Share the Wealth, Part II: Our Outlook on Four Cash-Rich Companies

Andy Obermueller's picture

Thursday, December 3, 2009 - 4:59pm

by Andy Obermueller

Perhaps Willie Nelson put it best.  "If you've got the money, honey, I've got the time."

The United States' top 10 most cash-rich companies certainly have enough jack to keep the party going. Today we continue looking at whether companies with a huge cash position make good investments.

Company (Ticker) Cash/Near Cash
General Electric (NYSE: GE) $61.4 Billion
Berkshire Hathaway (NYSE: BRK-B) $26.9 Billion
Ford (NYSE: F) $25.8 Billion
Merck (NYSE: MRK) $21.8 Billion
Oracle (Nasdaq: ORCL) $16.2 Billion
Hewlett-Packard (NYSE: HPQ) $13.3 Billion
Dell (Nasdaq: DELL) $12.8 Billion
ExxonMobil (NYSE: XOM) $12.5 Billion
Google (Nasdaq: GOOG) $12.1 abalance sheet2661llion
Johnson & Johnson (NYSE: JNJ) $11.9 Billion

On Wednesday, we examined GE and Berkshire Hathaway. (You can find that article here.)

Today, we will study Ford Motor Co., the drug maker Merck, software giant Oracle and Hewlett-Packard, the diversified technology titan.

No. 3: Ford Motor Co. (NYSE: F), $25.8 billion

When most investors hear "automaker" and "cash," one word comes to mind:

Losses.

The financial crisis all but killed a home-grown industry as Detroit crumbled under a huge pile of debt and out-of-control costs. Ill-conceived product lineups based almost wholly on gas-guzzling SUVs and light trucks led to car lots full of vehicles no one wanted to buy when gas hit $4 a gallon in the summer of 2008. Oh, and financing all those instantly upside-down buyers? That didn't turn out to be such a hot idea, either.

Result: A flailing Chrysler was pawned off on the Italians, and General Motors, an icon of American capitalism, filed for bankruptcy and is now owned by Uncle Sam.

And then there's Ford.

The storied automaker took no U.S. government bailout money. It posted losses along with everyone else, sure, but they weren't lethal. And in the midst of all of the talk about the death of U.S. automakers, Ford did something very surprising: It started building cars people wanted to drive.

Ford has always kept a mountain of cash on hand. In fact, the company's current $25.8 billion war chest is a little lighter than is typical: The cash line on its balance sheet hovered at $28 billion through 2005 and 2006 and rose to $35 billion in 2007. One reason Ford keeps a lot of cash on hand is that it goes through a lot of it: Its cash hoard is generally about three month's worth of operating expenses.  

Yet the overall picture isn't quite perfect, and hasn't been for some time. Look a little farther down on the balance sheet, to the all-important "shareholder equity" line. This is the difference between the company's total assets and its total liabilities. It's part of the company that investors actually own outright.

And it's a negative number.

That's not good. The breakup value of the company -- offloading Ford's $218.3 billion in assets and covering its $235.6 billion in debt -- would leave investors holding the bag for $17.3 billion. In other words, if I were to sell you Ford, I'd still owe you Starbucks. Not a cup of coffee, the entire company.

With that caveat in mind, however, it's worth noting that Ford is on track to post a profitable fourth quarter. The consensus estimate is for earnings of $0.25 a share, which would push Ford into the plus column for the year, with annual earnings per share of $1.29, comparable to pre-crash results. Given its typical valuation of between 15 and 17 times earnings -- and assuming the bottom of that range -- this gives Ford a current fair-market value of about $19, more than twice what it is selling for today.

As the market reached its ebb in early March, Ford shares sank to $1.50. Investors who bought at the low hit a five-bagger. Today, at about $9, substantial upside may well remain. The case can be made that these shares are still significantly undervalued -- presuming one believes that the economy will continue to recover and that Ford will continue to build vehicles that people want to buy. On the other hand, forecasts for a 2010 profit of $0.51 a share suggest that 2009's earnings could be an anomaly and that Ford is poised to deliver lackluster gains for the near-term.

On the whole, these shares are not for the risk-averse or faint of heart, though certainly significant upside potential -- even returns in excess of the market, or "alpha" -- exists.  

No. 4: Merck & Co. Inc. (NYSE: MRK), $21.8 billion

If you've seen the television commercials for drugs like Clarinex, Fosamax, Pepcid, Propecia, Singulair or Zocor, then you've heard about a Merck drug. The New Jersey-based pharmaceutical giant makes more than 40 prescription drugs and has more than 100 more in Food & Drug Administration clinical trials.

Since Jan. 1, 2005, Merck has taken in $110.0 billion and earned $26.5 billion -- even after spending an astonishing $22.0 billion on research and development. (Some studies place the average cost of bringing a drug from the laboratory to the pharmacy shelf at $1.2 billion.)

Merck is a good model for any company wondering how to use its cash. Merck has the money to fund its research and to make acquisitions -- including its March 2009 purchase of rival Schering-Plough, a $40 billion cash and stock deal. Schering-Plough brings not only billions in revenue and earnings to the table, but another 19 drugs in development, including a handful in late-stage Phase III trials, the last step toward FDA approval.

Over the long term, Merck must be judged as one of the most successful drug makers in the world. In the past 20 years it has not recorded an annual loss. In fact, it has earned $90 billion on $425.4 billion in revenue, an enviable 21% net profit margin. During the past 12 months, Merck has delivered a world-class +37.9% return on equity.

In the Hall of Cash-Rich companies, Merck has consistently delivered. Investors interested in long-term asset growth should consider buying these shares without a second thought. This Dow component has mirrored the market this year and, given its long history of success, seems like a steal at less than 10 times earnings. Cash alone accounts for 20% of Merck's market cap, which makes the value of this company's underlying business a compelling bargain.

No. 5: Oracle Corp. (Nasdaq: ORCL), $16.1 billion.

There's an old joke in Silicon Valley: What's the difference between God and Larry Ellison?

Answer: God doesn't think he's Larry Ellison.

Despite Ellison's out-size personality, which includes a penchant for massive yachts, it's pointless to deny that he is a visionary genius and a lion of American capitalism. His company has grown from a small software firm into a worldwide leader in the enterprise software that helps run thousands of companies.
In the past 10 years, the lowest Oracle's net profit margin has sunk is 20.3%, and is currently more than 10 percentage points higher than that. For this the company trades at a modest 20 times earnings, a slight discount to the S&P 500 overall and a little less than average for the top 10 largest companies (as measured by market cap).

Oracle typically keeps far less cash on hand. It recently issued $5 billion in debt to help fund an acquisition of Sun Microsystems, a deal that's being held up by European antitrust concerns. The company normally has about $8 billion on hand, or roughly 10 months of operating expenses.

Oracle is an IT play that ultimately depends on a rebound in corporate spending, something unlikely until global economic conditions improve significantly and companies begin to feel comfortable investing in their computer systems. In the meantime, investors would likely fare better pursuing other opportunities.

No. 6: Hewlett-Packard Co. (NYSE: HPQ), $13.3 billion

In 1938, Walt Disney bought eight oscillators from Bill Hewlett and David Packard to help engineer the sound for an upcoming picture called "Fantasia."  The two founders had started their enterprise in Packard's garage with an initial capital investment of $538 and the design they employed in their oscillator was used for 33 years -- probably the longest-selling design of all time.

HP's reputation for engineering and high quality has served it well: The company, one of the 30 that make up the Dow Jones Industrial Average, is now among the largest technology companies in the world. It sells computers, printers, ink cartridges, monitors and specialized network components known as servers, which are the backbone of the Internet. Its 2008 sales amounted to $115 billion, which is roughly the company's market capitalization.

From an income statement perspective, things look great for HP. Per-share earnings have trended upward for years. In fiscal 2010 ending Oct. 31, for example, the company is expected to earn $4.74 a share, a modest +9.7% increase from the current fiscal year.

But shareholders never seem to get anywhere. Equity has hovered at its current levels for the past 20 quarters. While some may see that as admirable given the current economic climate, I see it as an indication that HP has to spend a massive amount of money all the time to keep up with its competitors. The days of a long-running, profitable design ended decades ago. The industry's pace of change requires a constant investment -- about $4 billion a year, ideally -- yet without the robust profit margins of, say, a pharmaceutical company.  

Bottom line: HP keeps $13.3 billion on hand because it has to, both to continue to fund R&D and to weather the down times of a highly cyclical segment of the economy. That's prudent financial management, but it's not necessarily a good reason to buy the company.

HP is fairly valued at current levels, though it has some appeal over the long term for patient investors. At 12 times earnings, 2010 per share profits of $4.74 imply a fair-market price of $56.88, an +18% gain from current prices, a rate far in return of the market's long-term average. As technology spending by business increases, HP could well see an uptrend in profits in the next three to five years. 

Andy Obermueller does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.