C.H. Robinson Worldwide, Inc. (CHRW)
C.H. Robinson Worldwide, Inc. , the leading provider of domestic truck brokerage services, posted 25% growth in earnings per share in its most recent quarter, beating Wall Street estimates for the seventh consecutive quarter.While this growth rate is a deceleration from the 30% level that Robinson experienced through much of 2006, we believe that it demonstrates the company’s ability to outperform even in the face of slowing end-market demand. The freight environment, as reflected by total truck tonnage, has been declining (down 6%- 10% year over year) since last Fall. These rates of decline are the largest since early 2001, chiefly due to a slowdown in certain sectors of the economy with large freight requirements: autos, housing, and industrial materials.
As a pure truck broker, Robinson can weather slower demand by auctioning off what scarce freight exists to its network of 40,000 independent carriers. This can result in reduced purchased transportation costs and higher gross profits. Furthermore, the company can react quickly to the supply/demand of the market and adjust its branch-based hiring needs, leading to operating margin expansion as headcount grows slower than revenue growth. In addition, Robinson’s balance sheet contains $500 million of cash and no debt, and its annual free cash flow generation remains quite significant. The company plans to use this cash to repurchase shares, increase its dividend, and make strategic acquisitions into other higher-margin logistics segments like international freight forwarding.
Tiffany & Co. (TIF)
Tiffany & Co. has generated sparkling results and returns for shareholders of late, as its shares have advanced approximately 50% during the past six months. We believe this has been due to four principal factors: First, Tiffany’s strategy to open smaller (5,000 sq. ft) stores in smaller domestic markets, such as Tucson , Nashville , and Indianapolis . Competition for fine jewelry is less intense in these markets, and the iconic Tiffany brand has proven to resonate strongly among consumers there. Second, international markets, driven by Europe and Asia ex-Japan, have experienced double digit same-store-sales gains, as the cachet of the Tiffany brand has remained fresh and new overseas. In China , Tiffany has just six stores today, and we believe the potential exists for fifty more boutiques over time. Third, we believe that Tiffany also has a meaningful opportunity to improve profitability over the near-term with operating margins three full percentage points off peak levels set in 2000. The company has been in a major investment mode the last five years with capital expenditures increasing from 7% of sales to 14%. Now that the bulk of its investment projects have been completed, free cash flow has increased, and the company has returned value to shareholders in the form of large share repurchases. Fourth, record inflation in precious metal costs may be abating. For example, platinum and silver prices have each risen more than 130% during the last five years. As precious metal costs have begun to moderate, Tiffany appears to have enjoyed relative inelasticity to its price increases for fine jewelry. While Japan , where the brand is saturated, remains a sticking point for the company, we are hopeful that Tiffany’s renewed agreement with Mitsukoshi will allow the company to exit several underperforming locations and focus on its own stand-alone stores and other upscale partner doors including Takashimaya and Seibu.
Chicago Mercantile Exchange (CME)
Chicago Mercantile Exchange’s share price increased during the quarter as a result of continued strong volume growth in its core futures business. Average daily trading volumes rose approximately 30%, helped by the spike in equity market volatility in late February. In addition, we believe that there remains excitement surrounding the recent launch of its foreign exchange trading joint venture with Reuters. We believe that shares might have ended the quarter even higher if not for the increased uncertainty surrounding its planned merger with the Chicago Board of Trade. In mid-March a third futures exchange, the InterContinental Exchange, made a competing bid for Chicago Board of Trade. We believe that this announcement likely put downward pressure on Chicago Mercantile Exchange’s share price because of concerns that it may need to increase its bid to acquire the Board of Trade. (Katherine Harman)
Southern Union announced its longawaited strategy to enhance shareholder value on February 28 th 2007 . The plan calls for the company to create a master limited partnership (MLP) later this year, to which its initial contribution will be its Southwest Gas Storage assets. The MLP is expected to allow Southern Union to arbitrage the lower cost of capital inherent in the partnership structure, and we believe it is likely that other company assets will be sold to the MLP in the future. The company also outlined several organic growth projects it is pursuing while maintaining its commitment to an investment grade credit rating. Finally, late in the quarter, Southern Union received a final order in its Missouri Gas Energy rate case that was slightly favorable relative to expectations.
FactSet Research Systems Inc. (FDS)
FactSet Research Systems Inc. is a rapidly growing supplier of financial intelligence to the global equities investment community. FactSet’s core applications include tools that help investors perform detailed, data-driven analysis on individual companies and industries, screen for new investment ideas, monitor markets via real-time news and quotations, and better understand the components of portfolio performance. We believe that FactSet, which competes with Bloomberg, Reuters, and Thomson, offers a differentiated product in an increasingly undifferentiated industry. FactSet’s data offerings are significantly broader than its competitors’ because it offers users licensed data from multiple sources (including from competitors Reuters and Thomson) in addition to its own proprietary databases. Since competitors only offer internal data sources, FactSet’s users are able to employ a much broader array of analyses. We believe that FactSet’s Portfolio Analytics (PA) product is the most advanced amongst its competitors’, and enables money managers to understand portfolio performance at a detailed level. PA users upload their portfolio holdings to FactSet daily, thereby increasing the ‘stickiness’ of the product. Finally, FactSet offers an “always available” customer service model that users, consultants, and competitors all concede is far and away the best in the industry.
We believe that FactSet is currently serving just a small part of its addressable market. We estimate that FactSet’s existing product line currently addresses a $6-$9 billion subset of the financial intelligence market, implying an opportunity fifteen to twenty times larger than the $390 million in revenues earned in 2006. On a user basis, FactSet currently has just 30,000 subscribers out of a market that currently includes 500,000 potential users and is growing annually at a mid-single digit rate. Given a superior product and significant roomfor expansion, we expect FactSet to generate revenue growth in the high teen’s through the end of the decade. Interestingly, not all of the significant top line growth will necessarily come at the expense of its competitors. Historically, financial intelligence services have proven to be extremely sticky due to their low price relative to their value added and their tight integration into the research process via data uploads and Excel formulas. Therefore, we expect more users to have the opportunity to significantly improve the breadth and depth of their financial analyses via the FactSet platform regardless of whether they retain their legacy business information systems.
While FactSet’s end-user environment is presently strong, we believe that the company’s unique revenue model will help it continue to grow even if its endmarkets were to cool off. FactSet’s pricing model involves a base subscription cost of about $50,000 per year for the first two users. Customers then pay $6,000 for each incremental user, and pay incremental fees for access to additional databases and applications. In the event of a market downturn, clients may reduce their headcount. However, we expect that they will continue to perform the same depth of analysis and will, therefore, require the same level of content and application subscriptions. Additionally, given FactSet’s low installed base relative to those of its competitors, we believe that FactSet’s superior product offering will enable it to make new placements regardless of the state of the end market. As a result, we view FactSet’s user fees as the only truly variable component of its revenues, and we expect FactSet to be able to continue to post solid revenue growth independently of the broader market. This thesis appears to have been supported during 2001 to 2002 when the number of users declined by 25%, but the number of clients increased by 16% and revenue increased by 33%. (Neal Rosenberg )
SAIC, Inc. (SAI)
With more than $8 billion in projected revenues, SAIC, Inc. is the largest independent government Information Technology (IT) systems contractor (excluding multi-disciplined defense companies, such as General Dynamics, which have divisions that perform this type of work). SAIC was founded in the 1960’s amid the backdrop of the cold war. It functioned for the next forty years as a secretive, private corporation with broad- based employee share ownership, supported by the company’s internal valuation of its own share price. SAIC completed an IPO in October 2006, raising more than $1.1 billion.
SAIC has 44,000 employees (23,000 of whom have security clearances) focused on high-end IT work with various government agencies, including the Army, Navy, Air Force, and NASA. The programs on which SAIC employees work primarily address the government’s homeland security, defense transformation and intelligence needs. SAIC performs advanced technology development and research (e.g. information fusion, unmanned vehicle development and defeat of improvised explosive devices), systems engineering and integration (e.g. network connectivity and architecture design, as well as joint intelligence projects), and professional and technical services (e.g. logistics/product support, intelligence analysis and detection, and response to chemical, biological, radiological and nuclear threats).
The company’s key programs include generally well-funded, long-term government initiatives, such as (1) Future Combat Systems (FCS), a $2.7 billion ten-year program to outfit soldiers with state of the art communications systems; (2) Global Information Grid – Bandwidth Expansion, a $514 million five-year contract to engineer a high speed secure military fiber optic network, with an opportunity to build out the network under a $3 billion program through 2010; and (3) Information Technology Engineering and Support Services, a $428 million contract with the Department of Homeland Security.
SAIC has a diversified contract base, with 9,000 active contracts. Its largest contract comprises just 4% of revenues, and its top ten contracts comprise 14% of revenues. The overall federal IT budget was about $75 billion in 2006, with $63 billion of this contracted to outside companies. We expect the contracted portion to grow at a 5%compounded annual rate,meaning that by September 2011, it should exceed $80 billion. SAIC has a modest singledigit organic revenue growth profile (6%- 9%), but seeks to enhance this growth via acquisitions. Additionally, the company is in the midst of a substantial corporate restructuring program (more centralized control of project management and less inter-segment bid competitions), and expects to be able to improve its operating margins by 20 to 30 bps per year off its current level. We believe that in 2008, SAIC may be able to improve margins to a greater degree, as IT expenditures needed to create the operational improvements are reduced and the benefits are realized. As a result, we believe that SAIC should be able to grow its EPS by 15%per year for the next three to five years.