Fannie, Freddie, and other financial foibles

9/15/2008


Shares of Fannie Mae ($1; NYSE: FNM) and Freddie Mac ($1; NYSE: FRE) plunged on a proposed government bailout. The mortgage-finance giants, which combine to back about 75% of U.S. mortgages, will be placed under the control of federal regulators, who have the right to acquire nearly 80% of each company. The government will also hold $1 billion of senior preferred stock in each company and suspend all dividends for existing common and preferred stocks — moves that contributed to a sharp retreat in the preferred shares of both companies. The Treasury’s senior preferred stock will have the right to receive dividends before any other preferred or common shares. Fannie Mae is rated Neutral. Freddie Mac is not rated.

In related financial news:
Wells Fargo ($31; NYSE: WFC) said it would record a September-quarter noncash impairment charge for an undisclosed amount on its Fannie Mae and Freddie Mac preferreds. Wells Fargo is a Long-Term Buy.


Shares of American International Group ($18; NYSE: AIG) have been volatile, reflecting reports that the insurer may form a separate company to house underperforming assets, particularly mortgage-related securities. AIG is rated Neutral.


Federal regulators placed Washington Mutual ($3; NYSE: WM) on probation, requiring the thrift to provide updates and projections for earnings, asset quality, capital, and segment performance. Separately, WaMu ousted CEO Kerry Killinger, replacing him with Alan Fishman, former president and chief operating officer of Sovereign Bank, the nation’s second-largest thrift. WaMu is rated Underperform.

Retail review
U.S. consumers shopped carefully in August, generating little back-to-school buzz. U.S. same-store sales rose about 2%, according to Retail Metrics, but increased only 1% excluding Wal-Mart Stores ($61; NYSE: WMT). The discount giant posted same-store-sales growth of 3% excluding gasoline, nearly double the consensus estimate. Wal-Mart said bargain-hunting was not the only reason for the strong showing. Many customers are doing most of their shopping at Wal-Mart, buying both high-end and low-end goods rather than shopping at pricier specialty stores.

Deep discounter Family Dollar Stores ($27; NYSE: FDO) posted 3.6% growth in same-store sales, and the shares jumped on the news, with strength in consumables offsetting weakness in apparel. Kohl’s ($53; NYSE: KSS), Target ($56; NYSE: TGT), and J.C. Penney ($41; NYSE: JCP) all reported declines in same-store sales, while off-price retailer TJX ($34; NYSE: TJX) managed flat results. Wal-Mart is a Long-Term Buy. Kohl’s, Target, Penney, TJX, and Family Dollar retain their Neutral ratings.

Mergers and deals
Altria ($21; NYSE: MO) hasn’t quit the cigarette habit but wants to try more snuff. The tobacco company agreed to pay $11.7 billion in cash and the assumption of debt for UST ($69; NYSE: UST), a 29% premium to the smokeless tobacco firm’s market value before rumors about the acquisition drove up the price. While U.S. cigarette volumes are declining at a rate of 3% to 4% a year, smokeless volumes are rising 5% to 6% a year. Expansion into smokeless tobacco makes sense for Altria, but the rise in debt increases the shares’ risk. Altria is rated Neutral.


ConocoPhillips ($68; NYSE: COP) agreed to pay up to $8.2 billion for a 50% stake in Origin Energy’s coal-bed methane assets in Queensland, Australia. Liquid natural gas offers appealing growth potential, but the price paid by Neutral-rated Conoco was much higher than those seen for similar deals.


Zimmer ($72; NYSE: ZMH) agreed to buy Abbott Laboratories’ ($57; NYSE: ABT) spinal-products business for about $360 million in cash. The deal will boost the size of Zimmer’s spinal unit by more than 50% and reduce 2009 earnings per share by $0.08 to $0.10. Zimmer and Abbott are rated Neutral.

News roundup
The International Association of Machinists and Aerospace Workers, representing some 27,000 Boeing ($64; NYSE: BA) employees, struck Sept. 6. By most estimates, each week of a strike will trim Boeing’s per-share earnings by roughly $0.07 to $0.10, though profits could be recouped in 2009 with higher production volumes. A protracted strike might cause a delay in Boeing’s flight test program for the already-delayed 787 and negatively impact component suppliers, though it should have little effect on other large defense companies. In other news, the Pentagon postponed its award of a controversial $35 billion contract to build aerial refueling tankers, saying it could not review the proposals before the end of the year. Boeing will bid against Northrop Grumman ($71; NYSE: NOC) next year, under the new presidential administration. Boeing is rated Neutral . . . Hurricane Gustav was nowhere near as devastating to the energy industry as Katrina and Rita in 2005, but Transocean ($115; NYSE: RIG) reported minor to moderate damage to at least two of its rigs. One rig is being towed to a shipyard for repairs — and to avoid Hurricane Ike. Transocean is a Focus List Buy and a Long-Term Buy . . . According to published reports, Dell ($19; NASDAQ: DELL) is attempting to sell its computer factories, potentially abandoning the build-to-order business model the company pioneered. In other news, chairman and founder Michael Dell bought $100 million of company stock in September, bringing the stake controlled by Dell and his family to 13%. Dell is rated Neutral.

Freeport’s good bad news
Shares of copper and gold miner Freeport-McMoRan ($69; NYSE: FCX) have fallen more than $24 per share since the end of August, hurt by a sharp decline in copper prices and concerns about slowing growth overseas. Copper prices have fallen more than 12% from August highs to about $3.10 per pound, and futures markets project prices will remain close to that level over the next year.

On Sept. 10, Freeport warned of a “small scale failure” at its largest mine, lowering its 2008 copper and gold production estimates by 1.6% and 14%, respectively. Freeport trades at just six times the consensus 2008 profit estimate, which suggests Wall Street wasn’t confident in the estimate. At press time, three analysts had revised their 2008 per-share-profit estimates to reflect Freeport’s production guidance. The new estimates average $8.93, well below the $10.97 consensus before the announcement. While the consensus is certain to decline in the coming days, greater confidence in those estimates could help the stock’s price/earnings multiple expand. Freeport, still cheap at less than eight times the lowest profit estimate for 2009, remains a Focus List Buy and a Long-Term Buy.

Digest
A federal appeals court reinstated a class-action lawsuit related to Merck’s ($34; NYSE: MRK) Vioxx painkiller. A lower court dismissed the lawsuit last year. Merck is rated Neutral.


FedEx ($85; NYSE: FDX) raised profit expectations for the August quarter but reaffirmed guidance for the year ending May. FedEx is rated Neutral.


A Food and Drug Administration panel voted to approve Pfizer ($18; NYSE: PFE) osteoporosis drug Fablyn, which has already been rejected twice. Pfizer is rated Neutral.


In August, General Motors ($11; NYSE: GM) sold 20% fewer cars and light trucks in the U.S., while Ford Motor ($4; NYSE: F) reported a 27% decline in vehicles sold in North America. GM and Ford are rated Underperform.


Kimco Realty ($38; NYSE: KIM) plans to issue at least 10 million shares of common stock. The offering will boost Kimco’s share count by at least 3.9%. Kimco is rated Neutral.


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