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Why The Execs Are Still Getting Bonuses

One easy and obvious way for companies to save money is to cut executive compensation, but why doesn’t it happen?

I’ll look to one of my classroom experiences to answer this one.  On my first day of teaching Principles of Corporate Finance, I had my students participate in a role play exercise about a major airline in crisis.

I broke the students up into six groups, each representing a stakeholder in a major airline company: pilots, flight attendants, mechanics, executives, customers and stockholders.  There are more stakeholders, but I wanted to keep it pretty simple.

Each group had to explain (through one representative) their position on options to increase profitability.  All of the options came down to raising revenues or cutting costs, but I provided them with options such as raising airfares and fees for travellers, cutting salary and benefits for pilots, flight attendants and mechanics, cutting compensation for everyone, cutting dividends, and finally cutting the multi-million dollar bonuses collected by executives.   

My findings: After four sections, the groups were unable to agree unanimously on any changes.  The change with the most support was to cut executive compensation.

The argument from all of the workers outside of the executive suite was pretty consistent, including ”when times get rough we get punished and they keep on getting their millions…they don’t know what it is like out here doing the real work…what do they get so much money for anyway?”

My answers: true, probably true and I have no clue.

Executive talent is valuable.  Companies need good leaders and a good leader can go a long way, but in terms of compensation where do we draw the line? 

In each of my classes, the groups representing the executives said the same thing.  In a nutshell, if we’re losing a billion dollars a year, taking away a million dollar bonus from me won’t help as much as cutting the wages and benefits of all of you. 

By the numbers they are right, but the whole thing is just wrong.  I started this exercise in 2003, now companies are losing billions per quarter and many executives are still padding their pockets.   

A few leaders are asking questions, check out this interview with one congressman pushing for legislative intervention.

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Fundamental Fridays: Alcoa

In the second installment of Fundamental Fridays, TST will examine Alcoa.

Alcoa is a big time aluminum producer operating in 44 countries.  In the past 52 weeks, shares of Alcoa (Ticker: AA)bottomed at $9 and peaked at $44.77.  Shares closed yesterday at $11.20.  Wondering what to do with Alcoa?  Let’s see what the fundamentals have to offer.

Valuation measures

Note: This week I have added average ratios for the sector.

Price-earnings - Compares the current market value per share to the earnings per share.  P/E ratio for AA: 5.34, P/E industry average: 3.09.  P/E sector average: 1.51 Signal: OVERVALUED

Price-sales - Compares the current market value per share to the revenue per share.  P/S ratio for AA: 0.30 , P/S industry average: 24.4,  P/S sector average: 1.33   Signal: UNDERVALUED

Price-cash flow - Compares the current market value per share to the cash flow per share.  P/CF ratio for AA: 2.72, P/CF industry average: 1.84, P/CF sector average: 1.32   Signal: OVERVALUED

Some analysts use earnings or sales with the following formula to solve for a stock’s expected price.

Expected stock price = historical P/E average x Current EPS(1 + EPS growth rate) =  19.9 x 2.95 (1+0.3724) = $80.57

For AA, the 5 year P/E average is 19.9 (from ADVFN Financials), EPS from last year $2.96 (Reuters) and 5 year average EPS growth rate is 37.24% (Reuters), resulting in an expected stock price of $80.57.  The stock is currently trading around $11 per share.  Signal: UNDERVALUED

Profitability Measures 

Return on Assets - Net income relative to total assets.  ROA for AA: 5.18%, ROA industry average: 2.17%

Return on Equity - Net income relative to total equity.  ROE for AA: 11.27%, ROE industry average: 3.70%

Profit margin - Net income relative to revenue.  PM for AA: 6.84%, PM industry average: -18.63%

Bottom Line: Mixed bag on valuation, overwhelmingly positive on profitability.  

Ratios should always be evaluated relative to a company’s competitors, sector and industry averages to see how the company stacks up.  The data used is also pulled from financial statements which have been known to be subject to manipulation.

Based on the ratios used today, TST’s Fundamental Friday Recommendation for Alcoa: BUY

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Unforgiven: Credit Card Plea Denied

Big credit card issuers including Chase, Bank of America, Discover and Citibank banded together with consumer groups pleading for mercy from the Treasury Department. 

The regulators have spoken and like the cashier at a Palm Beach Publix when Ann Coulter attempted a credit card purchase back in February, the answer is…DENIED! 

About two weeks ago, a request was submitted to the Treasury Department by the Financial Services Roundtable (representative of the banks, etc.) and the Consumer Federation of America.  Last night, news broke that the request was rejected.

According to AP reports, the proposal allowed credit card companies to forgive of up to 40 percent of debt per person.  Each credit card holder could delay payment of income taxes owed on their forgiven debt until after the remainder of the debt was paid off.  The credit card companies would wait until the remaining debt was paid off to book their losses on the forgiven portion.

I can see how lowering balances and lengthening repayment terms would help borrowers (look at the government and AIG).  I can also see how this would help debtors.  The delayed recognition of losses can make a company look more profitable than it actually is.  This can make a company look more attractive to investors and lead to a higher stock price.  So again, we have banks coming together to aid the consumer and again, we know that they want to aid their bottom lines as well.

FYI: just like mortgages were used to back bonds so too are credit card receivables.  If the receivables are not received then we are in for more write-offs, write-downs and losses.  :(

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Will Your Favorite Mall Survive?

General Growth Properties (GGP), the nation’s second largest mall operator, warned of solvency issues yesterday. 

GGP is a real estate investment trust (REIT) which operates over 200 shopping centers from Hawaii to Maine.  The company has over $1.1 billion in debt coming due, the vast majority of it is payable within the next month.  Last month, GGP announced that it may sell assets in order to service its debt.

GGP operates one of my favorite malls, Tysons Galleria in northern Virginia.  Tysons is listed as one of General Growth’s Platinum Properties (the best of GGP) offering stores such as Tiffany, Neiman Marcus, Louis Vuitton, Versace, Saks Fifth Avenue, and Barneys New York…all of which I enjoy perusing through (looking, but not touching!) on my way to P.F. Chang’s or The Cheesecake Factory. :)

Does this mean our favorite malls will be no more?!?!  According to Ivan Friedman, president & CEO of RCS Retail Real Estate Advisors, store closings are much more likely than mall closings. 

It looks like we can relax, at least for now.  I wish I could say the same for GGP’s shareholders.

Last month, GGP did the boardroom shuffle and replaced its CFO.  In the same press release it announced the suspension of dividends on its common stock.  After yesterday’s debt warning, the company was promptly booted from the S&P 500 index (effective at the close of markets today). 

Shares opened today at $0.43 and before 10 AM trading volume is already over one-third of its daily average. 

Wouldn’t it be nice if the malls saw the same volume?

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Mortgage Lenders To The Rescue…For Who?

Citigroup has created the Citi Homeowner Assistance program to help mortgage holders avoid foreclosure.

Citi is not the first and will not be the last bank to announce homeowner relief efforts.  Bank of America and JP Morgan Chase have already taken recent measures to spare homeowners from foreclosures.  Fannie Mae and Freddie Mac will release details of their homeowner relief programs this afternoon.

According to MarketWatch, Citi has trained counselors who will initiate contact with homeowners particularly in areas where prices are falling and unemployment is high.  Over the next six months these counselors will attempt to make contact with 500,000 borrowers via mail, email, phone, social networks…this type of grassroots effort sounds familiar.

Perhaps CHANGE has come to Citigroup ;)  Wishful thinking.

All of this sounds nice: saving people from foreclosure, reformulating payments and interest rates, using every available method of contact to reach out… I can’t help but think that Citi’s primary motivation for the sudden flash of corporate altruism is to save it’s own bottom line. 

The current crisis can be traced back to many securities backed by mortgages.  They may have new owners, but nothing about the structure of these now infamous toxic assets has changed.  Citi (and every other bank) knows that home price stabilization is paramount to restoring value in both housing and financial markets.

A home is the largest asset most people own.  Many people refinance to pull out cash or borrow against equity in their homes for spending or paying off other debts.  Owners can’t access equity if they owe more than the house is worth so they spend less (hence the terrible spending and confidence figures) and perhaps default on other obligations (take a look at the rising rate of defaults on credit cards and auto loans).  With the surging defaults and falling prices, banks don’t want to make new loans and you know the rest.

Regardless of Citi’s motivation, assistance for some homeowners is on the way and I hope the relief reaches those who need it.

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Can AIG Repay Their Debt To Taxpayers?

Government officials would not lend out billions of taxpayer dollars if they knew the loans could not be repaid, but when the loan is to a company like AIG, how could they ever really know?

I don’t think lawmakers and regulators would knowingly have us foot the bill for bad loans, but their actions demonstrate some severe holes in the area of due diligence.  Due diligence is mentioned in many industries, but in the financial world it usually comes up in the realm of accounting, mergers and acquisitions.  Since the government did take a major equity stake in AIG, I think this qualifies as an acquisition.

Anyway, the idea behind due diligence is to thoroughly evaluate a potential investment so as not to cause harm to either party. 

Since receiving it’s first set of government aid, AIG reported a third quarter loss of over $24 billion versus a $3 billion profit for the same quarter last year.  Definitely looks like more harm than good, so the government upped the ante.

Today, the government raised the dollar value of AIG’s loans while easing the terms.  AIG has a new tab of $150 billion, the loan portion of which is to be repaid at lower rates and over an extended period.  Part of the AIG package is $40 billion in preferred stock sold to TARP (CNBC reported this as the largest TARP investment to date).

The new relaxed terms show that the government will do whatever it takes to prevent AIG from defaulting.  It is in the best interest of every taxpayer for them to do so (now that the decision to bail AIG out has already been made), but I hope they won’t have to do much more.

While the initial loan may not have been authorized with the expectation that it would not be repaid, it was definitely authorized under some faulty assumptions. 

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The Most Important Question You Need To Ask Your Broker

Have you ever paid for something and wondered why? 

Most of the time this happens to me in restaurants.  I order something that is supposed to be served hot and it comes out cold or I order something that is supposed to zesty and it comes out bland.  In cases like this, I could send it back for another one, order something else, or ask for a refund.

On other occasions this has happened to me with services. I took my car in for service to stop an annoying squeaking noise on the driver’s side.  I left with a new lower control arm and ball joint, two weeks later the noise returned.  I have since had resting struts replaced on both sides and you guessed it: the same annoying noise.  Cases like this are a little more difficult to resolve, but I am never afraid to push for a huge discount or a free rental car! 

Either way, if I pay for something and it is unsatisfactory I want to be made whole.  Who doesn’t?

When it comes to your finances and brokers, being made whole isn’t really an option.  Brokers provide advice and will act on your behalf (if you give them permission to), but none of their advice is guaranteed and they don’t come with a warranty.  Regardless of how your broker is performing, the most important question you need to ask is:

WHY AM I PAYING YOU?

This is a loaded question.  You may not want to phrase it like this, but you need to know the answer.  If they can’t tell you, this is a bad sign.  You can’t recover any losses realized due to bad advice from them, but you can save yourself the fees and commissions in the future.  After all, you can lose money on your own.  Why pay someone else to do it for you?

All brokers are not bad.  Every broker will make a losing decision at some point because markets are unpredictable, but if you can’t find the value in the service you are provided with it is time to ask the question.

After you ask it I would be delighted if you share the answers with me!

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Bank Of England Issues Massive Rate Cut

The Bank of England cut a key interest rate by a larger than anticipated 150 basis points!  Central banks across Western Europe followed the move, but much more conservatively.

The European Central Bank (ECB) and the Swiss National Bank issued cuts of 50 basis points.

BOE’s move was by far the most aggressive and for good reason. 

The country’s home sales were 52 percent lower in September 2008 than the same month last year (Associated Press).  In October, consumer confidence fell to the lowest level since 1974.  According to Global Insight, consumer spending accounts for 65 percent of the country’s gross domestic product (GDP).  Which for the third quarter, posted a worse than expected 0.5 percent decline.

The cuts lifted stocks from session lows, but the markets saw a regional decline.  The FTSE 100 lost 3 percent, take a look at today’s chart.

Rate cuts are used to decrease the cost of lending, but unfortunately they can’t restore trust! 

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Cloudy Days For SunPower

Many analysts commented that an Obama win would bode well with alternative energy stocks.  Well, not on Wednesday!

Shares of SunPower Corp. fell 34 percent, closing at $32.85.  SunPower saw about 7.6 million shares traded (over 2.5 times its daily average for the past three months) just one day after announcing that the recent strength of the dollar would cut earnings growth for the fourth quarter of this year and all of next year.

SunPower estimated that the foreign exchange woes would cause a $17 million hit to fourth quarter profits.  To put this in perspective, SunPower earned just $4.876 million in the same quarter last year.

Yikes!!!

With a P/E of 40+ its possible that SunPower was overvalued anyway. 

The news is definitely bad and through effective hedging probably preventable.  But if currency conversion issues are the only ones plaguing SunPower, I think it will make a comeback. 

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Markets Predicted Obama Victory

Throughout the election process I have heard several reporters say that the stock market favored Senator Barack Obama for President. 

Why so?  Well, it’s pretty simple.  It had nothing to do with his experience, qualification or policy proposals.  President-Elect Obama earned the market’s favor because when markets are down in the few months leading up to an election, a change in party typically comes to the White House.

I found this quite interesting since I googled “stock market obama” and most of what I saw blamed him for the market’s demise.  Here’s just a sample of the headlines: Is Obama Depressing the Market?…Is Obama Dragging Down Stock Prices?…President Obama and the Coming Stock Market Crash.

At a time like this, any bit of certainty is comforting to the markets.  I am glad to have the election over and done with.  Now, we can get down to business. 

As the rhetoric begins to subside this should remind us all that the election was not the end, it is just the beginning.

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