Friday, October 26, 2007

Industry Review (continued...)

Electronics: NVE Corp (NVEC)
This industry is still recovering from an industry-wide inventory correction but indications of reduced spending have manufacturers reluctant to increase production. This industry has also been affected by the telecom industry’s recent lack of significant spending. Most companies have benefited from moving production overseas but the logistics’ difficulty it creates has not made the decision worthwhile for others. Keys in this industry seem to be how effective a company can manage its inventory and lead times so it is better positioned to survive the cyclic nature of spending of its customers.

One profitable company in this industry is NVE Corporation. This company engages in the development and sale of devices using spintronics, a nanotechnology, which utilizes electron spin rather than electron charge to acquire, store, and transmit information. It has no debt, a return on assets of close to 20%, and a net profit margin of over 30%. The company is already generating decent free cash flow and margins are improving due to manufacturing efficiencies. There is, however, considerable speculation built into the stock price and since I have no idea if their magnetoresistive random access memory technolog (MRAM) solution provides a sustainable advantage, I will stay away.

Hotel and Gaming: Choice Hotels Intl Inc (CHH)

Share prices of many companies in this industry have risen recently due to takeover speculations after the recent proposed of the Hilton Hotels by the Blackstone Group. The reason lodging stocks are gaining such attention from private equity firms could be their multiples are currently about half of other real estate classes such as office companies. The long-term prospects of the industry look strong with growth in the Far East but there is considerable expansion in this industry and the supply of new hotels and rooms may exceed demand in some places. A key statistic in this industry is the revenue-per-available-room rate to measure efficiency.

Choice Hotels International, Inc. (CHH) operates as one of the largest hotel franchisors in the world with 5,400 hotels under proprietary brand names such as Comfort Inn, Comfort Suites, Quality, Clarion, Sleep Inn, Econo Lodge, Rodeway Inn, MainStay Suites, Suburban Extended Stay Hotel, Cambria Suites, and Flag Hotels. The stock has retreated to under $40 per share after peaking over $60/share in June, 2006. It has a current dividend yield of 1.8% and has recently expanded in stock repurchase program. However, there is nothing to suggest the stock is being offered at any discount at the moment.

Petroleum (Integrated): Denbury Res Inc (DNR)
This industry is reaping the benefits of a steadily increasing demand and subsequent rise in oil. A slowdown in the global economy seems to be the only possible roadblock in the way of a continued high oil price and a lack of new investment in refineries is keeping prices of gasoline high as well. Some interesting figures for this industry:
• 86 million barrels of oil are consumed daily worldwide
• Could be 100 million barrels a day in just over 10 years assuming 1.5% growth
The new supplies for oil will have to come from more places than OPEC. Russia, from whom BP derives a substantial amount of its oil, may be another area but it is not clear how much they want to be an oil-producing nation for the rest of the world. Off-shore drilling in the Gulf of Mexico is raising hopes for new discoveries. The oil sands of Canada are also a trendy pick for the next source of oil. It currently produces 1 million barrels a day and hopes are it can increase to 3 million barrels a day in the next decade. Deepwater drilling and Canadian oil sands are projects that require greater expertise and more unknowns and construction cost overruns are common. One lingering threat in this industry is legislation from Congress as oil companies have become one of their favorite groups to blame for all the ills of society.

Denbury Resources (DNR) is an interesting company in this field due to its unique method for oil recovery. They engage in the acquisition, development, operation, and exploration of oil and natural gas properties in the Gulf Coast region of the United States, primarily in Louisiana, Mississippi, Alabama, and Texas. This company is unique in that they specialize in using C02 as a method for extraction, as the CO2 acts like a solvent for the oil, removing it from the oil bearing formation as the CO2 passes through the rock. The company believes this tertiary operation provide a reasonable rate of return even at oil prices around $30 per barrel and that this limits competition in the area because they can are the only company positioned to use this method (it requires large amounts of C02 and the ability to transport it), and thus extract oil other companies could not recover. An interesting company at an above average price, maybe it will come down in the future.

Metals & Mining (Diversified): Alliance Resource Ptnrs L.P. (ARLP)

As the story goes, the growth of emerging countries like China and India has fueled the commodities bull market. The debate today is if the run is up or if it still has more years left in it. Aluminum has benefited from strong worldwide demand, but the demand in the U.S. has not been as strong. Aluminum producers have had difficulties dealing with lower demand in the U.S., rising energy costs, and a weakened dollar. Rio Tinto seems to have successfully acquired Alcan which would make them the leader in the production of aluminum, copper, and iron ore. Copper has been doing remarkable recently and producers are using this good time to pay down debt (in the case of Freeport-McMoRan) and shore up production facilities. However, there is some debate if copper supplies will exceed demand and volatility may be ahead. Domestically, the housing and automotive sectors account for almost half the country’s copper consumption and these sectors are not currently strong right now which may cause future weakness.

Alliance Resources Partners (ARLP) is highlighted for this industry. This company engages in the production and marketing of coal to utilities and industrial users in the United States. The stock currently trades at $37.24, which offers an attractive dividend yield of 6% at those prices. It has been a profitable company with a high return on assets (16.77% as of today), but coal is a cyclical commodity and this stock is trading in the mid-range of most of its historical multiples. It will be interesting to see how coal performs since the price of natural gas, a substitute for coal, has downward pricing pressure and may look attractive right now compared to coal.

No comments: