|Tyco's Tipping Point |
Stock revives under CEO Breen's leadership
Road to RecoveryInch, who replaced a Merrill Lynch analyst accused of pumping Tyco's stock, believes that fundamental improvements will continue to drive the company's share price. He points to cash flow generation in particular. He predicts the company will deliver $4 billion in free cash flow -- well ahead of current estimates -- as it streamlines its operations and capitalizes on rebounding economic conditions this year. Morgan Stanley analyst Stephen Volkmann, who initiated coverage on Tyco this month with an overweight rating, is similarly bullish. Volkmann says the company's solid cash flow has already strengthened a balance sheet that worried some investors in the past. He believes the company can now focus more on optimizing its assets and increasing its margins. But he also admits that "the easy money has probably been made" in the stock. Meanwhile, Volkmann acknowledges that risks still exist. He says that proposed legislation could eliminate some of the tax benefits Tyco enjoys as a Bermuda-based corporation. He also says that huge goodwill impairments, while unlikely, could lead to covenant violations that raise the company's borrowing costs. In the meantime, Tyco still faces shareholder lawsuits and remains under investigation by the Securities and Exchange Commission. And even Volkmann is waiting for the company's new management to really prove itself. "The key still is to gain trust, which will only come through continued operational success, in our view," Volkmann wrote early this month. "The plan is in place, and the results thus far appear promising. But a positive track record is the ultimate end game."
Caution AheadOne analyst has expressed more caution. Barry Bannister of Legg Mason raised several concerns after Tyco's latest earnings report in February. He said that Tyco posted organic sales growth of only 2% in the first quarter. He also saw some weakness in the company's cash flow. "Working capital free cash flow fell short of our view," wrote Bannister, who has a hold rating on the stock. "So Tyco is underspending depreciation and reducing acquisitions as offsets." Still, Bannister expects Tyco to top its own guidance by generating $3.46 billion in free cash flow this year. But he also sees the potential for an earnings shortfall at a time when, he believes, the company needs to be delivering upside surprises just to justify its current stock price. He isn't terribly optimistic, either. He says margins "are bouncing along rock bottom" in the construction business. They may have peaked in the health care division. And they are "struggling to maintain lift" in the electronics unit. Ultimately, Bannister believes that Tyco is worth only $25 a share even with some of the company's biggest risks behind it. In contrast, Volkmann feels that Tyco's stock is worth a full $10 more. "Legacy legal issues are still an overhang," Volkmann conceded. "We think this risk is real. But considering the outcomes of other high-profile suits, we think the overall effect on the company should be modest." Inch downplayed the current fraud trial in particular. "The realization of sustained cash generation, the success of business streamlining initiatives and leverage due to a rebounding electronics cycle should continue to drive the stock over time, in our view, rather than the outcome of the former management's trial," Inch wrote on Monday.