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Recent articles:
• Behind the curtain at Standard & Poor's, 8/14/2002
• A bowlful of trouble at General Mills, 8/7/2002
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Readers weigh in on General Mills
Inbox: Letter-writers take a bite out of a previous column on General Mills and chew over CEO certifications, stocks under $20 and Emulex's decline.
By Jon D. Markman
Cereal, data storage and picks under $20 were among the top subjects of reader mail in the past month. So while I vacation in the tropics, I hope you enjoy the second installment of SuperModels Inbox. (See first Inbox here.)
Question: Your column of Aug. 7 ("A bowlful of trouble at General Mills") is spot-on. As an ex-Pillsbury marketing guy, let me tell you a tidbit that amplifies the companys new product dilemma: Most of the so-called 80 new products have not been tested. Mills cut their market research and R&D staffs by 40% a couple of months ago and ended a number of ongoing product tests. They gutted what many consider the crown jewel that identifies, formulates and commercializes all these new products. So while I expect there will be nearly 80 products, there will be many silly line extensions and some failed new products coming down the pipe as a result. -- Charles Grace
SuperModels: You mean to tell me those fiends have foisted Suddenly Potato Salad on the public without focus-group testing? Its enough to make you want to tie them up with Fruit By The Foot Pokemon Rolls and make them eat Tuna Helper Cheesy Broccoli till they bring back the professional tasters.
Q: I enjoyed the breadth of information shared and see value in shorting General Mills (GIS, news, msgs) on a rally. However, with the CEO and CFO agreeing to certify their financials from a press release on Aug. 5, it appears the unusual or other costs should be explainable. Thoughts? -- Mike Chadwick
SM: I wouldnt take much comfort from the certification process. First of all, the CEO and CFO were liable for the accuracy of the books with or without the certification. And ultimately they all have to sign. So its really an election-year charade. If the Securities & Exchange Commission ultimately finds problems in the books, you can bet the CEOs will have a battery of attorneys explaining why their miscue was merely a misinterpretation. After all, the very first clause of the SEC disclosure form offers them an out. It begins: To the best of my knowledge They can always pull a Ken Lay and say they didnt know. Anyway, the earnings-quality issues that I referred to at General Mills have to do with the overly liberal use of legal book-plumping.
Q: How does a guy with a journalism degree become so adept at high finance that he can rip a company so authoritatively? Most of your analysis boils down to General Mills having some unforeseen problems digesting Pillsbury. General Mills has been a huge free-cash generator forever. They decided, in light of mid-single-digit unit growth, to make a big acquisition in their field of expertise. How much you want to bet they succeed? -- George Burman
SM: I may only have a degree in journalism, but I also spent about a thousand breakfast-hours of my youth eating Cheerios. General Mills has indeed been a prodigious cash generator for years. But they bit off more than they can chew with Pillsbury. Im not the one who cut the outlook on their unsecured senior debt to negative -- the credit-rating agency Moodys did.
Q: Good article on General Mills. I immediately checked out the long-term return on capital relative to their five-year average, and the difference is shocking. Currently, it's only about 5%, a huge drop from historical levels in excess of 25%. No way they can cover their cost of capital. I'm baffled by analysts recommending this as a defensive stock. I am quite worried that shoddy analysis is being done because of the repercussions it has for the market. I know there have been a few articles about the use of pension gains to plump up profits, but if I am not mistaken, this is still largely undiscounted by the market. -- Eve Kendall (former sell-side and buy-side analyst and fund manager)
SM: I agree that there are still a variety of potential negatives that remain undiscounted by the market. The use of pension gains to boost profit is one. The other is the issue of expensing stock options. Even if neither Congress nor the Financial Accounting Standards Board ever requires companies to expense options, the fact that many large companies, such as Coca-Cola (KO, news, msgs) and General Electric (GE, news, msgs), have decided to do so voluntarily changes the game entirely. Its hard to imagine that major institutional investors will treat GE differently than, say, Intel (INTC, news, msgs) or Cisco Systems (CSCO, news, msgs) on this issue. Investors will estimate the amount that options cost, and deduct them from net income. Unfortunately, I am afraid that estimated options expenses will wipe out earnings at many large technology companies and put a lid on the advance of the Nasdaq for years. In a worst-case but valid scenario for a new options-expensing environment, we may find that the share prices of Intel and Cisco will have a hard time staying above single digits. The issue will not affect many old-line companies such as General Mills that never handed out many options below the top executive ranks.
Q: Thanks for your insightful article on Emulex (ELX, news, msgs) ("7 pitfalls for one of Nasdaqs last holdouts"). Shortly after your article was published, I took a short position in the stock. Upon reviewing their earnings statement yesterday evening, I noticed a number of negative trends. Also, you made a prescient call on goodwill, as they are taking the big hit in the coming quarter. That said, the magnitude of today's sell-off seems overdone, in relation to the size of the warning. What do you think now? -- Dennis Shiao
SM: Investors are shooting first and asking questions later these days. Despite the 35% shellacking the stock suffered on Friday, Aug. 9, I would think further deterioration to around the $9 area is likely, though not perhaps until after a period of consolidation.
Q: Three years ago I corresponded with you and other columnists at the CNBC site on a regular basis. We discussed and argued the merits of various stocks and had a great time doing it. I, for one, was wrong. I bit on the "new paradigm" idea. After a couple of painful months, I decided to listen to that inner voice and moved my money to cash. I had realized better than a 300% gain in my new Datek account and had taken more chances than a high-wire artist. So I put half my money back into the market and I bought boring. I put equal amounts of that 50% total into McDonald's (MCD, news, msgs), Nike (NKE, news, msgs), Tommy Hilfiger (TOM, news, msgs) and Pepsi Bottling Group (PBG, news, msgs). A couple of weeks ago that "little" portfolio was sitting on a near 19% gain for the entire period. Now I feel the time is right to begin to shop again. I'm searching for the "right" $9 stocks. Any opinions you may have, with prices up to $20, would be appreciated. In my humble opinion as an economist, I believe we're in the beginning of a recovery much like the early '70s. -- William C. Fields
SM: You are one of many people from the old mania days who have written lately, stating that they went high, fell back a bit, got out and are now considering wading in a toe at a time. Walter Industries (WLT, news, msgs) is an interesting reorganization story down in Florida. It operates businesses in iron pipes, foundry coke, aluminum, single-family homes, modular homes, home financing, water, coal mining and methane gas. Management, which is affiliated with the leveraged-buyout firm KKR, is trying to streamline operations, and they seem to have a decent chance of getting more out of less. Its management has certified its financial statements, and it recently raised earnings guidance for the current fiscal year. Cash flow is improving and debt is being repaid. If you think the economy is improving, this relatively cheap potential turnaround stock could offer some decent upside, possibly to $16 or better in a year from its current perch around $12.25. Our StockScouter rating system gives it a 7 out of 10. One way to play it might be to attempt to purchase it on a buy stop at $13 to clear local resistance, with a stop-loss around $11. Look out for a potential double-top at $15.
While Jon Markman cannot provide personalized investment advice or recommendations, he invites you to send comments on his column to jmarkman@microsoft.com. At the time of publication, he owned none of the stocks mentioned in this column.
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