PowerTrend Brief: Bracing for the Smartphone Bloodbath

Chris Versace

Chris Versace is a financial columnist and equity analyst with more than 20 years of experience in the investment industry.

I want to start by welcoming back my existing subscribers and offering a hearty welcome to anyone who is joining us for the first time!

This past week had a rash of economic data that showed domestic manufacturing continues to improve, even though Europe and Asia are weak and slowing, respectively. Oil and gas prices continue to be at the forefront of the conversation this week with fresh data showing year-over-year growth in personal income. However, slow spending continued in January, while the savings rate dipped in January compared to December. The net effect has the S&P 500 only modestly change during the last week and the Dow Jones Industrial Average still grappling to remain above 13,000 on a sustained basis. Despite growing concerns of a near-term market pause, favorable supporting data for my PowerTrends continues to be had. Read my explanation below.

Last week, I mentioned the importance of this week’s Mobile World Congress 2012. I described the conference as one of the largest industry events for the far-reaching mobile ecosystem. As I wrote, we normally see a flurry of announcements as a result of this trade show. Those announcements include new product launches, updates, partnerships and more. Looking back on 2011, it was pretty evident that the competitive landscape for smartphones was growing more challenging. The latest Mobile World Congress confirmed it. I believe competition for smartphone manufacturers only will become more difficult in the months to come.

After just one day at the Mobile World Congress, Samsung shared its goal of selling 380 million mobile phones this year. That sales level is up from its 327.4 million mobile phone sales in 2011. A key part in this forecast is doubling Samsung’s smartphone shipments from 97 million in 2011. If Samsung achieves that goal, smartphones would account for more than half of the company’s mobile shipments and, I suspect, a greater percentage of its mobile operating profits. But Samsung is not alone in targeting the smartphone market. New product announcements from HTC Corp., LG, Sony, Huawei, ViewSonic, Asus, ZTE, and, of course, Motorola Mobility (which soon be owned by Google) served as evidence. As tends to be the case, Apple is not in attendance, but is expected to make some news in the coming weeks.

Shark-Like Competition Hurts Smartphone Makers

With smartphone penetration rising, particularly in the developed markets, incremental growth for smartphones will be at lower price points. We have seen this move before with earlier iterations of mobile phones, PCs and other consumer electronics. I suspect history largely will repeat once again. That outlook means that before too long, smartphone manufacturers will see their margins compress as price points come under pressure as manufacturers beef up marketing and subsidy dollars to differentiate themselves and win customers. This is not a good recipe for success for either the companies or their investors.

Leading this race to the bottom is Nokia, which just announced it will unveil smartphones that run Microsoft Windows software and have price points that are 30% less than models introduced just a few months ago. The argument goes that these price points will increase the sales potential for Nokia’s smartphones “by at least 60%.” Such sales growth may sound good to some observers but it just reminds me of what has gone on in other markets over time.

With the exception of Apple, I continue to have a negative view of the mobile phone and smartphone manufacturers. I would point investors to companies that are poised to grow much faster than mobile device manufacturers as the shift toward smartphones and the deployment of next-generation wireless networks increase their dollar content per mobile device. That trend equates to a favorable one-two punch for key RF semiconductor suppliers into the expanding smartphone and tablet markets. To me, owning RF semiconductor suppliers is a smart way to participate in my Always On, Always Connected PowerTrend.

Follow Up on Cashless Consumption and Mobile World Congress

As part of my discussion on Mobile World Congress last week, I shared expectations of some breaking news on mobile payments, which is a cornerstone of my Cashless Consumption PowerTrend. That PowerTrend centers on the changing way in which we are able to pay and manage our finances and investments from a variety of devices in a seamless manner, thanks to the underlying technology and infrastructure. As I expected, Mobile World Congress led to a number of announcements, including PayPal deploying a new payments system to Home Depot nationwide. In addition, Opera Software launched the Opera Payment Exchange to enable commerce on feature phones, as well as smartphones.

Not to be outdone, Visa and Samsung revealed the official mobile payments application of the Olympic and Paralympic Games. The application is based on Visa’s payWave technology that enables contactless payments at the Point of Sale. In the coming months, there will be a growing number of data points that confirm this transformation is indeed reality. I will have more on this situation as developments arise.

Keeping an Eye on Regulation Compliance

Earlier this week, I was privileged to discuss PowerTrend investing with the DC-Chapter of Better Investing and I had a great time. A number of great questions were asked by those in attendance. As I answered some of them, I touched on a conversation I had with Ms. Nicole Gelinas of the Manhattan Institute regarding the Dodd-Frank Wall Street Reform and Consumer Protection Act. The gist of the conversation centered on the changing regulatory environment and its impact on consumers, businesses and investors. As Nicole pointed out, this change is taking far longer to implement than originally expected. Generally speaking, regulatory compliance can be a key accelerator in demand. As a result, regulatory deadlines for compliance can be a real tipping point for a PowerTrend. However, any push back in mandatory compliance dates is a risk to watch.

A great example of this situation is the pending mandate of new safety regulations that would require automakers to furnish all new vehicles with rearview cameras by 2014. This will cost auto-manufacturers between $160 and $200 per vehicle to install the cameras and the viewing screens. The estimated cost would be $2.7 billion annually. I suspect a portion of this cost will be passed along to consumers. The cost to auto-manufacturers equates to new demand for a number of vendors of camera chips and LCD screens. While we all can agree that such cameras sound like a good idea, the reality is that this initiative originally was proposed in 2010. The lesson is that even though federal regulators may be proposing new regulations, it takes time for them to be implemented. As investors, we need to have a firm grasp on real-world implications, as well as timing when investing in my New Demand, New Solutions PowerTrend.

Rising Energy Prices Also Means Rising Cost Structures

Last week, I mentioned the impact that I expect higher gas prices to have on casual dining, as consumers come to grips with the direct and indirect costs associated with higher fuel costs. Even though those prices have given back some ground this week, the reality is that fuel prices remain nearly 10% higher than February 2011 levels. While many analysts are talking about the possibility of energy prices moving even higher, the growing question in my mind is how long gas prices will remain at or above current levels. Should we experience a sustained rise in energy prices, it will take a toll on not only business and consumer spending but squeeze cost structures of those industries and companies that have meaningful direct and indirect exposure to energy prices.

One such industry that always has been rife with consumer dissatisfaction, eroding service, and arguably opting to nickel and dime its customers at nearly every turn is the airline industry. In my view, this industry gets a one-two combination punch from a sustained higher move in fuel prices — given the potential crimp in travel spending in the face of higher ticket prices as companies look to pass on higher fuel costs at a time when consumers will be cutting back their spending, which includes vacation spending.

A quick read of the most recent United Continental Holdings 10-K shows that fuel costs accounted for 36% of total operating expenses in 2011. Those costs were when the average price per gallon was $3.06 for the company. And as one would suspect, as the average price per gallon of fuel rises, so does its impact on operating expenses. According the filing, UAL’s average price per gallon of fuel in 2009 was $1.80. At that level, fuel accounted for 26% of total operating expenses. As the price per gallon rose to $2.39 in 2010, the percentage of operating expenses rose to 31%. The price per gallon and airline operating costs are continuing to rise.

It does not look good for UAL, in my opinion. But what holds for UAL also holds true for Delta Air Lines, US Airways, Southwest Airlines, JetBlue and others whose cost structure is directly linked in a negative way to my Scarce Resource PowerTrend.

Next Week — Watch for February Employment Data

We are nearing the end of corporate earnings, as those reports begin to slow next week. The velocity of economic data next week also will dip compared to this past week. That slowdown will put even more emphasis on two items next week — Europe and the domestic employment report for February. Obviously, we will be watching the official unemployment rate as revealed by the Bureau of Labor Statistics, with a close eye on its composition and the labor participation rate. The latter indicator, which reflects the number of people actually looking for jobs who have not given up trying, has been falling over the last several months, which I find troublesome.

Recent findings from Gallup suggest the U.S. unemployment rose in mid-February to 9.0%, up from 8.3% for mid-January. Underemployment in mid-February also rose, according to Gallup’s findings, reaching 19% in mid-February, compared to 18.1% in mid-January. Also this week, Federal Reserve Chairman Ben Bernanke warned of slow progress ahead on the jobs front and that improvement hinges on “stronger growth in final demand and production.”

My concern about rising gas prices at sustained levels from last week remains and I continue to see rising oil, which falls into my Scarce Resource PowerTrend, reducing disposable income and fostering my Cash Strapped Consumer PowerTrend. As noted above, sustained higher energy costs could pressure profits at companies and restrain hiring, particularly if demand winds up being less than expected in the coming months.

Monday, March 5
Factory Orders (January)
ISM Services Index (February)
Nutrisystem Inc. (NTRI)
Princeton Review (REVU)
Stein Mart (SMRT)
Teavana Holdings (TEA)
VeriFone Systems (PAY)

Tuesday, March 6
Blount International (BLT)
Dicks Sporting Goods (DKS)
Shuffle Master (SHFL)
United Natural Foods (UNFI)
Ziprealty Inc. (ZIPR)

Wednesday, March 7
ADP Employment Report (February)
Consumer Credit (February)
American Eagle Outfitters (AEO)
Bon-Ton Stores (BONT)
CyberDefender Corp. (CYDE)
Men’s Wearhouse (MW)
Pall Corp. (PLL)

Thursday, March 8
Challenger Job Cuts Report (February)
Weekly Initial and Continuing Jobless Claims
Aeropostale Inc. (ARO)
Anheuser Busch InBev SA (ABI)
Buckle Inc. (BKE)
Gemalto NV (GTO)
Jones Soda (JSDA)
Smithfield Foods (SFD)

Friday, March 9
Employment Report and Unemployment Rate (February)

Chris Versace
Editor, PowerTrend Brief

P.S.Please join me for the Las Vegas Money Show, May 14-17, at Caesar’s Palace. To register, call 1-800/970-4355 and mention priority code 026656 or go to ChrisVersace.lasvegasmoneyshow.com.

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