Tuesday Losers: Priceline Searches For a Bottom

David Sterman's picture

Tuesday, May 11, 2010 - 12:03pm

by David Sterman

After a strong run, it’s typical to see a stock chart start to flatten out as buyers and sellers move into equilibrium. More often than not, that’s a sign to take profits. Not only do fundamental measures often tell you that a stock is fairly valued at this point, but the indicators used in technical analysis often turn from green to red.

Sure enough, the major technical indicators for Priceline.com (Nasdaq: PCLN) were flashing red in recent weeks, and indeed shares are finally responding this morning, down nearly 15%. First-quarter results released after Monday's close were solid, and a sharp improvement over a year ago, but forward guidance was disappointing. Management was quick to cite the headwinds associated with the Icelandic volcano and unrest in Thailand. But the real culprit was rising expectations that could not be sustained. Global travel had staged a solid rebound, reflected in ever-rising earnings estimates for Priceline.com. But a 56% jump in first-quarter profits likely represents the peak of the cycle. Priceline is still poised to grow as the economic rebound takes hold, but at a much more moderate pace.

The strategy: near-term caution, long-term bullishness. The factors that led to a downbeat forecast are still in place: The Icelandic volcano is still burbling and could yet again affect air travel. The unrest in Thailand will have an ongoing impact on that country’s tourist trade, and the recent economic crisis in Greece could crimp European discretionary spending. That should lead analysts to steadily ratchet down estimates. Even though shares of Priceline.com have fallen -20% from their peak, the stock is vulnerable to further weakness from both a fundamental (lower estimates) and technical perspective.

The consensus forecast for 2010 earnings per share is likely to fall below $10 from a current $11.21. But as these near-term headwinds recede, the 2011 forecast, while likely to fall, should still represent profit growth in excess of 20%. Put it all together, and shares would start to look more attractive once they breach the $200 barrier, or less than 17 times projected 2011 profits.

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Derivatives have been much maligned recently, as many observers believe they played a role in the obfuscation of balance sheets that led to the demise of firms like Lehman Bros. Indeed Congress is looking at steps to sharply reign in the derivatives market. But credit derivatives, which help provide bond buyers protect their portfolio against unexpected defaults, have clearly helped stabilize results for a wide range of companies that would have suffered even larger losses in the recent economic downturn.

Yet the firms that offer bond protection, such as MBIA (NYSE: MBI), Ambac (NYSE: ABK) and Assured Guaranty (NYSE: AGO), have taken it on the chin as they continue to pay out claims for all of the bonds that went belly up. MBIA and Ambac in particular have been so decimated that they are unable to currently underwrite fresh new bond insurance plans. That should be great news for rival Assured Guaranty, which has emerged in a healthier position, and continues to book new business. Yet both MBIA and Assured Guaranty are off roughly -10% in Tuesday trading, and for very different reasons.

MBIA is still taking hits from the unwinding of bad policies written a few years ago, but cannot yet offset that with new income from freshly-written policies. First-quarter results, released Monday evening, highlight a wide range of operational and litigational challenges the insurer will still face.

Assured Guaranty, in contrast, reported decent quarterly results Monday evening. The firm is still booking new business, which enabled it to post a quarterly profit. Per-share profits of $0.44 badly trailed the $0.73 consensus forecast. But management noted that the insurer is still losing money on loans previously made. There are tentative signs of improvement in that area, but it will be a slow road back to health for the value of previously-issued bond insurance policies.

Nevertheless, as the bad news for MBIA continues to trickle in, that must spell continued opportunities for Assured Guaranty. No doubt, the current consensus profit forecasts will need to come down, perhaps to below $2 for 2010 and below $3 for 2011, but that’s not bad for an $18 stock that is likely to keep benefiting from a beleaguered competitor. This is a very complex industry to analyze, so be sure to take the time to listen to the conference call and read the filings. You’ll probably find that Assured Guaranty is in the slow process of getting healthy once again.

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We talked about the sharp drop in Dean Foods (NYSE: DF) Monday's “losers” report, and suggested investors avoid an urge to bottom-fish. Shares are off another -7% today, and will likely soon find a floor. Inevitably, Dean Foods is likely to find appeal among private equity shops that specialize in these kinds of distressed assets. But they’ll have to assume Dean Foods’ $4 billion debt load as well. Keep an eye on this name, as any further drops are likely to heighten buyout speculation, perhaps at a premium to the floor that is eventually established.

David Sterman does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.