Wednesday, August 6, 2008

Valuations help provide a price floor

I just finished listening to the quarterly earnings call from Transocean (calls 4.9% of portfolio). The results were solid, and management discussed the pressures of cost inflation, as well as the benefit of dayrate increases. Their revenue backlog continues to grow, providing more confidence for the 2009-2012 period. For 2008, the company should earn about $14 per share, which should help provide a price floor. This is because even if a P/E ratio of just 10 is assigned to this year’s earnings, that implies a stock price of $140 per share. And since estimates for next year are closer to EPS of $17, that implies a 2009 stock price of around $170, assuming the same modest P/E ratio of 10. So while the market refuses to assign a higher multiple to the drillers (keeping with historical norms, expecting a downturn), even a low multiple should justify prices higher than the current price.

Another example of valuation floors may be evident in Titanium Metals (calls 4.6% of portfolio), which reported earnings of $0.26 per share. In this challenging environment, the company is still producing annualized EPS of approximately $1. So again, applying modest multiples produces a price near the current price. This hopefully will provide some downside price protection, barring any significant further deterioration in business conditions.