The Caterpillar Steamroller

WASHINGTON – The road and transportation industry is already rolling its heavy equipment into town to lobby for the reauthorization of the Transportation Equity Act for the 21st Century, which is set to expire this September.

The law authorizes the U.S. federal government’s 45% share–now $38.8 billion a year–of all capital spending on highways and mass transit. But the industry wants more.

Some background: When the transportation act, known as TEA-21, was enacted in 1998, it tied spending levels to revenue collected by the government from highway user fees (various taxes on fuels, tires and so on) and credited to the highway account of the Highway Trust Fund. At the time, this was considered a victory for the highway lobby, since Congress had been allowing unspent money to accumulate in the Trust Fund to make the federal budget deficit look smaller. After TEA-21, the federal government spent what it collected.

But in 1999, just a year after TEA-21 went into effect, the American Road and Transportation Builders Association (ARTBA) began preparing for their next offensive. Those preparations have gotten intense. Last week, ARTBA, along with the Associated General Contractors of America, held a legislative “fly-in”: 500 people signed up, representing 28 construction and building associations and union groups.

Fanning out on Capitol Hill, those groups carried the standard of one of ARTBA’s primary goals: to move TEA-21 from a receipts-driven, “revenue in/spending out” setup toward more of a needs-driven approach. What that means is the road builders want spending determined by various assessments from the Department of Transportation and others of what’s needed to maintain and improve the transportation infrastructure in the U.S. If receipts coming into the Highway Trust Fund fall short of those needs, the lobby argues Congress should close the gap.

Highway and transit builders have a strong reason to want to focus on needs rather than receipts. Starting in 2002, receipts from user fees began to drop significantly, thanks largely to the impact of a slower economy and increased sales of gasahol, an Ethanol-based fuel that isn’t taxed for the Highway Trust Fund and is heavily subsidized–thanks to the farm lobby and the efforts of Archer Daniels Midland.

Full story at Forbes.com

Stocks In International Trouble Spots

WASHINGTON – When war broke out in Iraq, we spoke with David Cooley, manager of J&W Seligman’s Global and International Growth equity funds. At the time, he liked prospects for Israeli stocks, particularly generic-drug maker Teva Pharmaceuticals.

Since that conversation, Teva shares have jumped 15% while Israel’s benchmark TA-100 index has increased 14%. From a 52-week low set in February, the index is up 29%. “Buying in front of a big geopolitical event is a scary ticket to write,” Cooley says, “but it’s often the right one to send to the trading floor.”

Cooley’s contrarian tactics don’t just apply to emerging economies or regions addled by conflict. In the wake of Gulf War II, he gives us a pick from none other than the Federal Republic of Germany.

Full story at Forbes.com

Risky Procedure: Buying Medical Supply Stocks

Stocks of companies doing business in medical equipment and supplies are often described as “defensive” or a “safe haven.” Truth is, they’re not all that safe.

“You can be a long-term investor in this business,” says analyst Ryan Rauch of Boston investment bank Adams Harkness & Hill. “You just have to be able to stomach volatility.”

One example is Inamed, a Santa Barbara, Calif.-based maker of products for cosmetic procedures, such as saline-filled breast implants, collagen implants for wrinkles and silicone bands used to reduce the stomach capacity of obesity sufferers.

Like many of its peers in the medical equipment business, Inamed stands to benefit from a demographic tailwind as millions of baby boomers head toward their golden years. In 2002, Inamed’s facial aesthetics sales grew 10%, to $74 million.

Moreover, Inamed’s business extends well beyond the U.S. and Canada. In fact, the company pulls in one-third of its revenue from outside North America. Should the dollar continue its recent weakening trend, Inamed’s results will get a boost.

Not surprisingly, expectations for the company’s financial future run high. Analysts reporting to Thomson First Call think the firm will enjoy an annualized earnings growth rate of 17% over the next three to five years.

So what’s wrong with the “safe haven” argument? In a sense, medical supply companies may suffer from their own success. Since 1998, health care equipment stocks in the S&P 500 have risen 39%, versus a 19% drop for the entire index. With those results, however, come rich valuations and high hopes. At the first sign of something amiss, these stocks often get dumped.

Full story at Forbes.com

Peace Dividend

Sometimes it pays to search troubled regions for investment ideas. Last year, for example, with Israel suffering through suicide bombings and a deteriorating political situation, we suggested a few Israeli technology firms (FORBES, July 22, 2002). At last check that portfolio was up 33%, versus the S&P 500’s 10% decline.

“I think you do need to be a contrarian on the geopolitics to a certain extent,” says Christopher D. Alderson, head of emerging-market equities with T. Rowe Price. Alderson notes how Turkey’s reluctance to contribute to the U.S. military effort, which led to the country’s failure to win an aid package, has hurt its financial markets. As such, Alderson says, some Turkish stocks, like NYSE-listed Turkcell Iletisim Hizmetleri, have begun to look attractive. Driven down by concerns about the finances of a big shareholder, Turkcell has a price-to-sales multiple of 1.4.

Full story (reg. required) at Forbes.com

Is That Revenue for Real?

A little over a year ago Duke Energy declared it had finished its “best year ever,” despite Enron’s collapse and the other problems afflicting the energy business at the time. It reported revenue of $60 billion, by that measure making it the 13th-largest U.S. corporation.

But the “best year ever” didn’t look so great the following June, when a task force at the Financial Accounting Standards Board reached a new consensus on how to account for energy trading. Reversing a position taken in 1998, it decreed that energy trades should be recorded on a net, not a gross, basis. In other words, if a company trades an energy futures contract for $100,000 and makes a $2,000 spread on the trade, it should recognize as revenue only the $2,000.

Whoosh. Duke Energy restated its revenues going back to 1997. With 2002 sales of $15 billion, the company ranks 115th on this year’s Forbes Sales 500. The stock has fallen from $37 to $13 over the past year.

A lot of puffery has been going into the top line. According to the Huron Consulting Group, a Chicago firm focused on corporate finance and restructuring, revenue recognition problems were behind 85 of the 381 accounting restatements of public companies in 2002. Typical mischief: recording a sale without accounting for the fact that the buyer has the right to return the goods, or, worse, hasn’t even taken title to them; counting revenue from deals with unfulfilled obligations (such as future consulting services).

In February the Securities & Exchange Commission filed fraud charges against eight past and present employees of Qwest Communications. The SEC says that, among other things, Qwest cooked up false internal documents to justify treating a $34 million equipment sale as something that could be booked in its June 2001 quarter. Qwest has overstated revenues in other ways, for example, by swapping fiber-optic capacity with other telecom companies. As of the latest tally the company had restated its 2001 revenues downward by $1.3 billion, or 7%.

From July 1997 to July 2002 the SEC launched 227 investigations of suspected financial misreporting, 126 of them relating to revenue recognition. Improper timing of sales is the biggest offense–borrowing from the next quarter in a desperate effort to make the analysts happy for this quarter. The SEC also found 80 cases of utterly fictitious revenues and 21 cases of improperly valued revenue, such as the right-of-return cases mentioned earlier.

Full story (reg. required) at Forbes.com

Transportation Transformation

Ever taken the train from Atlanta to Birmingham? It’s a pokey affair. The train, part of Amtrak’s New York to New Orleans run, makes the Atlanta-Birmingham trip in a leisurely three hours. Driving the 150 miles between the two cities takes half an hour less.

In the U.S., such a situation is typical when it comes to traveling by rail. But the era of the slow train could be nearing its end. Spurred on by frustrated business leaders, state governments around the country are developing big-ticket plans for high-speed rail, and Congress looks likely to play ball.

Take the Southeast, for example. The chambers of commerce from no less than 14 Southern cities have banded together in a coalition known as the Southeastern Economic Alliance (SEA). The group, whose leaders include top executives from the likes of Bowater and Bank of America, has proposed a plan to upgrade freight lines and build new tracks to form a network of reasonably fast passenger trains (ones that would travel at 85 mph). With the improvements, that ride from Atlanta to Birmingham would shrink from three hours to under two.

Why such interest in rail? For one, Southerners drive more miles than anyone else in the U.S., and traffic congestion in Southeastern cities is expected to increase 400% from now until 2020. Air travel, too, has its share of problems. Last year, a quarter of all flights in the Southeast were delayed.

“Our population growth continues to be very strong,” says Charles T. Hill, a co-chair of the SEA and a Richmond, Va.-based executive vice president of Atlanta’s SunTrust Bank. “We’ll end up with a bottleneck if we’re not careful.”

In its literature, SEA underscores a new “business approach” to developing rail travel. For example, the alliance advocates getting rid of the long-haul rides that Amtrak now loses so much money on. Instead, the SEA plan would connect cities within 300 miles of each other, an idea that squares with expert thinking on the subject.

“Rail can play a role as a short- and medium-distance carrier,” says Hank Dittmar, co-director of Reconnecting America, a transportation policy think tank.

Full story at Forbes.com

A Value Line Pro Stands Pat On Stocks

Amidst the wartime market’s nervous swings, Philip Orlando, chief investment strategist with Value Line Asset Management ($4 billion in assets), stays steady with a bullish outlook.

“There is a lot of pent-up demand among both businesses and consumers that will release itself once the geopolitical clouds lift,” Orlando says. If the situation in Iraq calms down, he suggests that such factors could push gross domestic product growth into the 3% to 4% (annual) range for the second half of 2003.

Adding to Orlando’s confidence: He sees the right ingredients for economic recovery in the fiscal and monetary policies being pursued in Washington, namely low interest rates, tax cuts, and–despite the recent hubbub–deficit spending. “These things shouldn’t happen ad infinitum,” he says, “but they are the appropriate near-term policy choices to get an economy out of recession and on to a proper growth path.”

Full story at Forbes.com

Fishing For Nasdaq Stocks

Since March 11th, the Nasdaq Composite index has rallied 12%. Whether the move signals a new bull market or just a war bounce is anyone’s guess. But the fact remains that the index is 72% cheaper than it was at the turn of the century. Although it could drop further, now seems as good a time as any for patient and careful investors to shop this market.

Here’s one idea: Cuno. The Meriden, Conn.-based company makes filtration technology for gases and liquids. Nearly half of the company’s sales come from products used for purifying drinking water for residential and commercial customers.

Over the past three years, Cuno’s revenue has increased by a modest 5% per year. But the company’s results should benefit from the growing demand for clean water in both developed and emerging economies. In the latter area, the statistics are particularly sobering. By the World Bank’s tally, 1.1 billion people lack access to safe water. As a result, 3.5 million children die each year from waterborne diseases.

Cuno seems well poised to tap into efforts to fix these and other water-related problems. Business outside the U.S accounts for 42% of the company’s revenue. In all, Cuno had $258 million in sales for its most recently reported fiscal year, ended October 2002. Analysts reporting to Thomson First Call expect that number to climb to $281 million this October and $295 million in 2004.

Full story at Forbes.com

Reading, Writing And Regulation

WASHINGTON – It may not be at the top of Congress’ to-do list right now, but the Higher Education Act of 1965 is up for reauthorization in 2003. For-profit purveyors of postsecondary education–and their shareholders–will be watching closely.

These outfits draw the largest portion of their revenue from government financial aid programs. Career Education (nasdaq: CECO – news – people ), for example, which runs schools such as The Texas Culinary Academy and the International Academy of Design & Technology, pulls in about two-thirds of its total revenue from government sources.

Some background: The main federal source of postsecondary funding is Title IV of the Higher Education Act. Title IV encompasses such programs as Federal Family Education loans, Pell Grants and Perkins Loans. For the 2004 budget, President George W. Bush recently asked for $62 billion in total grants, loans and work-study programs at the postsecondary level. Pell Grants, $11.4 billion for this fiscal year, would rise to $12.4 billion.

But with that money comes a raft of standards and requirements set forth by the U.S. Department of Education and others. These include ensuring that default rates on student loans don’t exceed 25% for more than three years straight; keeping each institution’s federal aid revenue under 90%; hitting certain targets, vis-à-vis completion and placement rates; and maintaining acceptable levels of “administrative capability,” such as providing sufficient financial aid counseling and other services.

So which way will the rulemaking pendulum swing in the reauthorization process? Some members of Congress have made noises suggesting a tightening. A fact sheet from the House Education & the Workforce Committee, for example, has this to say: “While the cost of a quality education continues to rise, questions remain about the quality and accountability of America’s higher education system.”

Analysts say such bluster shouldn’t cause investors in for-profit postsecondary education firms much anxiety. On the accountability issue, for instance, analyst Richard Close, who follows the sector for Atlanta-based brokerage SunTrust Robinson Humphrey, says for-profit providers have a fairly solid track record. “They have an incentive to provide a quality education that enables a student to get employment after [graduation],” he says, “and they do a pretty good job on that front, as opposed to their competitors in public schools and community colleges.”

Full story at Forbes.com

The Case For Mid-Caps

With the broader market bouncing around at 1997 levels, Tony Rosenthal, who helps oversee a $2 billion portfolio at New York’s TimesSquare Capital Management, sees opportunities in mid-cap stocks, or those with market values between $1.5 billion and $10 billion.

“Mid-caps combine the best of both worlds,” says Rosenthal. Unlike large stocks, he explains, mid-caps can be relatively “undiscovered,” particularly as the big brokerage firms pare down their equity research operations. On the other hand, mid-caps are usually more liquid and less volatile than smaller capitalization issues, which often get crushed when a big holder bails out.

A growth investor, Rosenthal looks for companies he thinks will increase sales, earnings and free cash flow by at least 15% over the coming three years. He pays particular attention to free cash flow, which Forbes defines as net income plus depreciation minus capital expenditures. The metric gives a sense of a company’s ability to buy back stock, pay down debt, make acquisitions and plow cash back into the business.

Example: Moody’s, the New York publisher of opinions, ratings and research on issuers of bonds and other credit obligations. The company certainly has a good track record generating free cash flow; its free cash flow margin, or free cash as a percentage of revenue, stands at a very robust 29% for the past 12 months.

Moody’s shares are down 15% from a 52-week high of $52 set last August. Driving the decline are worries that an eventual rise in interest rates will slow down the issuance of new bonds, meaning less business for rating agencies like Moody’s, Fitch and Standard & Poor’s. Another fear: Financial reforms will weaken the strong market position that Moody’s has enjoyed.

Rosenthal says such concerns are real but overdone. Although he expects Moody’s business to soften, he predicts that the firm, of which Warren Buffett’s Berkshire Hathaway owns 15.5%, will continue to deliver healthy free cash flow in 2003.

Full story at Forbes.com