"It's going to be a sad Christmas this year," says Ziv Tal, analyst at Oscar Gruss & Son, of the Christian holiday, which at one time marked the birthday of Jesus, until it became the focal point for a global shopping spree. Many corporations depend on the pre-Christmas spending frenzy, which is why many of them record a significant portion of their sales in the fourth quarter of the year. Others, the suppliers of those companies, can already feel the festive season in the third quarter, as the orders roll in, but Christmas this year, Tal predicts, will be different. It will take place against the backdrop of the credit crunch, which has officially become a global crisis.
"The entire world, especially the US, is moving from a period where credit was in abundance, to the opposite extreme, where credit will became a rarity," says Oppenheimer & Co analyst Amir Argaman, explaining the background to the change in the consumer mood. "If at first, we looked at the people involved in the sub-prime crisis, we now realize that in the past few years consumer behavior in all classes of the US population was excessive," he adds.
Because of the low interest rates and the continuous rise in real estate prices in recent years, says Argaman, many Americans took out a second mortgage, meaning that they remortgaged their homes in exchange for a loan which they used for consumption. "People's ability to live off the increase in value of their homes has more or less come to an end," says Argaman. "Add to that the labor market which is creating more and more unemployment, and the fall in free income, and you realize that the consumer spending tap has now been closed."
So we can now move on and look at the next stage of the credit squeeze - the extent of the exposure of public companies to consumer spending. As consumers in the US and the rest of the world tighten their belts, the value of the shares of the companies which sell them consumer or luxury products (or produce them) will shrink accordingly.
So we took a look at exactly how much exposure these companies have, both directly and indirectly, to consumer spending. As always, we will focus on Israel companies traded on the US capital market, but we should not forget that the ones that call the tune here are US blue chip companies.
Direct exposure
"There are a number of Israeli companies among those traded in the US, which have a high, direct, but inelastic consumer interface," Argaman notes. Among the companies he puts in this category are mobile telephony companies Cellcom Israel Ltd. (NYSE:CEL; TASE:CEL) and Partner Communications (Nasdaq: PTNR; TASE: PTNR. Another is generic drugs giant Teva Pharmaceutical Industries Ltd. (Nasdaq: TEVA; TASE: TEVA). "For Teva, the crisis could be beneficial in the long-term," explains Argaman. "Not only is demand for drugs inelastic and constant during times of recession, but the economic crisis could create pressure on governments to switch to a legal environment that is favorable for generics."
Sergey Vastchenok, Argaman's colleague at Oppenheimer's research department, names another company with consumer exposure - aesthetic treatment and device maker Syneron Medical Ltd. (Nasdaq: ELOS). "Surprisingly, Syneron has managed to post strong results in the last few quarters, despite being part of an industry which is considered a luxury. The question is how long it can last," he says.
Another company directly exposed to consumer spending is vehicle recovery and tracking systems provider Ituran Location and Control Ltd. (Nasdaq:ITRN); TASE:ITRN). "Ituran is exposed to the level of new car sales, principally in Israel and Brazil," explains Tal. "However, new regulatory requirements in Brazil mean it could still save 2009, even if it is now clear that the slowdown is spreading to emerging markets."
Indirect exposure
On the other hand, most of the Israeli companies traded in the US are not directly exposed to consumers. Most of them are technology companies which develop chips, produce production line testing systems, sell telecommunications peripherals, and develop software, but frequently their customers are the ones with substantial consumer exposure.
"There are stories which are pure consumer ones even among those companies which do not sell directly to consumers," explains Tal. One such company is DVD and multimedia chip maker Zoran Corp. (Nasdaq: ZRAN). Zoran does not sell a single product directly to end consumers, but it does sell to the consumer electronics industry, so it cannot escape unscathed from the fall in consumer spending.
"We will see the weakness of the upcoming Christmas season in the third quarter results, but Zoran is a story for 2009," says Tal. "With its share traded below its cash, and the management set to make an aggressive share buyback, an investment in Zoran is like a cheap option, if there is a recovery in consumer spending next year." Zoran is currently traded at $6.71, reflecting a market cap of $348 million, and it has $302 million in cash. The share has fallen 70% since the beginning of the year.
Another candidate is wireless handset chip maker DSP Group (Nasdaq: DSPG). DSP Group has fallen 43% since the beginning of the year, but analyst Jonathan Kreizman, also of Oppenheimer, believes the fall in consumer spending worldwide only partially explains the fall in the share price. "Wireless telephony is a sector which is seeing negative growth in its own right. The slowdown obviously won't help, but the negative growth in the field would have happened even without a recession," he explains.
Weakness in retailing
Another company in the second rank of consumer exposure is flat panel screen and printed circuit testing equipment maker Orbotech (Nasdaq: ORBK), which has already published an earnings warning for the third quarter. Orbotech took most of its investors by surprise this summer when it spent all its cash on the acquisition of US test and repair equipment maker Photon Dynamics Inc., the largest acquisition in its history. "Carrying out integration at a time of economic slowdown is a tough challenge," Tal notes. "Now that the acquisition has been completed, the company is a lot more dependent on screens, and that is a gamble which will only pay off if we see an improvement in the consumption of larger screens in the second half of 2009."
Orbotech's consumer exposure is even greater in printed circuits, which are at the heart of every electronic product. According to Tal, the visibility in this field is even lower, and orders are sometimes received just two weeks before their delivery date. The printed circuit sector was the reason for last week's earnings warning, and Orbotech's revenue from this business has been falling since the first quarter of the year. The company's share price has fallen 76% since the beginning of the year, and its current market cap is $138 million.
And what about the exposure of retail chain software maker Retalix (Nasdaq: RTLX; TASE: RTLX)? "Retail has now been weak for two years, so I would class Retalix as high-risk," says Vastchenok. "On the other hand, there is a chance that we might actually see an improvement in business, as a result of the need by supermarkets to improve efficiency," he adds. Tal believes that Retalix's customers stand to benefit from the recession. "We're in a period where people are looking for bargains, cheaper chains, and spending at the supermarket will come at the expense of restaurants and entertainment, so I see retailers investing more in systems like those of Retalix in order to maximize their revenue," he says. Retalix has fallen 42% since the beginning of the year, and it currently has a market cap of $183 million.
In conclusion, the analysts we spoke to stress that for most Israeli companies, consumer exposure is much more indirect. Many of them specialize in enterprise solutions, but enterprises also have to tighten their belts in times of recession. Tal nevertheless feels that there is a unique angle to this crisis for Israeli producers of telecommunications equipment for telecommunications carriers, television broadcasts and Internet access. "They say that in times of crisis, television and Internet consumption actually rises - as people prefer to stay in rather than spend money outside their homes." So it should come as no surprise if the most popular channels at times like these are the business news channels.
Published by Globes [online], Israel business news - www.globes-online.com - on October 23, 2008
© Copyright of Globes Publisher Itonut (1983) Ltd. 2008