companies. Barclays Capital says that for every 1 percent change in the amount of coal they ship, earnings per share will swing 0.2 percent at Union Pacific and 0.5 percent at both Norfolk Southern and CSX. Partially offsetting the effect of coal though will be improvement in other segments.

Rail companies' revenues from transporting shipping containers and the like rose 19 percent to $389 million on a 9 percent gain in traffic. Other key segments including agricultural, automotive and construction rose 10 percent in the first quarter to $1.68 billion on a 3 percent traffic gain. This segment was actually enhanced by the sharply increasing movement of fracking sand, which is used in shale gas and oil drilling, across the country.

The drop in coal shipments by the rail industry to power utilities nationwide may be the beginning of a trend which looks set to continue as long as natural gas remains so cheap. If so, this could mean a rather permanent falloff in railroads' revenues.

The rail companies are well aware of that possibility. Senior executives at CSX were discussing this after revealing that the company's coal shipments in the first quarter to electric power stations were down 28 percent from a year ago. They stated that US railroad companies would have to sit down with power companies across the United States to discuss revising their contractual agreements for delivering coal.

There may be a secular change occurring in the electric industry, where coal is only used for power during peak demand and natural gas is used for the majority of power needs. If so, the railroads do not want to have pay the entire expense of maintaining excess capacity, to deliver coal, which is used only occasionally. The companies want the utilities to share the maintenance costs and thus the need for “discussions” between the two industries.

For investors in these two industries, the results of these upcoming discussions may very well affect the future profitability of both industries and in turn shareholder returns.

This article was originally written for the Motley Fool Blog Network. Be sure to check out my daily articles for the Motley Fool at

Thursday, May 3, 2012

Nokia's Last Hope: Lumia

Mobile phone manufacturer Nokia ADR (NYSE: NOK) is no longer Finland's most valuable company as measured by market capitalization. The latest fall in Nokia's share value came after the company announced a surprise profit warning and technical glitches associated with its new Lumia phones.

Lumia is the first Windows-based phone that came as a result of the collaboration between Nokia and Microsoft (Nasdaq: MSFT). It was jointly launched in the US by Nokia, Microsoft and AT&T (NYSE: T). The problem – it it had difficulty connecting to the internet on AT&T's LTE 4G network – came to light soon after the Lumia 900 phone went on sale in the US.

Even more surprising than the technical problems with its new phone was the surprise profit warning. Nokia warned that its low-end phone division – which had always enjoyed great success in the emerging markets – was losing market share much faster than expected. Sales in this division sank 35 percent in the first quarter to about $3 billion.

Low-end phones, which make up 30 percent of Nokia's sales, lost market share to both Chinese manufacturers and devices using the Android operating system from Google (Nasdaq: GOOG). The loss of market share, particularly to Samsung's Android devices, is in large part due to the fact that Nokia is dumping its current operating system, Symbian, rendering those phones obsolete in a few short years.

These recent events just continue to emphasize the fact that Nokia has been left behind in the smartphone race in the last few years. Nokia's decline has left its shareholders smarting. Its stock sank by a fifth just last week after the bad news, leaving it down 90 percent from its peak since the iPhone from Apple (Nasdaq: AAPL) was launched in 2007.

Perhaps the last hope for the company lies in its tie-up Microsoft and the resulting Lumia phones. It has not been an auspicious start for Lumia, however. Even ignoring the technical glitches, initial sales (launched in November globally) of the Lumia range of phones have been disappointing. In the first quarter of 2012, only 2 million Lumia phones were sold. In comparison, Apple sold 37 million iPhones during the same period.

It remains to be seen whether the Lumia 900, with its very reasonable $99 price tag here in the US, will sell. Nokia has even been forced to offer a $100 credit on phone bills to anyone who buys it before April 21 in an effort to stimulate dull US sales so far. Of course, both Microsoft and AT&T are hoping Lumia succeeds too.

The lack of success so far for Lumia certainly calls into question whether consumers really want a Windows-based smartphone. If it turns out they do not want Windows-based phones, the tie-up with Microsoft has sealed Nokia's fate as it now has no future options except producing Windows phones.

Some investors already think the company is doomed as the cost of insuring the company's debt soared to a record high, implying that Nokia's debt was already considered to be “junk” status. The company is not dead yet though and still has net cash of 4.9 billion euros. However, it did burn through 700 million euros in the first quarter and has stated that it must continue spending heavily on marketing the new Lumia phones. So Nokia shareholders should not be surprised to see the dividend eliminated soon.

If the company burns through its cash pile, it may resort to selling assets in an effort to keep afloat. These assets could include mapping technology company Navteq or perhaps even some of its intellectual property rights. But if Lumia phone sales don't pick up some time this year, Nokia itself may be up for sale to Microsoft or other bidders. That would be a sad end for a company that once dominated the mobile phone industry.

This article originally was written for the Motley Fool Blog Network. Please make sure to check out my daily articles for the Motley Fool at

Tuesday, May 1, 2012

GE's Billion Dollar Gamble on Reshoring

The trend over the past several decades has been unmistakeable...manufacturing jobs in the United States have been moved offshore. That trend can easily be seen in one of America's blue chip companies, General Electric (NYSE: GE). At the end of 2011, a good number of its employees – 170,000 of 301,000 total – resided in countries like South Korea, Mexico and China.

However, GE has been one of the major companies leading the charge to bring manufacturing jobs back home to the U.S or 'reshoring'. Since 2009, the company has created 13,500 new jobs in this country with 11,000 of them in manufacturing. Overall, the United States has added 429,000 factory jobs in the past two years, barely replacing a fifth of the jobs lost during the recession.

And now GE is placing a large bet - $1 billion – on the company's domestic appliance business. This business, together with its lighting business, accounts for 6 percent of General Electric's revenues.

This will be a tough mountain for GE to climb. The North American appliances business is pretty much a no growth business. According to two of GE's appliances rivals, Whirlpool Corporation (NYSE: WHR) and Electrolux AB ADR (OTC: ELUXY) total sales in North America fell by about a quarter between 2006 and 2011. Whirlpool expects sales this year to grow by no more than 3 percent. No surprise then that this division's profit margin was only 3.5 percent last year, much less than the 15 percent or higher GE's other industrial divisions achieved.

GE is moving its appliances business back onshore because it found out, in the words of the chief executive of GE Appliances Chip Blakenship, that “over time [offshoring] wasn't that sustainable a business model” after enjoying the one-off cost benefit. These benefits have largely disappeared as wages have risen in China. When adjusted for productivity, U.S. wages will be only 2.5 times Chinese wages versus 4.6 times in 2006, according to the Boston Consulting Group. In addition, GE found that an extended supply chain generates some of its own problems due to higher energy costs.

The company decision to reshore these appliance manufacturing jobs back to the U.S. was based on several factors such as $17 million in tax incentives. But the main reason was the adoption of “lean” manufacturing techniques that make its U.S. plant in Louisville, Kentucky more efficient.

The interesting note here is that these techniques were pioneered by Japanese automaker, Toyota Motors ADR (NYSE: TM). These techniques also mark a dramatic shift away from the six sigma management culture at the company instituted by former CEO Jack Welch. Instead of a top-down management style, Toyota's methods places a stress on staff at all levels to focus on raising performance.

At GE's Louisville facility, the “lean” manufacturing techniques have meant putting all the functions associated with manufacturing appliances onsite such as development, design, engineering, quality control and production. GE's CEO Jeff Immelt said that, by using these lean production techniques, its Louisville plant has cut by 68 percent the time needed to build a dishwasher. Thanks to being 'lean', employment at the plant is expected to jump from about 4,100 today to 5,000 next year.

But as stated before, it will a tough go for GE. About half of all the appliances sold in the United States are imported. Korean competitors like Samsung and LG will be difficult to beat, not to mention Sweden's Electrolux and US-based Whirlpool. American workers surely hope that GE will be successful. As will its shareholders who would enjoy an upgrade in its brand if its $1 billion appliances gamble pays off.