Sunday, January 30, 2011

Technical Breadth Indicators: Historical Data

As promised, below is a Chart and Table of historical data for Technical Indicators which were first written about on 1/29/11.   As a refresher, both indicators are used to indicate whether investors are being compensated for risk.  Alternatively, when they blink SELL, the market is at a High Risk of sudden drops.

As one can infer from the line-chart below, the indicators turned into Negative Territory (about -3% and lower) about 1 week ago.   Though, they've been lower, reaching as low as -8.9% near the market top of March 2000.  Does anyone remember the "Tech Wreck" ?

While a negative 3% value isn't as low as the 2000 time period, note that it hasn't given a sell signal for a long, long time (since 2008).  Thus, this signal may be more reliable.  I find that it's less reliable in periods of high market volatility.  Data start date is 1994, which wasn't shown as the chart would've been too small.

Furthermore, I can't recall the last time both the Sentiment and Technical Signals indicated that the market was at such a High Risk.  For perspective, the last time they both gave Buy Signals was in March 13, 2009 (at +10.7% for this Indicator).

 The table below shows how the stock market performed (Gain/loss or flat market) after 1 week, 2 weeks, etc. time periods after the Down Signal indicator reached significant low values.  The higher the percentage, the more times the Indicator was accurate.

Best time period was T5 (6 weeks after signal) at 57%.  This is lower than the accuracy of the Sentiment Indicator.   However, note that I always use what's called Dummy signals. These are incorrect signals I place purposely to avoid any potential biases.  Essentially, they make the results look worse than they actually were.  Removing the Dummies, yields the actual % Declining/Total of 65% (meaning the indicator worked 65% of the time at the T5 period.  Still not great, but better than before.



Saturday, January 29, 2011

Technical Breadth Indicator turns BEARISH...

Technical Indicators turn Bearish:   
To All readers of the Socially Responsible Investing website:

While I advocate always being invested in the market (see Background Information below), duly note that my Technical Indicators are now saying we're in a Above-average Risk environment.  The indicators turned Bearish on January 21, 2011.

Though, as I'm writing this capital markets of all shapes and sizes (from stocks to commodities) were being agitated by the implications of the Tunisian Turmoil.  As many of you already aware, peoples' demands for freedom have now reached Egypt.  This time the establishment is refusing to "cave in" so easily.  Going forward, Monday's markets may bounce, but the contagion may reach other countries, particularly Saudi Arabia (which has publicly stated its support of Mubarak).  Obviously, that would be a shock to the oil markets, (Strait of Hormuz, etc). Further, the Euro-Crisis remains an unresolved issue.

Behind the Indicators:
The Technical Indicators measure how the average stock is performing compared to the major market indices. For example, if the Dow Jones is performing well but there are more stocks declining than advancing, the indicators would turn Bearish.  A Bearish reading is approximately -3% or lower.



Conclusion: Investors are not being compensated for all the risk they're taking on (witness the low corporate Bond spreads).  By the very least, I would expect higher market volatility. At worst, a correction will ensue.  I do not expect a Bear Market as economic fundamentals are improving (see below).

Note on Economic Growth:  The headline news was that GDP for the fourth quarter 2010 was below expectations (up 3.2% vs 3.5% expectations).  Actually, it was one of the best I've seen in years, looking behind the numbers.  Consumer Spending was good and Final Sales were great, rising 7.1%, and the best since 1984  (this is GDP adjusted for the affects of inventories.).





 BACKGROUND INFORMATION:
As a long-term investor, I believe the time for Socially Responsible Investing is now…right NOW.  Long-term investors are not concerned over the current level of the stock market and whether the Market’s going to rise or fall the next day.

I propose investors be “fully invested” in equities most of the time.  Being “fully-invested” is different for different people depending on age, risk tolerance, etc.  As a Heuristic, I suggest being 75% long equities as a “base-case” level.  The remainder would be invested in bonds, real-estate, hard assets, and alternative/exotic investments (e.g., natural gas, platinum, rare-earth anyone?).

With that being said, there are certain times that are better to invest in the market.  Rather than choosing tops and bottoms based on certain fundamental criteria (e.g. price to earnings ratio), I have developed two Market Timing Indicators.  These indicators help me maintain objectivity with regards to my investment positions, as I have no influence on them.  They were designed during late 1992 and have been updated weekly since.

The two major indicators are:

1.    Sentiment:  based on human behavior, and supported by theories backed by Behavioral Finance. 

2.    Technical:  which measures market breadth, or underlying strength in the broad market.  This indicator was Neutral-Slightly Negative early Jan'11, but turned Bearish on 1/21/11.

These indicators are used to obtain my Portfolio's Investment Position.  Note, they do not know, or represent market levels.  They are measures of perceived risk, especially the Sentiment Indicators.  I have often taken mental notes of how everyone seems to clamor to buy things when their expected rate of returns are minimal compared to their inherent risks. 

This website will include three simple colored (traffic) signals.  Green for “Buy” (i.e, low-risk levels) which means allocate your portfolio to a fully-invested equity position.  For me, that’s about 75-80% invested, but it could be lower for a more-risk adverse, or retired individual.  Yellow, means caution, risk levels rising.  Red means “High-Risk”; investors should reduce their investment positions to conservative levels perhaps 30-40% equity.  The remainder could be in treasuries, gold, high-grade corporate bonds, etc.

Feel free to contact me for additional clarity or to answer other questions.

Thursday, January 27, 2011

SRI list: Best Companies for Multicultural Women 2010

As stated in our "Mission Statement" at the top of this website, we are seeking SRI candidates using Positive Screening

Ideally, we're looking for "earthy, granola" organizations that are Big on ESG, especially within their community - the "S" in ESG.  But, this community isn't just the community of investors, or other stakeholders such as suppliers.  It isn't even just the local community where the company operates.

We believe, a company's employee community is just as important.  It is employees who help create a corporation's unique personality/soul.  When it works best, it builds a cohesive climate of mutual trust and respect where employees can feel comfortable to perform their best, not because they have to, but because they want to.

You know, there's a saying that "Charity begins at Home" meaning before you can even attempt to change the world in a positive way, you'd better look inside yourself first.  As a side-note, we're using the word "Charity" to make a point.  In reality, all we're looking for is that each and every one of us feel like we've got a fair shot of what we deserve in the first place.

We are fond of Working Mother magazine, and have read several of its presentations and publications.  They have many interesting online articles including several lists, you can access here.

The list below is of the Best Companies for Multicultural Women.  The publication's Working Mother Research Institute screened companies that provided great working environments for women of color, both in their support when they start at the company and throughout their career.

Companies were chosen based on detailed applications sent to the Institute, then an independent Research firm tabulated the scores.  However, note that these companies were not elected or voted for by an advisory board/committee.  For example, if a great company didn't submit an application, it was not included in the list.

Note:  Most of these companies are publicly-traded, and thus, potential SRI candidates.  Individual company excerpts are written by Working Mother Institute.

Disclosure:  the author is long American Express, Cisco Systems.


Success breeds success at this financial services and insurance giant, which has just introduced Momentum, its new mentoring program that specifically targets multicultural professionals.
Fortunes may have fluctuated at U.S. companies recently, but this utility powerhouse has held steady through the turmoil, losing not one person and cutting not one benefit due to the recession.
Cultural awareness is a business imperative for this financial services company, which operates offices in every state and 44 countries around the world.
This fast-food giant strives to discover the perfect match for its corporate multicultural women. Candidates are interviewed at length about their personal and professional goals by volunteers from...
Talented women do well at this information technology and networking company, which just introduced its Inclusive Advocacy program for high-potential employees.
Supporting multicultural women is a top priority for this global financial services company, which boasts a whopping seven women’s councils in North America alone.
Efforts to increase the status of female employees have led to impressive figures at this professional services firm, which now has ten times the number of female partners, principals and directors...
While multicultural women make up just 7% of all U.S. employees, they are on the move, representing 18% of last year’s salaried hires, 16% of management hires and 23% of rehires.
Opportunities abound for women at this investment bank, thanks to a wide array of new programs.
The company pays for high-potential women to attend a four-month program called Leading Women Executives. Its sessions teach the staffers to knock down barriers and learn the skills that will help...
Women make up 31% of employees at this technology juggernaut, and they got a big boost last year with the introduction of its North American Women’s Council.
Working smarter, not harder, is the idea behind the Career Advancement program for employees at this financial services corporation.
Women and minorities comprise 60% of the workforce at this audit, tax and advisory services firm, which employs a full-time team of diversity recruiters to seek out the best in the field.
Special training sessions at the company help multicultural employees focus on how smart planning and good networking can help advance their careers.
Asian, African-American and Hispanic employees also have programs dedicated to their specific advancement, with a focus on cultural issues.
Nothing speaks as loudly as results, which is why female agents flock to the Women’s Sales Forum offered by this insurance, employee benefits and financial services provider
Sponsoring the first leadership program specifically devoted to the needs of multicultural women was a watershed moment for this consumer goods company, which signed on in 2007 as a corporate partner...
Keeping diversity top of mind during the economic downturn was important to this accounting firm, which offers audit and assurance, tax and advisory services.
Multicultural women who work for this consumer products giant now occupy 50% more jobs at the vice president or general manager level than they did in 2006, thanks in part to the work of the company’...
Impact, a yearlong mentoring program offered by this food and facilities-management services company, recently matched 90% of its 125 mentor/mentee pairs across divisions and functions—a move that...
Earning a degree is a snap when you work for this leading insurance company, which sponsors employees as they pursue their CPAs and PMPs and covers up to $5,250 in college tuition per year for anyone...
Creating a new generation of diverse leaders preoccupies this massive broadband and communications company, which offers a variety of programs to educate and develop its multicultural women.
Women dominate at this big-box retailer, where they represent 59% of all associates and 30% of all corporate officers.
 

Monday, January 24, 2011

The Anti-Christ of SRI lists: the Worst companies..

Here is a list we were pointed to by Michael Bluejay, who operates several websites including Socially Responsible Stocks

The list was compiled (and written) by Multinational Monitor and is called Multinational Monitor list of the 10 Worst Corporations of 2008.  Unfortunately, this list, and there are older ones too, (and the website) appears defunct.

As we state clearly at the top of our website, we are only performing Positive Screening for SRI candidates.  However, we recommend as a cross-check that one ensures that your SRI candidate (such as Interface) is not on this bad-boy list.  We went through this list and see nothing, with the exception of GE, that may be considered an SRI candidate.

Here, presented in alphabetical order, are the 10 Worst Corporations of 2008.

AIG: Money for Nothing

There's surely no one party responsible for the ongoing global financial crisis. But if you had to pick a single responsible corporation, there's a very strong case to make for American International Group (AIG), which has already sucked up more than $150 billion in taxpayer supports. Through "credit default swaps," AIG basically collected insurance premiums while making the ridiculous assumption that it would never pay out on a failure -- let alone a collapse of the entire market it was insuring. When reality set in, the roof caved in.

Cargill: Food Profiteers

When food prices spiked in late 2007 and through the beginning of 2008, countries and poor consumers found themselves at the mercy of the global market and the giant trading companies that dominate it. As hunger rose and food riots broke out around the world, Cargill saw profits soar, tallying more than $1 billion in the second quarter of 2008 alone.

In a competitive market, would a grain-trading middleman make super-profits? Or would rising prices crimp the middleman's profit margin? Well, the global grain trade is not competitive, and the legal rules of the global economy-- devised at the behest of Cargill and friends -- ensure that poor countries will be dependent on, and at the mercy of, the global grain traders.

Chevron: "We can't let little countries screw around with big companies"

In 2001, Chevron swallowed up Texaco. It was happy to absorb the revenue streams. It has been less willing to take responsibility for Texaco's ecological and human rights abuses.

In 1993, 30,000 indigenous Ecuadorians filed a class action suit in U.S. courts, alleging that Texaco over a 20-year period had poisoned the land where they live and the waterways on which they rely, allowing billions of gallons of oil to spill and leaving hundreds of waste pits unlined and uncovered. Chevron had the case thrown out of U.S. courts, on the grounds that it should be litigated in Ecuador, closer to where the alleged harms occurred. But now the case is going badly for Chevron in Ecuador -- Chevron may be liable for more than $7 billion. So, the company is lobbying the Office of the U.S. Trade Representative to impose trade sanctions on Ecuador if the Ecuadorian government does not make the case go away.

"We can't let little countries screw around with big companies like this -- companies that have made big investments around the world," a Chevron lobbyist said to Newsweek in August. (Chevron subsequently stated that the comments were not approved.)

Constellation Energy: Nuclear Operators

Although it is too dangerous, too expensive and too centralized to make sense as an energy source, nuclear power won't go away, thanks to equipment makers and utilities that find ways to make the public pay and pay.

Constellation Energy Group, the operator of the Calvert Cliffs nuclear plant in Maryland -- a company recently involved in a startling, partially derailed scheme to price gouge Maryland consumers -- plans to build a new reactor at Calvert Cliffs, potentially the first new reactor built in the United States since the near-meltdown at Three Mile Island in 1979.

It has lined up to take advantage of U.S. government-guaranteed loans for new nuclear construction, available under the terms of the 2005 Energy Act. The company acknowledges it could not proceed with construction without the government guarantee.

CNPC: Fueling Violence in Darfur

Sudan has been able to laugh off existing and threatened sanctions for the slaughter it has perpetrated in Darfur because of the huge support it receives from China, channeled above all through the Sudanese relationship with the Chinese National Petroleum Corporation (CNPC).

"The relationship between CNPC and Sudan is symbiotic," notes the Washington, D.C.-based Human Rights First, in a March 2008 report, "Investing in Tragedy." "Not only is CNPC the largest investor in the Sudanese oil sector, but Sudan is CNPC's largest market for overseas investment."

Oil money has fueled violence in Darfur. "The profitability of Sudan's oil sector has developed in close chronological step with the violence in Darfur," notes Human Rights First.

Dole: The Sour Taste of Pineapple

A 1988 Filipino land reform effort has proven a fraud. Plantation owners helped draft the law and invented ways to circumvent its purported purpose. Dole pineapple workers are among those paying the price.

Under the land reform, Dole's land was divided among its workers and others who had claims on the land prior to the pineapple giant. However, wealthy landlords maneuvered to gain control of the labor cooperatives the workers were required to form, Washington, D.C.-based International Labor Rights Forum (ILRF) explains in an October report. Dole has slashed it regular workforce and replaced them with contract workers.

Contract workers are paid under a quota system, and earn about $1.85 a day, according to ILRF.

GE: Creative Accounting

In June, former New York Times reporter David Cay Johnston reported on internal General Electric documents that appeared to show the company had engaged in a long-running effort to evade taxes in Brazil. In a lengthy report in Tax Notes International, Johnston reported on a GE subsidiary's scheme to invoice suspiciously high sales volume for lighting equipment in lightly populated Amazon regions of the country. These sales would avoid higher value added taxes (VAT) in urban states, where sales would be expected to be greater.

Johnston wrote that the state-level VAT at issue, based on the internal documents he reviewed, appeared to be less than $100 million. But, he speculated, the overall scheme could have involved much more.

Johnston did not identify the source that gave him the internal GE documents, but GE has alleged it was a former company attorney, Adriana Koeck. GE fired Koeck in January 2007 for what it says were "performance reasons."

Imperial Sugar: 14 Dead

On February 7, an explosion rocked the Imperial Sugar refinery in Port Wentworth, Georgia, near Savannah. Days later, when the fire was finally extinguished and search-and-rescue operations completed, the horrible human toll was finally known: 14 dead, dozens badly burned and injured.

As with almost every industrial disaster, it turns out the tragedy was preventable. The cause was accumulated sugar dust, which like other forms of dust, is highly combustible.

A month after the Port Wentworth explosion, Occupational Safety and Health Administration (OSHA) inspectors investigated another Imperial Sugar plant, in Gramercy, Louisiana. They found 1/4- to 2-inch accumulations of dust on electrical wiring and machinery. They found as much as 48-inch accumulations on workroom floors.

Imperial Sugar obviously knew of the conditions in its plants. It had in fact taken some measures to clean up operations prior to the explosion. The company brought in a new vice president to clean up operations in November 2007, and he took some important measures to improve conditions. But it wasn't enough. The vice president told a Congressional committee that top-level management had told him to tone down his demands for immediate action.

Philip Morris International: Unshackled

The old Philip Morris no longer exists. In March, the company formally divided itself into two separate entities: Philip Morris USA, which remains a part of the parent company Altria, and Philip Morris International. Philip Morris USA sells Marlboro and other cigarettes in the United States. Philip Morris International tramples the rest of the world.

Philip Morris International has already signaled its initial plans to subvert the most important policies to reduce smoking and the toll from tobacco-related disease (now at 5 million lives a year). The company has announced plans to inflict on the world an array of new products, packages and marketing efforts. These are designed to undermine smoke-free workplace rules, defeat tobacco taxes, segment markets with specially flavored products, offer flavored cigarettes sure to appeal to youth and overcome marketing restrictions.

Roche: "Saving lives is not our business"

The Swiss company Roche makes a range of HIV-related drugs. One of them is enfuvirtid, sold under the brand-name Fuzeon. Fuzeon brought in $266 million to Roche in 2007, though sales are declining.

Roche charges $25,000 a year for Fuzeon. It does not offer a discount price for developing countries.

Like most industrialized countries, Korea maintains a form of price controls -- the national health insurance program sets prices for medicines. The Ministry of Health, Welfare and Family Affairs listed Fuzeon at $18,000 a year. Korea's per capita income is roughly half that of the United States. Instead of providing Fuzeon, for a profit, at Korea's listed level, Roche refuses to make the drug available in Korea.

Korean activists report that the head of Roche Korea told them, "We are not in business to save lives, but to make money. Saving lives is not our business."

Thursday, January 20, 2011

SRI Sentiment Indicator: Historical Data

The chart below shows the Sentiment Indicator going back from 2005 to the present day.  As you can see, it's not perfect, but does do a decent job at showing market tops.  The Sentiment Indicator has been back-tested, by hand for reliability.  Data goes back to 1992/93.



                   Sentiment Indicator: Historical Chart vs. S&P500 Index.





The table below shows the results of my Backtesting.  Highest accuracy was in the T1 (one month time period) after Sentiment Indicator gave a High Risk/Bearish Signal (which would be a lower number, e.g., below 4.0).  Average subsequent S&P 500 loss was 2%.

I refined the Accuracy/predictive power of the Sentiment Indicator by examining at (and from) what levels it worked best.  When the Sentiment Indicator is well-below its recent peak, the Sentiment Indicator works best.  The most recent signal (1/2011),  and two previous: 1/2010 and 4/2010, have followed the above trend.  This raises my Confidence level in the implications of the current reading.

Tuesday, January 18, 2011

SRI Sentiment Indicator at a HIGH Risk level (Bearish Reading)

Sentiment Indicators turn Bearish:   
To All readers of the Socially Responsible Investing website:

While I advocate always being invested in the market (see Background Information below), duly note that my Sentiment Indicators are now saying we're in a very HIGH RISK environment.

Though, as I'm writing this, markets, both here and abroad, are up in overnight trading after hearing the great earnings releases from mega-techs, Apple and IBM, and growing comfort over European Union support of PIGS (e.g., Portugal, etc..)

What does this mean?
Essentially, investors are not adequately being compensated for all the risk they're taking in equity, as well as Bond markets (e.g., lower corporate bond spreads).  There is a high probability of a sudden, unexpected correction in capital markets over the next month.

Conclusion:  Now...right now... would be an opportune time to take profits.

What people are saying:  You know, so many people are telling me that they're earning little, if any in their bank. And so, they have to invest in stocks and bonds.  My answer is this, "No one's twisting your arm", "There's nothing wrong w/ keeping some of your assets in zero-yielding money markets."  Don't listen to what your friends are doing folks, do what you think makes good sense.




 BACKGROUND INFORMATION:
As a long-term investor, I believe the time for Socially Responsible Investing is now…right NOW.  Long-term investors are not concerned over the current level of the stock market and whether the Market’s going to rise or fall the next day.

I propose investors be “fully invested” in equities most of the time.  Being “fully-invested” is different for different people depending on age, risk tolerance, etc.  As a Heuristic, I suggest being 75% long equities as a “base-case” level.  The remainder would be invested in bonds, real-estate, hard assets, and alternative/exotic investments (e.g., natural gas, platinum, rare-earth anyone?).

With that being said, there are certain times that are better to invest in the market.  Rather than choosing tops and bottoms based on certain fundamental criteria (e.g. price to earnings ratio), I have developed two Market Timing Indicators.  These indicators help me maintain objectivity with regards to my investment positions, as I have no influence on them.  They were designed during late 1992 and have been updated weekly since.

The two major indicators are:

1.    Sentiment:  based on human behavior, and supported by theories backed by Behavioral Finance. 

2.    Technical:  which measures market breadth, or underlying strength in the broad market.  This indicator was Neutral-Slightly Negative as of 1/2011.

These indicators are used to obtain my Portfolio's Investment Position.  Note, they do not know, or represent market levels.  They are measures of perceived risk, especially the Sentiment Indicators.  I have often taken mental notes of how everyone seems to clamor to buy things when their expected rate of returns are minimal compared to their inherent risks. 

This website will include three simple colored (traffic) signals.  Green for “Buy” (i.e, low-risk levels) which means allocate your portfolio to a fully-invested equity position.  For me, that’s about 75-80% invested, but it could be lower for a more-risk adverse, or retired individual.  Yellow, means caution, risk levels rising.  Red means “High-Risk”; investors should reduce their investment positions to conservative levels perhaps 30-40% equity.  The remainder could be in treasuries, gold, high-grade corporate bonds, etc.

Feel free to contact me for additional clarity or to answer other questions.

Tuesday, January 4, 2011

SRI Analysis: Interface, Inc. (IFSIA)


Introduction:  Interface Inc. (NASDAQ: IFSIA) is an environmentally responsible manufacturer and marketer of interior floorings.  This Atlanta, GA based company specializes in modular carpets.  Modular carpets are essentially the square carpet tiles one often observes on the floors of open offices.  The photo below highlights the company’s fancier squares marketed to the more fickle consumer market.
Interface Inc. is what this website labels a Socially Responsible Investment.  The various sections below examine different parts of the company and factors affecting its valuation (stock price).  This research report examines the company from all perspectives, not just whether it fits our ESG criteria.  We have gone to great lengths to examine the company as objectively as possible.

Stock Chart courtesy of Google Finance.
Disclosure:  the author is long shares of IFSIA.
Executive Summary
What we really like…
And not so much..
·     Attentive, focused management
·     Shares near 52week high
·     Brand leader, high market share
·     Moderate financial leverage
·     Strong orders/business trends
·     High volatility of stock (Beta)
·     High peak-earnings power
·     High earnings volatility
·     Leadership in Sustainability
·     Low business diversity
·     Conservative accounting
·     Sensitive to the business cycle
·     Successful restructuring
·     Moderate Insider Selling










We believe Interface, Inc. is a good SRI investment candidate.  Our rating is “7” (out of a possible 10).  This rating incorporates quantitative and qualitative factors, including the corporate, social and responsibility efforts of the firm.  The Executive Summary above summarizes key investment factors/risks.  With the goal of maintaining objectivity, every investment is required to have a full list of Negatives, or if you will, “things we don’t like very much.”
Firstly, this is a company with a soul, best exemplified by its chairman and founder, Ray Anderson.  In 1994, he set his company the aim of having zero impact (“Mission Zero”) on the environment by 2020.  As Ray describes, it was a dramatic wake up call, analogous to “a spear in his chest.”  He challenged his employees “to head the first company that, by its deeds, shows the entire industrialized world what sustainability is in all dimensions: people, process, product, place and profits – and in doing so, become restorative through the power of influence.” And the company hasn’t looked back since!
After a long day trail-running in Bend, Oregon, it was a pleasure to run into Ray Anderson’s book at the local library.  Readers are encouraged to literally check it out!
                                    
This “Mission Zero” has enabled the company to be ever focused on its customers, end markets and products.  In fact, the company now specializes only in modular carpet.  This enabled Interface to become a leading niche player in flooring, though to the risks of low business diversity and high sensitivity to the Business Cycle.
One big byproduct of Mission Zero has been a transformed culture, one that has inspired creative solutions, making carpeting as exciting as iPads.  Key share data and our rating are below:

Share Data:


Interface, Inc.
IFSIA-Nasdaq

Price (1/03/11)
$16.20
Our Rating:
52-Wk Range:
$17.15 - $7.05
7
Out of 10.  Higher is better.
YTD % Change
88%
Market Cap (mm)
$1,020mm
Shares Outstanding
63mm
Beta:
1.6x  (Bloomberg)
Dividend (Yield %) qtr.
$0.02 (0.5%)
Price/Book value:
3.8x

Earnings estimate:
$0.60 (12/2010)
This report is provided for information purposes only and is not a recommendation.
P/E ratio (on above est)
27x














Share Data on Interface Inc. (see table) reveals a company with moderately-priced shares as measured by their Price/Book value (3.8x), Price to Earnings (P/E) ratio, and the fact that its share price is closer to its $17.15/share 52-week high, than to its low.  Dividend Yield (of <1%) and high Beta imply volatility of the shares.   Market Capitalization of $1Bn categorize this as a Small-Cap investment, further increasing return, as well as risk.  Our overall investment rating is 7, reflecting strong business order trends, but higher-than-average balance-sheet and share price volatility.
Given the company’s higher overall volatility, we expect its share price to be highly sensitive to the business cycle.  The best time to purchase shares of such industrials are during the bottom of business cycles (e.g., 2009) when companies are reporting net losses.  Based on economic forecasts, it appears economies (especially the U.S. are in the beginning to mid-stage of recovery).  Hence, upside “remains in the cards.”
 Income Statement ('09)
      Balance Sheet
 Cash Flow statement
Revenues:    $858.9mm
Current Assets: $388.0
Cash Operating: $55.5
Oper Inc.:         64.7
Total Assets:        727.2
Cash Investing:   (-7.4)
EBITDA:         89.9
Total Liabilities:  481.1
Cash Financing:  (-3.5)
Net income:     10.9
Total Sh.Equity:  246.2
Free Cash Flow:  43.6

Revenues for FY Dec’09 were $858.9mm, down from the $1.1Bn peak reached in both FY’08 and FY’07.  Given strong order growth, analysts say revenues could reach their previous peak by FY’11.  We believe Interface can easily meet this estimate given its excellent execution.  As such, the most vital factor will be whether or not a secular transition to modular carpets continues overseas, particularly Germany (a large market), where carpet tile penetration remains under 10%.  (Refer to the Industry Discussion for additional information.)
Interface has large operating leverage as well as moderate to high financial leverage.  This combination can yield exciting earnings gains when business trends improve.  Thus, a 1% Revenue gain will likely lead to far higher changes in net income.
Shareholders’ Equity of $246.2mm is somewhat low, given the company’s moderate (mostly long-term) debt profile needed to support fixed assets/machinery.  Shareholders’ Equity has declined over the last 1½ years given net losses and a restructuring.
Surprisingly, Interface managed to remain Free Cash Flow positive over the last 3years, though this was attributed to the inclusion of non-cash items.
In the charts below (sourced by Bloomberg LLC), rather than focusing on the absolute dollar level over the years, note the volatility of them.  This volatility can be seen in nearly all aspects of the company ranging from earnings, cash flows, assets and share price.  Such volatility visually demonstrates that this company is riskier than average.  From left to right number 1) is Revenue, 2) Operating Income, 3) Pretax income, 4) Income bef XO items, 5) Net income, 6) Basic EPS before abnormal items. 

Profitability
E: estimate
Gross Margin (%)
35.1% (2010E)
EBITDA Margin
12.5% (2010E)
Operating Margin
9.8% (2010E)
Return on Assets
5.3% (2010E)
Return on Capital
6.0% (2009)
Net Profit Margin
2.6% (2009)

Gross margins have been fairly good, rising from 33% in FY’09 to 35% by 2010E.  We expect this to continue into 2011, as the company moves up-market into the consumer market.  However, it is not certain how net income will be affected, as the consumer market requires more advertising spending.  Overall, net profit margins are likely to surge given the company’s high operating leverage.  Interface’s Return on Capital is also expected to rise given the above comment, as well as lower interest costs related to its recent bond refinancing.

Recent Financial Performance:
3Q’10 highlights, and trends
Revenues
$253MM (+16% Y/Y) ­
SG&A
61.4MM (24% of sales) 
Operating Income
$28MM (11% of sales)­
Net Income
$12MM (5% of sales)­

Recent Financial Performance:  In the table above, we summarized Interface’s 3Q’10 financial performance.  Please see link for Press Release.  Rather than reiterate the company’s statements, we highlight key data points, comments and provide our opinions below.
  • Overall performance was quite good (rising GPM, OpM and NPM compared to previous quarter and year-ago).
  •  Profitability and margins accelerated.  However, we expect limited SG&A improvements.  In fact, management stated SG&A might not go lower than 23% going forward.
  • Revenue growth rate accelerated (+16% Y/Y) 
  •  Order growth was very good (+20% Y/Y)
  • Company is gaining market share
  • Geographic strength in Emerging Markets (China, India, Brazil)
  • The upscale consumer business; Bentley Prince Street, is slowly returning to profitability (but not yet…)
  • Management indicated that 4Q’10 is tracking well.

The most important factor in the 3Q’10 report, in our opinion, was the strength in Emerging Markets.  This strength is vital as the company is about to open a new plant in China, and needs the demand.  This plant likely won’t be profitable until sometime later in FY’11, given start-up costs and low initial capacity utilization (15%-20%).  We also note that the Chinese authorities have made significant efforts over recent months to cool their economy and associated inflation.

Liquidity / Credit Stats:
E: estimate
Credit Ratings (Moody’s / S&P)
B1/B+ (senior secured ratings)
Bank lines:
New $300MM Revolver on 11/9/10
Cash & Near Cash items:
$115.4MM (FY’09) $81MM (Sept’10)
Capex
$28MM E (FY’10)
*Significant Debt maturities:
$100MM (FY’12) $150MM(FY’13)
Free Cash Flow:
$50MM E (FY’10)
  *company is refinancing its public bonds
Overall liquidity is quite good, supported by a new revolving credit facility, positive Free Cash Flow and longer debt maturities.  During Nov’10, Interface announced it would refinance its two bonds with a new $275MM senior notes due 2018.  At a 520bp spread (estimated) the notes would yield approximately 7.6%.  This compares with a weighted average coupon of 10.6% on the retiring bonds (aggregating to $260MM).  Both Moody’s and S&P affirmed Interface’s credit ratings in their review of the company’s new notes.

Leverage
FY’09 ended 12/09
Operating Leverage
3 (very high)
TD/ Common Equity
124% (moderate)
TD / Total Capital
54.5% (moderate)
TD /EBITDA trailing 12 mos.
3.3x (moderate)
Net Debt / EBITDA
2.0x (low to moderate)
Total Debt / Market Capital
56% (moderate)
Cash flow Operations / TD
18% (low to moderate)

As implied from the table above, Total Leverage (operating leverage + financial leverage) is high.  Using 3Q’10 data to calculate Operating Leverage, for every 10% increase in revenues, Interface’s EBIT rises 30%.  Total Debt is somewhat high too, especially relative to Common (Shareholders’) Equity, which in itself has been volatile over the last 10-year period.  (Refer to the chart below.)  However, other measurements such as Net Debt/EBITDA indicate a company with lower financial leverage.
Source: Bloomberg LLC

Valuation:
Forward data based on estimates
P/E ratio:
33x  (TTM FY’10)  27x forward P/E
Price /Book
3.8x (as of 3Q’10 ended Sept.)
Price / Sales
1.1x  (TTM FY’10)
EV / TTM EBITDA
10.5x (TTM FY’10)
Dividend Discount Model (DDM) calculated price:

$4.20 (Source:  Bloomberg LLP)
Actual Share Price
$16.20 (as of 1/03/11)
DDM price vs. actual share price
(-74%) thus shares are Overvalued
   Notes: EV: Enterprise Value,  TTM: trailing 12 months.
Interface is moderately priced using most measures.  In one extreme, Price-to-Sales is low, indicating undervalued shares.  On the other extreme, the Dividend Discount Model (DDM) is indicating very overvalued shares.  The model utilized is a 3-stage DDM consisting of a growth, transition, and mature stage.  The Beta applied was 1.56x (source: Bloomberg) which we confirm given Interface’s high share and balance sheet volatility.  (In fact, the Beta provided by Google Finance is even higher, at 2.5x.)  The long-term growth rate used was 14.7%, which declines to 8.7% at the Maturity stage.  Both growth rates are higher than we are comfortable utilizing.
As a check on the DDM, we calculated an intrinsic share price value based on the Free Cash Flow (FCF) model.  Under the above FCF model, the equity valuation of the firm was $10/share, using a 1.56x Beta, but more conservative growth rates, including 3% terminal growth rate.

ESG Profile


CsrHub ratings:
Rating
AGR Rating
Overall rating
47
CONSERVATIVE
Community rating:
46
AGR Score
Employees rating:
50
     93rd Percentile
Environment rating
44
Governance rating
45
Equity Risk Factor:  5 (best)

Source: CSRhub.com

Highest rating is 100

Source: Audit Integrity

As mentioned in our introduction to Interface Inc., the company is a global leader in sustainability.  This would be the “E” in ESG.  While not a recognized leader in overall ESG, I believe the company may be better than what’s implied by its CsrHub rating (left column).  CsrHub rates Interface an overall 47 rating.  This is slightly below the average rating for a US company as well as its industry peers.  They do, however, give Interface a 50 rating for its relationship with employees, which is higher than the overall company average of 48.
This website will use CsrHub and Audit Integrity ratings given that they are a good standardizing and benchmarking tool.  However, we also recognize the high weighting of qualitative criteria in Socially Responsible Investing.
CSR Hub is a website used to aid people such as SRI investors and socially conscious consumers make decisions on whom to do business with.  CsrHub’s overall ratings are based on four categories that are in the table above.  Their major data sources are ASSEAT4 (from Thomson Reuters) Governance Metrics International, IW Financial, Trucost, Vigeo, and several others.
Interface has received numerous awards over the years, including advancing to 16th place in CRO Magazine’s 100 Best Corporate Citizens.  This is a prestigious ranking often cited by the media.  Though, we note the company hasn’t placed in CRO Mag’s more recent lists.  Interface was also recognized by Time Inc. 2007 edition of Heroes of the Environment magazine special.  More recently, Interface was honored by the Centers for Companies That Care.
Another aspect of SRI due diligence is analyzing the company’s quality of financial reports and accounting.  This website will rely on Audit Integrity to benchmark companies in this area.  Interface, Inc. earns high ratings in this category, rated in the 93rd percentile of all companies examined by Audit Integrity.  This means the company’s financial statements and governance have not been flagged by Audit Integrity.  Flagged companies tend to have a higher probability of earnings restatements, and litigation.  AGR, did note though, that executive/board Insider Selling was a concern.
Further, Interface’s AGR score has remained high (usually above-average) over the last 3 years (See chart below).  The company also earns an Equity Risk Factor of “5”, its best rating.  Companies with such a rating have outperformed the market.

Industry & Macroeconomic Data:
Industry / factors:
Broad End-market
End Markets
Carpet/Flooring
Commercial
Corporate Office
Growth: 3% CAGR
Consumer
Consumer/Home
Size: $2.3Bn U.S. (2009)
Institutional
Government
Secular Trend towards Modular carpeting

Healthcare
Mature industry

Hospitality


Retail




Interface participates in the carpeting segment of the Flooring industry.  The Flooring industry is in the Maturity stage of its life cycle.  This stage is marked by low growth, high penetration, high competition and revenue cyclicality.   Despite competition with fairly large companies (e.g., Mohawk Industries: $5.4Bn in revenues FY’09) Interface continues to compete successfully using a niche strategy focusing on innovating the modular carpet market.  During the last 10 years, it has shifted its business from 40% modular to 92%. 
Most readers are probably familiar with modular carpet.  It’s basically the square carpet tiles seen in offices.  In modern day offices, they offer some key advantages, allowing technology workers to simply add/remove floor cables without having to cut into the whole floor.  Modular tiles also have no need for padding, offer quick installation, and produce less waste.  And what waste there is left over, can easily be recycled thanks to Interface’s lead in sustainability.
The total U.S. Commercial Carpet market was $2.3Bn in 2009 and is forecast to grow 3% annually to $3.3Bn by 2020 (Sources: Interface, Invista, Floor Focus, Carpet & Rug Institute, Catalina Research).  Penetration of modular carpet was 38%, up from 26% in 2004, and the company hopes this could reach as high as 65% by 2020.
In the United Kingdom (not part of the above research data) the penetration rate is as high as 44%, hence this implies some room for US penetration increases.  The largest opportunity lies in Germany where the market size is large and the penetration rate is just 8%.
Of course, carpet growth is influenced by construction activity, and anyone following the Financial Crises is well aware that construction is at recessionary levels.  The table below forecast that both non-residential (e.g., offices) and residential construction won’t take off until 2012.  However, we note new construction is only one part of the equation, as office remodelings are another demand factor.  Interface estimates that remodeling is as high as 90% in the U.S., but far lower 10% in Emerging Markets.  Of course, most of the buildings in Emerging Markets are relatively new, so there’s a lower need for remodeling.
Forecast for end markets
2010e
2011e
2012e
2013e
Real GDP (United States)
2.6%
2.4%
3.3%
3.2%





Real Nonresidential Construction
(14.8%)
(4.9%)
4.4%
14.7%





Residential Construction
(3.7%)
8.4%
32.4%
15.8





Source:  S&P Economic Research,  Baseline forecast.








While the majority of revenues have historically been to the Office Market, Interface is expanding its customer base into the Retail, Government, Healthcare and Education Segments.  It’s also moving into the Consumer market via its upscale FLOR brand.  Interface opened its first retail store in Chicago in 2009.  This is a big risk and return opportunity for the company.

Peer Analysis:
As stated earlier, the module carpet industry is a segment of the larger Carpet industry, which includes conventional broadloom carpet.  However, several carpet companies are part of larger, home furnishing companies.
Interface’s largest direct competitors are highlighted in yellow shading below.  Interface also competes directly with Shaw Industries (not in table below) especially for modular carpeting.  Shaw, which is also Georgia based, was acquired by Warren Buffet’s Berkshire Hathaway in 2000.  Shaw is the world’s largest carpet company with estimated revenues of $5Bn and over 30,000 employees.

As the reader can see from the above tables, Interface, is smaller than the largest publicly-traded home furnishings/carpeting companies.  Interface’s revenues approximate nearly $1Bn; however this compares with the industry median of $2.8Bn.  Though, revenues and EBITDA are expected to grow much faster relative to the industry, which has been suffering a slow turn-around.  (All numbers, including estimates were provided by Bloomberg LLC.)  This faster growth results in a higher than peer group P/E ratio of 25x. (Note: P/E based on stock price data as of 11/2010).
The P/E column is repeated in the second table for Valuation comps with its peers.  Interface’s shares are clearly trading at above its peer group.  We have also provided the WACC, showing just how high weighted average cost of capital is not only for Interface, but the industry as a whole.  Privately-held Shaw Industries, in comparison has the luxury of being under the Berkshire Hathaway umbrella; and the firm likely has a far lower cost of funding compared to most of its peers.
In conclusion, we truly believe Interface will continue to do well in business and Mission Zero, as the company continues to grow more innovative, smarter, and maybe even a bit kinder!
DISCLOSURE:  The author is long IFSIA, Interface, Inc.   The above research is not a recommendation to purchase the securities of Interface, Inc.

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