Corporate America Slims Down

2/28/2011


For many of us, the phrase "efficiency expert" might call to mind a guy with thick glasses and a clipboard, counting paper clips and counseling executives to stop buying donuts for morning meetings.

But when times get lean, efficiency becomes a sexier topic, as companies cut back on a myriad expenses in an effort to beef up the bottom line. It seems as if everyone has gotten into the act.

The S&P 500 Index's operating profit margins fell to 10.3% in the September 2009 quarter, the lowest point in at least 17 years. Through a combination of higher sales and aggressive cost cuts over the next four quarters, margins widened to 14.6%. Strong profit growth has the index on a pace to have reached 15.3% in the December quarter. That 15.3% would mark the fattest operating margin since the December 2007 quarter.

The margin gains reflect broad-based improvements. Over the last year, the average operating margin increased for all nine nonfinancial sectors within the S&P 1500.

Efficiency improvements have also manifested themselves through statistics other than operating margins. In the 12 months ended September (December-quarter numbers will not be available until the last index component declares earnings), the index posted a 13.8% return on equity. ROE, or net income as a percentage of shareholders equity, had dipped to 2.8% a year earlier.

In an effort to tap into the efficiency movement, we screened for quality stocks that have increased their profit margins and ROE while reducing the time required to turn inventory and receivables into cash. The table below lists 10 stocks that passed our tests. Three are reviewed below.

Lam Research ($54; LRCX) makes etching products used to create integrated circuits. It derives half of its sales from three companies and can be prone to sharp swings in revenue. But the entire semiconductor-equipment group enjoys favorable trends in analyst estimates, boosted by impressive December-quarter results. Wall Street sees Lam growing per-share profits 44% in the March quarter and 20% in the June quarter.

Competition among the biggest makers of semiconductor equipment can be intense. But these companies tend to compete on performance rather than price, helping to protect profit margins. In the past year, Lam's days to sell inventory declined 43%, while the average collection period fell 25%. Return on equity has steadily improved in each of the last four quarters after turning negative in 2009.

Lam generated free cash flow of $5.04 per share in 2010, versus a negative amount in 2009. The company's cash holdings rose 60% last year and now equal $8.11 per share, 15% of the share price. Lam scores among the top 35% of U.S. stocks in all six Quadrix® categories. With an Overall score of 100, Lam Research is a Buy.


Research In Motion ($67; RIMM) has widened its operating profit margins by 6.4 percentage points over the last year. RIM attributes that gain to a shift in product mix and higher service revenue from additional subscriber accounts. Service revenue (16% of total sales) jumped 51% in the nine months ended November. Making up for a 9% decline in the average selling price of its BlackBerry devices, RIM sold 43% more units in the nine months ended November.

RIM's return on equity is steadily rising, nearing the record level experienced in the August 2008 quarter. And over the last four years, both revenue per employee and net income per employee more than doubled.

The company is moving its inventory at a historically fast pace. On average, it took 23 days to sell inventory in the 12 months ended November, down from 28 days a year earlier and 41 days in fiscal 2008 ended February. RIM's inventory rose 11% in the year ended November, well below the sales-growth rate of 29%, another sign of efficiency. The stock earns a Financial Strength score of 94, Quality score of 99, and Overall rank of 100. RIM is a Buy and a Long-Term Buy.

Stryker ($62; SYK) generates solid returns on assets, equity, and investment — all three metrics rank in the top 20% of our research universe.  The medical-device maker's operating profit margins also widened by 3.5 percentage points in 2010. The fruit of these operational efficiencies has been stashed on its balance sheet. Net cash of $3.84 billion, or $8.57 per share, rose 15% in the past year and accounts for 14% of Stryker's stock-market value.

Stryker has weathered hospitals' recessionary budget cuts and is starting to see a better purchasing environment. The medical and surgical business, of which 60% is capital equipment, grew 16% in 2010, rebounding from a 5% decline the previous year. Growth in orthopedic implants, which carry higher margins than Stryker's other products, remains weak, as cash-strapped patients seem reluctant to pursue knee and hip replacements. The unit's sales rose 5% last year, on top of a 4% gain in 2009. As the economy improves, Stryker stands to benefit from the pent-up demand for both hospital capital equipment and joint replacements. New-product launches, coupled with stronger volumes, should help mitigate pricing pressure and expand market share. Stryker is a Long-Term Buy.

SCREEN OF THE MONTH — IMPROVING EFFICIENCY
We screened for A-rated stocks that have increased operating profit margins and return on equity while reducing days to sell inventory and average collection period over the last year. All of the stocks that passed the screen earn Quadrix Quality and Overall scores of at least 70. Stocks recommended for purchase are presented in bold.
Operating
--- Profit Margin ---
Return
----- on Equity -----
Days to Sell
----- Inventory -----
Avg. Collection
--- Period (Days) ---
------- Quadrix Scores * -------
Company (Price; Ticker)
Last 12
Months
(%)
1 Year
Earlier
(%)
Last 12
Months
(%)
1 Year
Earlier
(%)
Last 12
Months
1 Year
Earlier
Last 12
Months
1 Year
Earlier
Quality
Fin'l
Str.
Overall
Applied Materials
($16; AMAT)
17.1
NM
12.9
NM
105.7
202.6
60.0
92.8
74
82
95
Corning ($23; GLW)
22.2
9.3
20.6
14.4
87.5
92.0
49.2
49.6
94
89
99
CSX ($73; CSX)
29.2
21.3
18.0
13.4
12.1
14.5
33.0
37.5
92
61
96
DuPont ($54; DD)
11.6
8.4
36.3
24.4
87.0
90.2
79.2
85.5
70
50
79
EMC ($27; EMC)
16.5
9.7
11.6
7.7
52.0
57.0
44.4
48.3
83
81
89
Hewlett-Packard
($43; HPQ)
10.5
9.0
20.9
19.7
26.0
25.4
58.8
59.2
80
41
94
Lam Research
($54; LRCX)
26.0
NM
37.9
NM
74.6
131.4
67.0
89.9
95
94
100
Microsoft
($27; MSFT)
39.6
32.7
44.4
41.4
27.0
30.2
60.3
61.6
91
92
95
Research In Motion
($67; RIMM)
23.9
17.5
42.2
35.6
23.0
28.3
64.9
65.0
99
94
100
Stryker ($62; SYK)
25.3
21.8
18.5
18.4
170.6
174.0
57.0
59.1
86
83
88
* Quadrix scores are percentile ranks, with 100 the best.   
NM Not Meaningful because profits were negative in the year-earlier period.

 


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