Oplink Update

Derek has an update on Oplink's 2006 first quarter at Armchair Analysts Club.

For those of you who don't follow Oplink, it is a small optical components manufacturer that has been a favorite of the KU Applied Portfolio Management class for years. The company itself is nothing special, but most of the stock price is made up of cash, so there is very limited downside with a lot of potential upside to the stock.

This week has been a great week for Oplink shares. Shareholders have been agitating for a share buyback, which could be a possibility starting next week.

Timothy Burger
timothyb(at)timothyburger.com

Merck Wins! (Not That it Matters)

Yesterday morning pharma giant Merck won the second Vioxx case to go to trial. The case cleared Merck of responsibility for a heart attack suffered by an overweight postal worker who had taken Vioxx for only two months. The verdict spurred a rally in Merck stock on Thursday.

The biggest issue facing Merck shareholders right now is the unknown liability that will result from Vioxx litigation. Most analysts have a liability between $30 and $50 billion baked into their estimates. Merck currently has 6,400 Vioxx lawsuits pending against it representing 11,700 plaintiff. That means that a $30 billion liability assumes that Merck loses every case against it and pays defendants about $2.5 million apiece, a $50 billion liability assumes they pay about $4.27 million each, Merck has a separate reserve to pay their attorneys.

The size of the liability is a huge deal, Merck will end up paying the widow of a marathon running produce manager $24 million after a Texas jury found that he died as a result of taking Vioxx, they won't pay this week's plaintiff anything. Estimates of actual deaths caused by Vioxx vary, and may include people who died while taking Vioxx but whose deaths were not caused by Vioxx. Merck certainly faces a huge liability, and a liability that may people believe they deserve to pay due to their lack of caution in promoting Vioxx.

For Merck shareholders the Vioxx liability remains the biggest question mark, followed closely by the 2006 loss of patent protection for cholesterol mega drug Zocor. But even with all of the bad news that will certainly hit Merck in the next year, the market may still be taking too dim a view of Merck's future prospects. Even after Thursday's rally, Merck is still priced at only 11 times earnings, and still has thousands of scientists searching for new drugs and vaccines every day.

Timothy Burger
timothyb(at)timothyburger.com

Tylenol Turns 50

Tylenol, one of the great American brands and great American products just turned 50. Impressively, Tylenol sales are up 9% year to date.

Among the many lessons that can be learned from Johnson & Johnson's management of a brand like Tylenol (identical in every way to the cheaper, generic acetaminophen products that sit on shelves across the nation), is the way J&J managed the 1982 tampering crisis.

Tylenol’s biggest challenge, the 1982 cyanide tampering scare in Chicago that killed seven people, is considered “a case study of how to deal with a brand crisis,” said Mark Bard, president of Manhattan Research. He said pharmaceutical companies such as Vioxx maker Merck & Co. and Bextra maker Pfizer Inc. “could learn some lessons from what happened 20 years ago. ”J&J had its sales force remove 264,000 Tylenol bottles from Chicago area stores; consumers also were urged to return any Tylenol they had for a safe bottle, and prompt alerts from J&J and the FDA kept the public informed, recalled Dr. Anthony Temple, head of medical affairs for McNeil Consumer in 1982.

If you leave people in the dark, you have a real risk of them never being able to trust you” again, said Temple, now senior medical consultant for McNeil Consumer. It took just a few months to regain public confidence, he said.

Bard said it was worth it for Johnson & Johnson to spend around $100 million on the recall to save its brand, given that nonprescription drugs are on the market for decades, compared with prescription drugs that lose patent protection, and thus most of their sales, in 10 to 15 years at most.

Timothy Burger
timothyb(at)timothyburger.com

Valero Reports Strong Third Quarter

This morning Valero, the largest refiner in the US, reported strong third quarter results and gave positive guidance for both the fourth quarter, and for 2006.

Valero's net income of $1.3 billion, or $4.37 per share was driven by improving refining margins, and a wide spread between sour crude and light sweet crude and positive results from the recently completed Premcor acquisition. Valero is one of the leading refiners of sour crude in the United Sates, 47% of Valero's 3 million barrels a day of refining capacity is used for sour crude.

For 2006 Valero reported that they plan on increasing refining capacity by 100,000 barrels per day, but noted that capacity creep will not be able to keep up with increasing demand for refined products if the economy stays strong. While the outlook for pricing appears to be robust, Valero's costs are driven in part by the price of natural gas.

Valero indicated that for 2006 futures are continuing to indicate strong refining margins. Valero feels confident enough that prices and margins will stay high. This quarter Valero's results were negatively impacted by their hedging operations, to their positive outlook on prices and spreads, they are not actively trying to hedge prices for 2006.

In a related announcement, Valero CEO Bill Greehey will step down, to be replaced by Bill Klesse, who is currently Valero's COO. Greehey will remain Chairman.

Since the question of a "wind fall profit tax" is still a hot topic it is worth noting that management discussed the poor returns Valero earned when oil prices were low and spreads were tight. It is also worth noting that Greehey was able to build Valero to its current size because nobody wanted to own refineries when they were not making money, one of the key factors leading to our current high gasoline prices. Through the first nine months of 2005 Valero has already paid over $1.22 billion in taxes.

Timothy Burger
timothyb(at)timothyburger.com

In Defense of Exxon's Record Profits

Last week Exxon Mobil announced quarterly earnings of $9.9 billion, a record for quarterly net income. In reaction to this many politicians have indicated support for a wind fall profits tax, essentially a tax on companies that politicians decide have made too much money. Aside from the arbitrary nature of this tax, there are three important points that I wanted to make sure everyone keeps in mind.

First, highly successful companies already give back to society. Remember that Exxon creates jobs, provides a vital commodity for the economy and every day life, and distributes profits to shareholders, allowing ordinary Americans to save for and fund retirement, college education, and a host of other important life goals. Exxon isn't owned by some mysterious cabal, it is owned by people like you and me.

Second, Exxon already pays more taxes than you and I can comprehend. During the third quarter, when Exxon reported it's $9.9 billion in profit, Exxon also paid $25 billion in taxes to the government, in other words, the government made almost three times as much money as Exxon shareholders. For the first nine months of 2005, Exxon has already paid $72 billion in taxes, that's right $72 billion in the first nine months alone, Exxon is on track to pay $96 billion in taxes during 2005.

Third, Exxon is in a risky business. They do business in unstable places, in unpredictable political environments, environments where their assets and businesses could be seized at any time. They spend billions to drill new wells, wells that could end up dry holes in the ground. They sell a commodity that has huge price swings, all to bring gasoline and natural gas to American consumers. When oil is at $60 a barrel, people want to take the "excess profit", but when oil is below $20 per barrel, nobody wants to step in to take on the "excess" losses.

High oil prices may be a big problem for American consumers, but taking away profit in a cyclical industry is a sure way to make sure that nobody wants to invest in that industry, and that is a great way to insure high prices in the long run.

Timothy Burger
timothyb(at)timothyburger.com