Friday, October 19, 2007

Industry Review (continued..)

Computer Software & Services: MicroStrategy Inc (MSTR)
This industry, which includes companies like Microsoft, is tied to the health of the economy. However, due to the long-term interests of companies to shift to more automated business processes there are plenty of opportunities to find attractive companies in this industry. One key is to look for companies that are able to secure maintenance contracts and thus a steady stream of income. This could become extremely profitable as the company expands their customer base.

Microstrategy is a smaller player in a market segment that has garnered a lot of interest lately, business intelligence. MSTR is a provider of business intelligence software that enables companies to report, analyze and monitor the data stored across their enterprise to reveal the trends and insights needed to make better business decisions. The company competes against large competitors like IBM, Microsoft, Oracle, SAP AG who have been actively acquiring smaller companies to compete better in this business intelligence space. The stock price has recently recovered after a serious dip for missing earnings estimates. It is debt-free with healthy amounts of cash generating a return on assets of over 25%. Some believe their product is the best at what it does, but will that be enough to allow it to compete with larger competitors? A more likely scenario is this company being acquired in the future and integrated into a larger company.

Drugs: ViroPharma Inc (VPHM)
This industry, maybe more than any other, seems especially attractive for large-cap companies due to their economies of scale and substantial R&D funding. An interesting dynamic to this industry is its relationship to interest rates. On average over the last 20 years, drug stocks have performed better in periods of rising interest rates versus periods of lower interest rates. More important is political risk for this industry as many politicians may pressure for lower drug spending and universal health care would hurt likely hurt profit margins. Branded drugs will see continued pressure from generic drugs which are substantially cheaper and thus promoted by health insurance companies through lower co-pays for customers opting for generics. The pipeline for new drugs is critical for drug companies because sales deteriorate once patents expire and companies must find ways to replenish their product offerings.
The mid-cap company in focus is ViroPharma (VPHM). ViroPharma has been profitable since 4Q2004 when they acquired the rights to start selling one product, Vancocin ® HCl capsules, which is approved by the FDA for treatment of enterocolitis caused by S. aureus (including methicillin-resistant strains) and antibiotic associated pseudomembranous colitis caused by C. difficile . Both are potentially serious infections of the gastrointestinal (GI) tract. I don’t know what that means but you do not want to get it. Vancocin is the only product approved to treat this condition. They also have other products in the pipeline. On March 17, 2006, the FDA’s Office of Generic Drugs, Center for Drug Evaluation and Research (“OGD”) changed its approach regarding the conditions that must be met in order for a generic drug applicant to request a waiver of in-vivo bioequivalence testing for copies of Vancocin. This could reduce the time period in which a generic competitor may enter the market and could cripple future sales and profits. This is a good example of the risks of investing in smaller drug companies that do not have a diverse product line and R&D pipeline. It is a boom-or-bust proposition and at best the boom period will only last the length of the patent.

Paper & Forest Products: Pope Resources L.P. (POPEZ)

Companies in this industry are facing margin pressure on both fronts. Excess production capacity is limiting the ability to raise prices while rising energy and transportation costs are increasing overall costs and shrinking margins. One segment within this industry currently doing well is pulp (currently selling for about $830/ton), which is enjoying strong global demand. International Paper is the big name in this industry and, in an effort to improve margins and strengthen product portfolio, recently converted one of its mills from producing uncoated paper to linerboard. An interesting dynamic in this industry is United States relations with China, as the two countries have fought over levies applied by the U.S. on Chinese exports which the U.S. claims is necessary due to what they accuse is predatory pricing by Chinese companies being aided with subsidies by the Chinese government.

The company in this industry for focus is Pope Resources, which through its subsidiaries, engages primarily in managing timber resources in the United States. The company operates in three segments: Fee Timber, Timberland Management and Consulting, and Real Estate. The Fee Timber segment engages in growing, harvesting, and marketing timber. This segment sells logs and timber products to lumber mills and other wood fiber processors located in western Washington and northwest Oregon. The Timberland Management and Consulting segment provides timberland management and forestry consulting services to third-party owners of timberlands. The Real Estate segment engages in managing approximately 2,700-acre portfolio of property; and leasing residential and commercial properties in the Port Gamble town site. It currently offers a dividend yield of 3.8% and has a return of assets of over 9%. A further investigation on the true value of its real estate holdings would be needed to get a better idea of the company’s valuation.

Recreation: Ambassadors Group Inc (EPAX)
This diverse industry, which includes companies ranging from Harley-Davidson to Hasbro, relies mostly on the discretionary income spending of consumers which may be concerning for investors in this industry going forward.

Ambassadors Group (EPAX) is highlighted in this industry due to its extraordinary growth and profitability in the past few years. Ambassadors Group, Inc. is an educational travel company which organizes and promotes international and domestic programs for students, athletes, and professionals through a non-profit organization called People to People. Sales have increased 34% in 2005 and 29% in 2006 and net margins are over 30%. The company also has close to $140M of cash and a miniscule amount of debt and is thus in strong condition to weather any potential risks. The stock has been on a steady rate of appreciation the last couple of years and the stock is not cheap at these prices, but could offer an appealing investment if you can become convinced of sustained growth.

Toiletries and Cosmetics: Bare Escentuals Inc. (BARE)

The Toiletries and Cosmetics Industry is a defensive industry which has not has a particularly strong run in the recent economic growth period. Due to the consumer’s routine use of toiletries and cosmetics, performance tends to be steady in good times and bad. While this is a rather mature market in the United States, emerging markets offer great growth potential and new product development can help spur sales in otherwise saturated marketplace. The aging baby boomers also offer potential opportunities for new product lines in areas such as skin care. Finally, companies are looking at new distribution channels such as the internet and spas to improve margins and boost revenues.

One company that has been on a tear in this industry is Bare Escentuals, Inc. This company engages in the development, marketing, and sale of cosmetics, skin care, and body care products. They sell its products primarily through infomercials (comprising 25% of sales), home shopping television, specialty beauty retailers, company-owned boutiques, spas and salons, and online shopping. This company is growing rapidly as sales have increased fourfold since 2003. While the firms long-term prospects seem bright for reasons mentioned above, the fast growth of the company will probably cause some missteps that might make scare investors and make this a more attractive investment in the future.

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