Beware of the Sell-Side Love-Fest for Individual Names
Research Director, Mad Money
From: James Cramer
Sent: Tuesday, February 21, 2012 7:11 PM
To: Nicole Urken
Subject: SELL BLOCK
After what Mark Papa from EOG said today on nat gas, I want to tell people to sell nat gas AND coal. Sure enough look at CNX—I think we put that in the sell block—let’s see some stuff, I think it would make a great Thursday sell block—put it together please!
From: Nicole Urken
Sent: Wednesday, February 22, 2012 7:15 AM
To: James Cramer
Subject: Re: SELL BLOCK
Got it. Commodities front & center this week with oil continuing to surge—will focus on the commodities in the cross-hairs here—natural gas and coal. While CNX is very favored (25 buys, 4 holds, no sells from sell-side), downside risk present even though better positioned than some peers. Will lay out.
Tuesday morning, Consol Energy followed last week’s thermal coal production cut news by announcing it was idling its longwall mining unit at its Buchanan Mine, and reducing its continuous mining operating schedule. The company cited current market conditions, specifically rising inventories and decreased international demand for met coal. This sent the stock, and its coal cohort, down significantly.
However, this news should not have come as any surprise given what we’ve seen from the coal sector—one of the reasons why we put CNX in the sell blockon February 23rd. Coal has been a ‘commodity in the cross-hairs’ due to (1) near-term concerns about decelerating infrastructure build in Asia, (2) intermediate concerns about continued natural gas switching, with gas prices at new lows, and (3) longer-term concerns surrounding heightened EPA regulations. Additionally, CNX’s exposure to nat gas doesn’t provide additional optimism.
As Mad Money viewers know, we have continued to emphasize issues of oversupply in the sector, particularly given increased horizontal drilling techniques and still-limited uptake and support of the fuel in the US (though we are seeing incremental changes of tone from Obama!)—the very reason why E&P companies like EOG Resources andChesapeake have been aggressively shifting their capital to liquids.
But the key take-away from CNX sell block segment was discrepancy between the sheer optimism from the sell-side analysts on the name despite clearly unfavorable underlying fundamentals. 25 buys, 4 holds and no sells for a stock that is exposed to the two commodities with severe overhangs? Coal coverage in particular is reflective of the ‘group-think’ that permeates Wall Street research these days. The buy-to-sell ratios in the sector are not in-line with the underlying sector fundamentals. (And, interestingly, some of the negative sentiment on the commodity has come from analysts in related sectors, like the Wells Fargo and JP Morgan railroad analysts who downgraded their coverage universe recently because of coal headwinds).
The “CNX lesson” is yet another reminder not to blindly listen to sell side analysts—particularly when they are universally positive on an individual name.
Another much-loved stock? Pandora. Heading into Tuesday evening’s quarter, the stock had 15 buys, with 4 holds and only 3 sells—with the 3 negative notes from boutique firms. This is emblematic of the hype that has surrounded the social-media IPOs (a subject that Cramer touched upon in last night’s ‘no huddle’ segment. Low and behold, the stock traded down nearly 20 percent after it reported its quarter Tuesday after the close, given weaker-than-expected 4Q revenue and a profit outlook for FY13 that was well below the breakeven consensus analysts were anticipating.
The main issue? Profitability. Ultimately, monetization is lagging the huge growth in listener hours. And yes, profitability does matter. While two analysts did downgrade the stock after the report (better late than never?), the majority continued to defend its growth prospects and defensible position. Beware: Increased content costs and no near-term profitable outlook are warning signs enough to outweigh the ‘market opportunity’ and ‘competitive positioning.’
Two other names to add to the “over-loved cohort”? Zagg and Skull Candy. These companies—which makes scratch protectors and headphones, respectively, for various gadgets like smartphones—have continued to be touted as an Apple derivative play. Analysts have ignored the commoditized nature of the company with low barriers to entry. And with all buys on the stock (no holds and no sells), if you listened to the analysts on these, you would have had to cope with severe underperformance.
The bottom line: Ultimately, sell-side analyst reports are a key tool to learning more about companies—they can often provide excellent background and insight into expectations. However, they should never be relied upon. Instead? Listen in on conference calls. Look at the company presentations. Make sure you understand the underlying sector fundamentals. Building a thesis is never as simple as it seems. And remember, industry-related conference calls can shed insight on derivative plays. One quick example? The conference calls of Foot Lockerand Dicks Sporting Goods in the last week have both provided bullish commentary on Under Armour and Nike—two names we have continued to back on Mad Money. More than anything, avoid the trap of the sell-side analyst love.
Random musings: In the industrials complex, we have gotten solid guidance reiterations from Eaton,Cooper Industries, Caterpillar, Honeywell andGeneral Electric. And, importantly, CAT China comments bullish relative to the worries about China slowing, after the country lowered its growth forecast from 8 percent to 7.5 percent—reflecting the strong positioning of the company.
"Inside the Madness" appears twice a week at madmoney.cnbc.com
A previous version of this story stated Zagg's chief financial officer had resigned. In fact, Skull Candy's CFO had resigned.
When this story was published, Cramer's charitable trust owned Apple.
General Electric owns 49 percent of CNBC's parent company NBC Universal.
Follow Nicole Urken on Twitter @nicoleurken
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