As sub-prime mortgage debt continues to fill headlines, and hedge funds get taken out because of leveraged bets, ratings agencies have been in the spotlight. I profiled Moody’s Corp back in June when the mess began as a potential short idea. The trade worked out well as MCO dropped from 61 to a low of 52 on Wednesday.
Wednesday morning the company announced earnings and it has given the stock quite a boost (not to mention the market has been stronger helping to drive the price). While the news out of the company wasn’t particularly spectacular, it appears investors were mostly relieved that the news wasn’t any worse. The company actually beat estimates coming in with earnings of $0.76 on revenue of $641m. The figures are up 31% and 26% respectively from last year and show that for the time being, the company has had plenty of business as it rates newly issued securities and continues to sell its research.
A red flag was raised when the company re-affirmed guidance for the entire year saying revenue and EPS would still be at the low end of the previously given range despite weakness in Residential Mortgage Backed Securities (RMBS). If you look at this information critically, you will realize that beating numbers for the first half, and remaining flat on your full year guidance means you expect a slowdown in the second half. This isn’t exactly a news flash as it is widely known that financial ratings will be difficult, but it appears to be a little more serious than the company lets on in its public statements.
An analyst had a pertinent question about contagion during the conference call. Contagion is when markets become more correlated than previously thought and usually describes the idea of a worldwide recession where diversification in many markets becomes less effective as all markets are hit. Management noted that some contagion was possible but not to the extent many were speculating, and the company remains confident that diversification into many additional international markets will add stability.
A benefit to the stock is the fact that the company repurchased 7.7 million shares last quarter at a price of roughly $65. MCO has $800m still left in its stock re-purchase program and just authorized an additional program of $2 billion. John Neff from William Blair commented that it was interesting to see the company likely borrowing a good bit more to re-purchase stock when they are basically operating from a negative equity balance sheet. If rates continue to be firm or are bumped up to fight inflation, it will likely 1) cause a lower PE in many companies including MCO, 2) reduce the number of new issues thereby reducing MCO’s potential new ratings business, and 3) punish companies with a high debt load (maybe a company who borrowed too much to re-purchase shares?)
So I continue to look at the environment for MCO as challenging. I still have a short position that I hedged before the announcement but I am likely to roll out of the hedge as it has served its purpose. Volatility in this market and in this stock bring opportunity, but as always, make sure you are exercising discipline and risk control.
FD: Author has a short position in MCO
Additonal Reading:
The WSJ (8/15) has an interesting discussion of Moody’s and S&P’s assesment of sub-prime loans over the past decade.
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August 3rd, 2007 at 6:41 pm
hey zach, i have zero exposure to financials and realize they have problems… is now a good time to dip buy Goldman Sacs – GS 182s up 1% off 180s lows friday? the dip metric is hot: $55 off $235s.
August 3rd, 2007 at 6:45 pm
Goldman is a great name with strong fundamentals with the best management money can buy. It’s definitely not my forte to pick lows in stocks but I would be one willing to leg into some exposure on a day I begin to see strength in the name. If you’re disciplined about selling if you’re wrong, this may be a fine time to get involved, but I am just not good at picking low spots. Good luck!
August 3rd, 2007 at 8:09 pm
i agree about the danger. i just wanted to dabble in such a low price point on the charts. i will probably pass. Beside i finished my work on sina and iam gonna stick to that.
i have already bought up a more preferred dip, SINA 42s/43s, in front of mondays earnings report. BAIDU and SOHU have good reports and good market reactions…. upgrades… and i hope SINA, as a better grade industry player, will benifit from some of the same trends.
August 3rd, 2007 at 9:55 pm
Good luck with the SINA – sorry I didn’t get to it this week for you. It’s been a bit hectic as you can imagine.
My exposure is light. Today I made enough money to buy gas for the weekend
but thats a far shot better than losing my shirt in this volatility. Enjoy the weekend!
August 4th, 2007 at 2:38 pm
yeah. i am going to west palm today and wont be able to post much until tommrow. if you didnt make much long profits this week hopefully you did make it when the gettin was good, april-july. to me the nasdaq index has been washed out by the financials and is oversold. it should not go much lower cause its priced in deflating dollars. SINA – sina reports after the close monday so i like this $5+ dip very much. competitors Baidu had Q2 ‘07 +47% top line sequentials and smaller SOHU had +11% top line sequentials. weaker SOHU forcast about 28% sequentials for the 3rd quarter. SINA is positioned to do very well and has june’s google deal in hand when reporting and issuing guidance. you ought to consider opening a long or some lowish priced $40 calls. after sina iam going to back off trading. sunpower traded down to $38.03 friday the dip is $5.50+ so thats exciting. Broadcom was upgraded on thursday and the analyst pinpointed 4 catlyst for the small bounce off $29 to expand $11 to $40. i have no chip exposure and want to have some represtation in technolgoy rally. i will building up broadcom long inventory next week after sina earnings, aim to price below $33 in market is weak. key- make sure you are DVR-TIVO recording fast money every day. if you dont have a box comcast and the others rent them for $10 a month.
August 6th, 2007 at 3:39 am
if cmg cools off, where would you dip buy? when are you going to open STP?
August 6th, 2007 at 2:57 pm
monday morning… crox is slammed. the dip is $61s > 52.50 or $9. i have zero and iam opening longs with limited buying power.
August 7th, 2007 at 12:44 am
some drawing board ideas. monday may have seen the worst of the 11+ day index selloff. iam glad that financial industry index chart meltdown is exhausted for the short term.
the nasdaq closed 60 points off the lows. i would not be surprised to see this as the beginning of a steady multi day reflex rally. already Goldman Sas c has bounced +$12 off the $175 low point and American Express has bounced $5 off the $55.50 low point. SINA earnings were boring and the dip from $47 expanded to $7+ into the $39s. my oversized 88,000s long position averages $42 per share cost, and are 5% priced premature or perhaps worse tommrow. iam in a expanding state of >$200K+ MELTDOWN PANIC!! lesson belief this is a google of china caused greed on seqentials potential. not this quarter!!!! SUNTECHPOWER… STP found a $36.60 low point, where the dip maxed out for $7-ish this morning. i hope you got it in 36s/37s with slick limit orders, otherwise get on the bounce band wagon tommrow average in at market and slight pullbacks , and dont stall with unreasonable low limit orders. Broadcom- BRCM has offically blocked all Qualcomm imports, so i expect BRCM 1 month bounce off $29 to start expanding soon. Coach- should start rallying with the market and indexs. cover. most old economy consumer franchise stocks on my screen today, like McDonalds , roared today with 2%-4%. True Relgion Guru denim soared 6%+, another negative red flag for your short position danger. Crox- down $9+ to the $52s. a deep dip long position in crox would help hedge the Coach short.
August 7th, 2007 at 12:53 am
CHINA. touching SunTechpower and SINA …. the major Shanghi indexs rose 3% on friday to a new 52 week record. for monday they opened with priced strength in the morning and closed with further gains of 1.5% to 2.0%.
the Shanghi Chinese indexes are climbing very well during this 11+ days in the USA major averages / Index downdraft lead by finacials. i have 88,000s of sina priced at $42.00 and its falling $2 – $3 as of afterhours monday. stay or go?
August 7th, 2007 at 1:41 am
Zach,
Good call on Moody’s puts.
With the abrupt drop off in debt securitizations, rating agencies will get hammered. This is from Moody’s 2006 annual report:
“Approximately 80% of Moody’s revenue in 2006 was derived from ratings, a significant portion of which was related to the issuance of credit-sensitive securities in the global capital markets. The Company anticipates that a substantial part of its business will continue to be dependent on the number and dollar volume of debt securities issued in the capital markets. Therefore, the Company’s results could be adversely affected by a reduction in the level of debt issuance.”
Let’s take a closer look at Moody’s recent revenue growth. In 2002, prior to the huge wave of debt securitizations, Moody’s revenue was $1.0 billion with net income of $289 million. By 2006, revenue had doubled to $2.0 billion and profits jumped to $754 million.
Certainly, there is a significant risk that the Fed drops interest rates to keep this crack-up boom running along, however, it is doubtful that the easy debt securitization days are over for CMBS and LBO financings alike.
Finally, who is going to take the fall for all of this? Investment banks and retail investors are going to target groups like Moody’s.
Full disclosure: we own 2009 put LEAPs on MCO.
August 7th, 2007 at 1:58 am
yeah that coach hit bottm near $44 this morning. i would cover.
August 7th, 2007 at 3:49 pm
2 day STP starter bounce expands 36.60 > 40.60
+$4.00 +11%
August 7th, 2007 at 7:31 pm
SINA dip expands 47 > 38 $9 or 18%. if you have no inventory the price point is attractive.