Gimme Credit

Shares of Arrow were up substantially today after the company reported results that exceeded expectations. Overall revenue growth was 8%, including a 7% gain in Components and a 10% increase in Computer Products. Revenue growth was aided by the recent acquisitions of LOGIX and Achievea. While the revenue gains were impressive, EBITDA margins fell 50 basis points versus last year, mostly due to weakness in the Components segment. In addition, European sales were sluggish, and the increased mix of Asia Pacific business constrained margins. Management expects normal seasonality for the third quarter, with ongoing weakness in the European region. Free cash flow for the quarter declined versus last year.

BUD's steady sales and profit gains for its second quarter were overshadowed by its recent agreement to sell the company to Inbev for $70 per share. Net sales increased 4.6%, mainly because of higher prices as sales to wholesalers in the U.S. rose only 0.5%. Bud Light Lime and Landshark Lager are examples of successful new product innovations. EBITDA increased 2.8%, but margins fell because of higher commodity costs and brand investments. The company's expanded Blue Ocean restructuring plan should generate enough cost savings to boost profit margins in the future. Since BUD has suspended its share repurchase program, free cash flow was used largely to repay debt. Leverage declined to 2.15x from 2.37x. But this is just a short-term phenomena as the debt-financed Inbev deal will lead to a significant increase in borrowings. We expect BUD's debt to be assumed by the new entity.

Hershey reported mixed results for its second quarter. Although sales comparisons improved, profits still declined versus a year ago and EBITDA margins were lower than the first quarter. Net sales increased 5.1% because of higher prices and better mix as overall volumes were flat. Hershey has achieved strong results from its new Bliss chocolates and from increased support for its core brands. Adjusted gross profit margins rose 80 basis points as pricing and productivity more than offset input cost inflation, which is still estimated to be up $100 million in 2008. But the company ramped up its advertising & promotional spending by 34% in the period and S,M&A costs rose 24%. The higher brand investment was to support new product innovation, expand retail coverage, and broaden its overseas presence. As a result, adjusted EBITDA declined 13.7% and margins slumped 350 basis points. Adjusted E.P.S. of 29 cents fell 17%, but beat estimates by a penny. On a positive note, the company made good progress on improving its working capital position, leading to lower debt levels. Leverage has been steady at 2x despite the weak operating results. The company has curtailed share repurchases amidst rating agency pressure. Hershey affirmed its full year guidance and expects savings from its global supply chain transformation project to accelerate in the 2H. The company provided a cautiously optimistic outlook, helping to boost the stock by over 5% on the day. We view 2008 as a transition year. The company must prove it can grow both sales and profits, but at least comparisons will get easier.

Whirlpool reported better than expected results for its second quarter. The world's largest appliance manufacturer is battling weak U.S. demand and record commodity cost inflation. U.S. appliance demand fell 8% during the period, but Whirlpool's sales only dropped 4% as it gained market share. The company now expects full year U.S. appliance industry sales to be lower by 6%-7%, one point worse than its prior forecast. Raw material cost inflation has become a global challenge, with costs expected to be up $600-$650 million, a $150 million boost from just three months ago. To combat the difficult market conditions, Whirlpool is raising prices, adjusting its manufacturing footprint, and improving productivity. In the second quarter net sales rose 4.6%, led by currency-adjusted sales gains of 8% in Asia and 7% in Latin America. The company has taken several cost-based price increases, including up to 13% in Asia and 6%-10% in North America. Operating profit fell in NA, its largest segment by revenues, and Europe. Whirlpool has announced four facility closures in NA and it is aggressively seeking cost savings. These efforts helped trim the EBITDA decline to only 2.9% in the period, far better than the 1Q drop of 17.1%. We consider this performance very impressive considering the environment. E.P.S. of $1.53 compares to the $1.44 consensus. As we had expected, leverage declined sequentially to 1.7x. The company still must generate nearly $1 billion of net CFFO in its second half. This will allow it to get closer to its target leverage of 1.0-1.5x. Whirlpool's results have held up well overseas, but it could start to exhibit further weakenss in these markets. It maintained its full year E.P.S. guidance range of $7-$7.50. The company's stock jumped over 12% on the day. We recently included Whirlpool among our top picks in our latest sector report.

Predictably strong second quarter earnings from ConocoPhillips, dominated by upstream strength, particularly in the Lukoil investment. Net income per BOE increased $7.44 to $25.12. It was good to see some profit improvement (sequentially) in Refining & Marketing where realized refining margins increased by 24%. COP noted its refining margins failed to match the global average improvement of 50%, due to secondary products prices (20% of COP's output during the quarter) not keeping pace with crude oil. Big picture: Cash from operations of $5.4 billion covered capex of $3.6 billion and dividends of $0.7 billion with $1.1 billion to spare. COP repurchased $2.5 billion of shares during the quarter, using free cash flow, plus about $600 million of cash on hand, $400 million of asset sale proceeds, and an incremental $400 million of debt. At quarter end, total debt was $21.9 billion, or 19% of capitalization. COP indicated another $2-3 billion of shares will be repurchased in Q3.

Exactly a year ago, General Motors started hosting global sales conferences, probably to highlight its strong performance outside of the U.S. After that call, we told investors that growing demand from emerging markets could help offset weakness in North America. (GCHY 07/23/07) Today GM reported strong global unit sales with unit growth up 34% in Russia, 29% in Brazil, 14% in China, and 13% in India. On the call GM said high commodity prices and easy credit boosted sales in Russia and Brazil while strong economic growth helped sales in India. GM's Chevrolet and Cadillac brands performed particularly well in Asia and Latin America. Although GM added only 14,646 units in Europe due to weak demand in Western Europe, it still added a total of 115,998 units outside North America. That partially offset a 236,365 unit decline here, which was partially due to the American Axle strike. So for the quarter, total unit sales were down 5% to 2.287 million. Year-to-date unit sales are down 2.9% to 4.54 million. GM acknowledges that the biggest risk is that the downturn in the U.S. economy will start to impact the global economy. The Chinese government's lifting of fuel subsidies and weak economies in Spain and Italy are clearly impacting sales in those countries. But GM says that so far weakness in the U.S. hasn't yet spread abroad, at least not to Europe, since there is no subprime problem there and the strong Euro has helped offset higher oil prices. But it bears watching since we believe emerging market demand, which has kept sales from collapsing this year, along with the large number of GM workers poised to retire soon will be the two keys to how GM will fare long-term.

As domestic airlines falter, it's only natural for the markets to fret about Boeing. But the fact that in reporting second quarter earnings this morning the company reaffirmed its full year sales and E.P.S. guidance should give some comfort. Boeing's commercial airplane deliveries are sold out for 2008 and essentially sold out for 2009. We always look to Boeing Capital for the first signals of weakness among Boeing's customers, and the company did take an $80 million valuation reserve for customer financing in the quarter. BCC is still paying the parent dividends albeit at a lower rate. Boeing's adjusted earnings fell 3% on flat sales growth, leading to flat adjusted operating margin, as some of the negative impact of sales mix was offset by cost savings. Cash flow and free cash flow were down markedly because of working capital increases for the 787 Dreamliner but this was not unexpected. Total company and nonfinancial debt was unchanged but some of the company's cash was used for share buybacks. As usual we will scrutinize Boeing Capital's 10-Q report when it is filed, but we see no major cause for concern regarding Boeing at this time.

Hexcel continues to benefit from aircraft makers' increasing use of composite materials as well as the aerospace boom that is being driven by launches of new planes and emerging market demand. Total second quarter sales rose 17.5% to $359.5 million. Most of the sales growth came from the aerospace division where revenue increased 25.1% thanks to a 30% jump in sales to Airbus, primarily because of the new A350. Hexcel's sales to Boeing rose only 12% due production delays on the B787. The space and defense division also contributed to Hexcel's total sales increase with revenue rising 21.5% to $75 million on growing demand for rotorcraft and European military aircraft. Sales for the industrial division were flat at $85.8 million as demand for materials for wind energy applications went unfilled due to capacity constraints. Gross margin dropped to 21.2% from 24.3% because the impact of higher volume was offset by higher raw materials costs, exchange rates, and start-up costs for new facilities including prepreg plants in China and Colorado which will supply the wind energy market. Second quarter EBITDA was $52.2 million, up from $46.2 million. LTM interest coverage is 9.8x but only 1.4x after capex which, year-to-date, is almost double what it was for the first half of last year. Because of higher capex and substantial working capital investment to support sales growth and invest in new facilities, free cash flow for the year-to-date (cash from operations less capex) is negative $91.7 million versus negative $19 million for the first half of 2007. Since June 2007, total debt has grown almost $80 million to $395.5 million; although EBITDA growth has kept leverage at a low 2.1x. Hexcel expects 2008 sales to come in at the high end of its guidance range but because of higher costs and capex, it now expects to end the year with total debt that is $40 million higher than previously forecast. Although we are concerned about the lack of free cash flow and whether emerging market demand can continue to offset weak demand here in the U.S., we believe the increasing use of lighter-weight composites, particularly for fuel efficiency, is a long-term trend that mitigates some of this risk.

Exelon Corp second quarter earnings were better than expected, driven primarily by strong performance at Exelon Generation and its nuclear fleet. Of consolidated net income of $748 million for the quarter, $653 million came from Exelon Generation, $35 million from Commonwealth Edison, and $58 million from PECO Energy (with holding company/other making up a net $2 million). Exelon Generation had offsetting one-time events in the quarter, with a $47 million mark-to-market gain in economic hedging activities largely offset by a $44 million charge for the Illinois electric rate settlement and $15 million of unrealized losses in the nuclear decommissioning trust. Absent one-timers, Exelon Generation's quarterly earnings were still up $76 million, with increased output (fewer refueling outages/days) and higher margins ($40.53 per MWh, versus $35.97 per MWh a year ago.) ComEd income was up only $6 million, reflecting a transmission rate increase, slow customer growth, some demand destruction, and mostly adverse (too cool) weather. ComEd's delivery service rate case is approaching a September completion, with the Administrative Law Judge recommending a $218 million increase (10.3% ROE, 45.04% equity ratio), versus the original $360 million request (subsequently reduced to $345 million and $314 million.) PECO Energy was the only operating subsidiary to report a decline in net income, by $38 million to $58 million. An increase in uncollectible accounts (not quantified) played a role, as did an increase in the customer transition charge amortization (1998 restructuring fallout.) PECO experienced adverse weather for its natural gas delivery (heating) business, but mixed weather for cooling (degree days down 1% from 2007 but 18% above normal). A $98 million gas delivery rate case is pending, with regulatory staff and consumer advocacy groups suggesting $50-60 million would be more approprate. A final decision should be made by the end of the year. A very good quarter, little angst. Generation is still the star.

Revlon's credit quality is improving. The company recently reported strong preliminary second quarter earning. Revlon posted preliminary second quarter sales of $375 million up from $350 million in the prior year period. Operating income rose to $60 million v. $17 million and we calculate adjusted EBITDA (excluding a one-time gain) near $75 million (v. $42 million). The company said growth was attributable to new products including delivery of second half launches. SG&A spending was lower as well. We estimate last twelve months EBITDA at $275 million leading to net leverage of 5.1x, down from 7x a year ago. The improvement in credit measures has not resulted in a huge improvement in bond prices. The 9.5% bonds (we rate them outperform) still yield 13.8%. While we believe the company will manage its cash and liquidity, the 11% Mafco term loan matures in August 2009. Perelman entities continue to support this credit and would likely refinance if the capital markets were closed. Nevertheless, we are basing our recommendation on improving results that could lead to a further reduction in leverage by year end.

Steel Dynamics' second quarter results were very strong, with both financial and operational results exceeding consensus expectations. Sales of $2.4 billion were up 164% year over year, while adjusted EBITDA more than doubled to $440 million from $218 million in the year-ago quarter. Although year-over-year comparisons are skewed by the effects of recent acquisitions and sequential results mirrored some seasonality, both period comparisons reflected favorable underlying performance trends. Revenue was up 26% sequentially essentially flat volumes and a 25% higher average selling price, while improved margin realizations helped boost EBITDA 30%. The company's Steel Mill operations, which account for about 56% of total revenue, showed continued improvement as a result of strong shipments and higher selling values. But the Scrap and Scrap Substitutes segment, which the company has been building over the past year, was the real standout. Now accounting for about 40% of revenue, this segment provided strong margin contribution, driven by robust demand for recycled ferrous scrap. By all accounts, it was a good quarter for Steel Dynamics. Interest coverage improved to 12.4x from 11.6x in the first quarter. Capex, acquisition spending, and higher working capital contributed to a $461 million increase in net debt to $2.4 billion, even after applying proceeds from the issuance of $500 million of senior notes to pay down bank debt. This brought leverage to just over 2x, up from pro forma leverage of 1.6x at the end of the March quarter. Encouraged by the strong first half performance and despite expectations for seasonal weakness and continued raw material and energy cost pressures, Steel Dynamics raised its full year EPS guidance from $3.00-$3.25/share to $3.80-$3.90/share. Given management's admission on the earnings call of having only limited visibility into the second half, we were a bit surprised to see the company raise guidance. Nevertheless, we estimate that SDI's new guidance would equate to full year 2008 adjusted EBITDA of about $1.45 billion.

AKS reported very strong second quarter results, characterized by record sales, shipments and profitability. Shipments for the quarter were up 10% year over year to 1.7 million tons, while the average selling price for the quarter was up 13% to $1,287/ton. The two combined to drive a 25% increase in net sales, which totaled $2.2 billion for the quarter. The increase in average selling price and volumes was especially impressive considering the fact that a majority of the company's sales are contracted and that the U.S. auto industry is its largest customer segment, representing almost 30% of quarterly sales. The company's stronger-than-expected performance was largely attributable to a higher proportion of sales into the export and spot markets, which more than offset the loss of revenue from the auto sector which accounted for 40% of sales in the year-ago quarter. A higher percentage of spot market shipments and overall higher selling prices combined with decent cost containment, to drive a 26% improvement in unit profitability to $137/ton up from $109/ton in the June 2007 quarter. What strikes us about this is that it was accomplished in the face of unprecedented raw material and energy cost increases and without the benefit of vertical integration (which has historically caused AKS' profitability to lag that of its peers). EBITDA of $290 million was up 10% for the quarter, causing interest coverage to improve 25x, up from 15x in the June 2007 quarter and 18.5x in the March quarter. Free cash flow (EBITDA less interest, taxes and capex) of $200 million, enabled the company to make $75 million in early pension fund contributions and trim funded net debt by $108 million to $284 million, resulting in net leverage (adjusted for post retirement liabilities) of 2.2x, based on EBITDA for the last twelve months of $925 million, down from 2.5x in the twelve months period ending with the March quarter. The company ended the quarter with a strong liquidity position, consisting of $1.1 billion of $380 million of cash and $680 million of availability under its credit facility. AKS said expected shipments to down about 8% sequentially to 1.55 million tons, due to seasonality and a planned outage at its Middletown Work mill. Despite these factors, management was optimistic the company would again see record profitability in the third quarter and guided for operating profit in a range between $170- $175/ton. This equates to third quarter EBITDA of $275-$280 million, based on our estimates.

American Express had already warned in June that it was seeing "credit indicators deteriorate beyond our expectations" (see Gimme Credit intraday note dated 6/25/08). But investors seemed rattled by the company's comments this week suggesting that weakness accelerated in June and was "evident even among our longer term, superprime Cardmembers." AXP earned $653 million in the quarter ended 6/30/08, down 38% from the year-earlier quarter. Results include a $600 million addition to U.S. lending credit reserves and a $136 million charge reducing the fair value of retained interests in securitized loans. AXP punted its earlier earnings guidance of 4-6% E.P.S. growth, and warned that credit losses are likely to increase in the second half of the year. AXP's "spend-centric" business model and its focus on high-spending, affluent consumers have historically set it apart from the competition. But the company is seeing now seeing evidence of weakness across its entire customer base in the U.S. (International and network & merchant services are more stable, although AXP did boost the loss provision for network and merchant services by nearly $50 million, in part to provide for exposure to the airline industry.) Significantly, delinquency rates (30+ days) rose nearly 32% on a year-over-year basis among customers with tenure of four years or more (the most seasoned part of the client base). Customers with "multiple mortgages" (even if they have solid FICO scores) are particularly stressed. Overall, the U.S. card services net write-off rate (managed basis, including fees and interest) rose to 6.5% in the first quarter, up from 5.3% in the first quarter and 3.7% a year ago. Average basic cardmember spending in the U.S. increased only 1% in the second quarter versus the prior year, as affluent consumers tempered their spending proclivities. The company said it does not believe it is losing share to its rivals, but the rewards card segment (where AXP is strong) is increasingly competitive. Rivals like JPMorgan are aggressively promoting rewards options such as the Chase Freedom card and the BP Gas Card (10% rebate at all BP locations for the first 60 days!). We continue to view AXP as favorably positioned within the credit card industry, but competitive conditions (as well as the economy) are likely to remain difficult for at least the next few quarters. However, we are maintaining our stable credit score. AXP put share buybacks on hold in the second quarter. It also stands to collect up to $1.8 billion in payments related to its recent antitrust settlements with Visa and MasterCard, enhancing financial flexibility.

BSX is up to its old tricks again, adjusting its brains out in ways that - surprise - make its adjusted results look better. The company reported second quarter sales down 2% and a 15% drop in net income, but adjusted sales rose 5% and earnings adjusted for everything including the kitchen sink increased by 26%. The key "takeaway" here is that even after adjustments gross margin continued its steady decline (down 260 basis points) as did domestic sales of drug-eluting stents (down 30%) and DES market share. In the quarter BSX felt the heat from a new competitor from Medtronic, and whether or when it will get the anticipated boost from its next generation Taxus product or from its second DES platform, Promus, remains to be seen. Debt paydown of $300 million was another slightly misleading headline, as net debt fell by an insignificant $160 million. In fact, we estimate trailing adjusted debt/EBITDA actually rose a bit in the quarter. To be sure, free cash flow and divestitures are being used to reduce debt, but progress is painfully slow. The stock market did not appear to be fooled by management's contortions, and sent the stock down 11% today.

WCI's offer to exchange its 4% unsecured convertible notes is not going well. We pointed out a number of problems we saw with the deal in our last report, so we are not surprised (GC 7/14/08). The company has sweetened its offer to exchange the notes for new 17.5% 3rd lien secured notes by adding warrants to purchase 33.7392 shares of common stock. It also lowered the required minimum tender condition to 90% of holders from 95% to make it easier to get sufficient approval. The amended deal has the same problems we discussed, and it remains contingent upon the successful placement of 2nd lien secured notes and approval from its banks to amend its credit agreement (again). We suspect that those agreements also remain under discussion and likely to change. If any one deal fails to close, none of the deals will close. We think it still is possible that some form of refinancing could happen, but the window of that opportunity seems to be closing. Either way, we don't believe that the value of WCI's assets covers its unsecured debt and stock, even at currently distressed levels. We remain sellers of WCI.

XTO Energy reported second quarter earnings that exceeded expectations. XTO also announced another $800 million of Barnett Shale producing property acquisitions (expected to close in early October) and noted its $1.3 billion of announced property acquisitions in the second quarter (of which $1 billion closed during the quarter). XTO now believes 2009 production will increase by 22%, with a development budget of $4.6 billion, plus another $700 million for infrastructure. But here's the punchline: XTO expects to generate cash of $8.6 billion in 2009, so that $5.3 billion of development and infrastructure capex, plus about $300 million of dividends, still leaves $3 billion of free cash flow. So while the company intends to make additional property acquistions to augment development of properties owned, it expects to do so with internally generated funds. XTO expects to grow proved reserves from 15 Tcf by the end of 2008 to 22 Tcf by the end of 2011. More in an upcoming report.

US Concrete lowered EBIDA guidance for the second quarter to $18.5-$19.5 million from $21-$27 million. At the mid-point of new guidance, this implies a 33% decline from the second quarter of 2007, before adjustments for discontinued operations. EBITDA margin could fall to 8.2% from 12% last year. The company said its business had fallen below expectations beginning in May, resulting in a 9% decline in concrete volume. A 2.6% average price increase will not offset the impact of higher costs for aggregates and fuel. Management described the sales environment as "challenging." We have expected US Concrete to fall short of expectations since December when we told investors to sell the bonds at 94 (GC 12/3/07. At the recent price of 84, we continue to expect US Concrete to underperform.

Wabtec beat market estimates again for the fourth straight quarter. It also increased guidance for 2008 revenue from high single-digit to 12%-14%. By our estimate, the company seems to be tracking a 15% increase in 2008 revenue to $1.56 billion. Revenue in the quarter was up 20% to a record $390 million and the backlog increased 18%. Working capital improvements also contributed to the strong increase in cash to $242 from $175 million in the first quarter. After the quarter ended, Wabtec purchased a European brake equipment maker for $80 million in cash (and no increase in debt). We will get more detail when the 10-Q is released, but we continue to like the prospects for this company. Positive rating action on this company is long overdue. We continue to rate Wabtec a buy.

UPS reported mixed results for its second quarter. Total revenue rose 6.7%, but this was due entirely to higher yields as overall volumes were flat. Segment operating profit declined in U.S. Domestic Package and International Package by 24.6% and 14.3%, respectively. The company blamed the "faltering" U.S. economy, a shift away from premium products, and a 67% rise in fuel costs. In fact, UPS indicated that at least 50% of its profit shortfall could be attributed to the two month lag in fuel surcharges. EBITDA fell 13.2%, which was a further deterioration from the 6.6% drop in the first quarter. Adjusted E.P.S. of 85 cents was in line with estimates. Although net CFFO has been robust at $5 billion year-to-date, UPS's free cash flow of $2.3 billion compares to $2.4 billion of share repurchases. It has committed to buyback $10 billion of stock in 2008-2009. We expect gradual credit deterioration at UPS. The UPS stock was actually up over 3% on the earnings news after hitting a 52-week low last week. Perhaps the market was cheered by the fact the company forecast its second half would be better than the first half. We remain bullish on its long-term prospects.

Halliburton's second quarter earnings were about as expected, reflecting 20% consolidated revenue growth, driven by strength in the Eastern Hemisphere and Latin America. In North America, the emphasis on unconventional (shales, tight sands) oil and gas production and horizontal drilling are very positive developments for HAL. A couple of things for bondholders to think about: 1) HAL still has $2 billion remaining under its share repurchase program; 2) $200 million has been added to the capex budget, to new guidance of $1.9-2.0 billion (not enough to create a FCF deficit); 3) Although the energy M&A market is "aggressive", HAL is still looking for select acquisitions, especially in Eastern Hemisphere markets; 4) HAL's $1.2 billion 3.125% convertible debt issue due 2023 is now callable at par, and trading at a huge premium. If called, principal would be payable in cash and the current market premium of roughly $1.8-2.0 billion would be payable in either cash or (treasury) stock. Management took pains to point out that either course would not be dilutive to earnings (if stock, the shares are already included in fully-diluted EPS, and if cash, the after-tax cost of debt would be more than offset by share count reduction.) But management didn't say what their druthers were. While this probably shouldn't weigh on HAL's largest debt issue with its short 2010 maturity, we infer from conference call comments that HAL might be thinking about adding some more debt to its capital structure.

Wishin' don't make it so. WCI is not in play, despite reports that a press release was faxed to the media over the weekend which claimed the company had received a bid of $5.25 per share for the company. That would be nearly 300% of the Friday closing price on the stock; clearly a work of fiction. WCI has confirmed that the rumor is false and it did not send out the press release. It sounds to us like some greedy scamp who jumped into the stock late to make a fast buck was trying to craft his own exit now that it seems clear that WCI's equity is most likely worthless.