This column was originally published on Street Insight on June 14 at 12:24 p.m. EDT. It's being republished as a bonus for TheStreet.com and RealMoney.com readers.
Most of the news was bad for
as it reported second-quarter earnings that fell below consensus estimates.
The New York-based firm earned an adjusted $3.40 a share for the second quarter ended May 31, below expectations of $3.50 a share. (This excludes an unusual accounting charge of 88 cents a share for a write-off of discontinued operations.) It looks as though the company can now only earn an adjusted $14.50 a share for all of fiscal 2007 (ending Nov. 30), barely above last year's tally.
Revenue, however, was nominally higher than last year's $2.5 billion, ahead of consensus estimates of $2.3 billion, suggesting that it is the quality, not the growth, of the broker's business that is now of greatest concern.
There was still some good news. Underwriting and M&A volumes were strong because of the benign global macro environment. This was also the case for equity-linked markets, particularly in asset management, international equities, derivatives and proprietary trading. Some lower-margined operations experienced record sales, and hedge fund-linked activities (clearing, margin lending, prime brokerage) were also robust. In addition, the quarter grew stronger toward its end as time passed after the late February market fall, encouraging Bear.
But the firm's mix was too highly skewed toward consumer-oriented mortgage activities, and to a greater extent than is true at other brokerage firms. Fixed income generally wasn't doing so well, and there were lower margins and higher losses in mortgage-related businesses because of slowing in the housing market. This was only partly offset by strength in structured credit, particularly connected with M&A transactions, and corporate credit generally, including distressed securities.
Expense ratios have also risen at the firm since Bear Stearns staffing is up in its stronger businesses, particularly overseas, in advance of anticipated revenue. Bear feels that its weaker businesses (e.g., mortgage) have stabilized, and the brokerage is expecting other fixed income operations to benefit from a steepening yield curve. So the broker is managing for a fair weather scenario.
But there may not be fair weather ahead. It's a good-news (equity), bad-news (fixed income) story at Bear, but more bad than good. Stocks are rising at the same time that bonds are falling (as happened in 1987), and if these contradictory moves are resolved in the direction of fixed income, some of Bear's currently strong operations could head south. As a result, there's no reason to buy these shares at this time.
At the time of publication, Au was long BSC, although holdings can change at any time.
Thomas P. Au, CFA, is a principal with R. W. Wentworth, a financial services firm in New York City. Earlier he was an emerging markets portfolio manager for the investment arm of Cigna Corp. and an analyst with Unifund, S.A. of Switzerland and Value Line. He graduated cum laude with a B.A. in Economics and History from Yale University and an M.B.A. in Finance from New York University. Au is the author of
A Modern Approach to Graham and Dodd Investing
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