Wednesday, October 17, 2007

Industry Review (continued.)

Medical Supplies: Alcon Inc. (ACL)
This is an appealing industry due to the fact it is not as directly tied to economic cycles. There is also high risk/reward in many of these companies due to the rapid development in new technologies that can transform the industry. However, regulatory approval processes and threats of lawsuit should give investors pause to tread carefully in this sector. But the right company has the ability to carve out an economic moat in an industry where the long-term prospects look very bright.
Taking a break from the mid-caps, Alcon (ACL) is a large-cap company that is a world-wide leader in eye care products and has carved itself out a definite moat in this segment. For example, the firm’s Infiniti Vision system for the treatment of cataracts requires large upfront investment and has thus high switching costs for doctors once they become trained on this equipment. The company does share some of the same problems facing many its industry including patent expiration on some of its drugs, smaller operating margins for international sales, and keeping its R&D pipeline stocked with innovative, new products. The growth in revenues and profits for the company are properly reflected in today’s stock price so this is a good example of a great company being offered at a below average price.

Maritime Transportation: General Maritime Corp (GMR)

In contrast to the medical supply industry, the maritime transportation industry is highly cyclical. This industry has been helped by the global commodity boom, particularly in China, which has helped push dayrates for drybulk shipping to new highs. Since oil refineries are not being built fast enough to keep up with demand, transocean shipments of gasoline has increased. However, shipping capacity has been increasing more than demand which has caused tanker rates to crash recently. As higher oil prices have increased the demand for offshore oil drilling, older vessels have been increasingly converted to floating storage units. If global economic growth levels off in the near future as many predict, this would negatively impact this industry in the short-term due to the increasing tanker supply outpacing demand.

The company profiled in this industry is General Maritime Corporation (GMR). Similar to its competitors, this company offers a hefty dividend (currently at 7.8%). GMR has a current fleet of 19 wholly owned vessels providing international seaborne crude oil transportation services. The stock does not seem to be priced at a particularly attractive P/E multiple compared to its larger competitor, Frontline. An analyst also recently downgraded the stock due to lower tanker rates in the near term. Maybe the negative sentiment will propel prices further downward and create a buying opportunity in the future. Frontline, and not GMR, might be the better investment if that time comes.

Internet: Travelzoo, Inc. (TZOO)

There are definitely plenty of stocks growing rapidly in this sector (though others have been doing equally bad) and impressive results from some companies have attracted many investors. Online advertising continues to show impressive growth which should continue to benefit companies such as Google. Companies in this industry can gather a powerful network of users to carve out an economic moat and produce above average growth. However, the fast moving nature of technology in this industry makes it harder to predict the long-term sustainability of most of these companies.

The stock in focus for the internet group is Travelzoo (TZOO) which is a profitable internet stock which has established an extensive network base. Travelzoo, Inc. publishes travel offers from various travel companies. Its publications include Travelzoo Web sites, the Travelzoo Top 20 email newsletter, and the Newsflash email product. Its return on assets is over 40% and its profit margins are over 20% and both have shown steady growth. In what is pretty common for this industry, this company became a rumored takeover candidate. Priceline is rumored to be interested in this company for $400M due to its 10 million subscriber base for its Top 20 email newsletter. Travelzoo is a good example of the best and worst aspects of investing in internet stocks: strong network effects can fuel impressive growth but if the earnings do not meet analyst expectations, the stock price will be clobbered. Travelzoo was no exception recently.

Semiconductors: Hittite Microwave Corp (HITT)
This is another industry dependent on discretionary consumer spending to drive sales of products like DVDs, HDTV, and MP3 players. The market for microprocessors used in personal computers is obviously dominated by Intel and Advanced Micro Devices (AMD). However, due to the wide range of uses for chips, there are plenty of niches for smaller players to make a profit in this industry. Demand in this industry is expected to grow, but like many industries there is some trepidation that a slowdown in consumer spending will result in lower than expected growth. One of the challenges in this volatile industry is finding a company that has established enough differentiation to avoid becoming a commodity competing on price alone.

One smaller semiconductor company that may have found this niche is Hittite Microwave Corporation (HITT). HITT is a fabless semiconductor company that develops high performance integrated circuits, or ICs, modules and subsystems for automotive, industrial, military, homeland security, scientific and medical applications. Providing to these customers insulates HITT from some of the volatility of consumer spending. This niche also allows HITT to sport net margins of over 32% and returns on total capital of 27% which makes HITT a company worth keeping on a watch list to see if an opportunity to buy arises in the future.

Environmental: Landauer Inc. (LDR)
Waste collection and disposal will always be in demand but the industry still benefits from a healthy economy to raise rates and boost earnings. One important measure in this industry is the internalization rate, which represents the percentage of waste that a company disposes in its own landfill. This has the effect of improving margins for the company. Improving margins is a key tactic of many companies in this industry since a few years ago the weaker economy was preventing them from raising prices more than modest amounts. However, companies have a hard time improving the internalization rate while at the same time making acquisition to provide growth so finding the proper balance is important for companies like Waste Management and Allied Waste. An example of a company with a niche offering in this industry is Stericycle for medical waste disposal.
Another company that offers a niche service is Landauer Inc. (LDR). This profitable company derives substantially all of its revenues from radiation monitoring services, with typically twelve-month agreements, and other services incidental to radiation dose measurement and relationships with customers are generally stable and recurring. This company generates a return on assets of over 21% and a profit margin over 23%. Growth is the missing element in this stock and rising SG&A costs and stagnant revenues have kept the stock price relatively unchanged in the past year. Unfortunately, it is still not trading at a bargain price despite being a successful company with a differentiated service offering.

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