Thursday, October 11, 2007

Industry Review

The following is the first post in a series providing a brief overview of an industry along with a quick synopsis of a profitable (for now) mid-cap company that may warrant a further look. I do not own any of the stocks in this post or any of these future "industry review" posts.

Banking Industry: Corus Bankshares Inc. (CORS) Industry: Down

The Banking Industry has been affected by the recent subprime woes and fears of liquidity problems. The demand by investors for high yielding bonds backed by subprime mortgages has slowed considerably thereby affecting the banking industries ability to sell their securitized loans and subsequently lend that money for new loans. This volatility in the market is creating many opportunities and time will tell how it will play out.

One example of a company experiencing these problems is Corus Bankshares (CORS). This company provides banking services as well as mortgage lending to overheated real estate areas including Florida, California, and Nevada (Las Vegas). It has enjoyed the recent boom period but there is serious concern right now about its ability to collect on its loans and there may be significant cancellations on unfinished Florida properties it has lent money to which should hurt the bottom line in the future. This may be worth a further look for investors since there is high uncertainty in this stock right now but the risk of bankruptcy needs to be better understood.

Insurance (Property/Casualty): Zenith National Insurance Corporation (ZNT) Industry: Down

The insurance industry is another industry currently in a cyclical downturn with cases of declining premiums. With top-line growth stagnant, the more profitable insurance companies are those with either a niche offering or those with a solid loss ratio. Today, insurers seem more careful writing up policies even if it is at the expense of less market share, a painful lesson the industry learned back in the 1990’s.

Zenith National Insurance Corporation (ZNT) is one of these type of companies. The company underwrites workers’ compensation policies focused on lower-risk profiles such as retailers and restaurants. It has a current dividend yield of 4.4% and has had uninterrupted dividends since 1978 and seven rate hikes in 3.5 years. It also has had a decent buying level by its insiders recently.

Natural Gas (Diversified): San Juan Basin Rlty. (SJT) Industry: Down

The diversified natural gas industry is comprised of companies that produce, sell, process, and transport natural gas. Due to high inventory levels and mild weather, natural gas prices have fallen below $6 per mmbtu recently. Hurricane season would be one catalyst for higher natural gas prices in the next month otherwise demand would have to come from a cold winter season. In the North American market, drilling in the Canadian oil sands should increase demand for natural gas there, which will reduce Canadian imports to the United States. However, supplies of natural gas remain high and demand is still low in the short-term. Many of the stocks in this sector may appeal to income-oriented investors.

San Juan Basin Royalty Trust (SJT) is a good example of a company in this industry. This is an express royalty trust that is not empowered to carry on any business activity and has no employees. The trust has a 75% net overriding royalty interest carved out of Burlington Resources Oil & Gas Company LP's oil and gas leasehold and royalty interests in properties in the San Juan Basin of northwestern New Mexico. The Trust currently has an 8.4% dividend yield but due to the recent weakness in the natural gas price, the dividend paid in the next couple of quarters could be much lower than 8.4% current yield.

Steel (General): Steel Dynamics (STLD) Industry: Up

Keeping on the theme of cyclical industries, we next look at the steel industry. Unlike previous industries like insurance that are at the bottom of their cycle, steel seems to be at about its high. The health of the steel industry is tied closely to the growth in the United States GDP and has thus been enjoying a few solid years in a row. The industry has been enjoying solid growth since 2003 but earnings are expected to be a little lower this year. There are currently a lot of acquisitions happening in this industry and it will be interesting to see how it changes the landscape. Residential construction has slowed but commercial construction has still been strong. If the economy can avoid a recession, the downturn in the steel industry may not be as bad as previous downturns.

One mid-cap company in this industry is Steel Dynamics (STLD). Steel Dynamics has a profit margin over 11% and a Return on Assets of close to 19%. This company has become an acquirer lately, buying The Techs Holdings, Inc., a flat-rolled-steel galvanizing company, for $370 million and OmniSource Corp., a privately held scrap recycler, for about $885 million. To illustrate the good times in this industry of late, this company was selling for about $6 per share in 2003 and sells today for $46.45 per share.

Petroleum (Producing): Hugoton Royalty Trust (HGT) Industry: Middle

The Petroleum (Producing) Industry is benefiting from high oil prices but is being hurt by lower natural gas prices. The bull market in oil is in full force currently but questions about lower demand due to high prices and a slowing economy are giving investors reason to pause. Natural gas prices continue to be down compared to oil which may continue as imports for liquefied natural gas (LNG) increase and more start-up projects start producing more supplies.

Another stock that may appeal to income investors is the Hugoton Royalty Trust, currently supporting a 6.4% dividend through its holding 80% net profits interests in certain natural gas producing working interest properties, owned and operated by XTO Energy, Inc. XTO Energy engages in the production and sale of oil and gas in the Hugoton area of Oklahoma and Kansas, the Anadarko Basin of western Oklahoma, and the Green River Basin of southwestern Wyoming. Similar to the San Juan Basin Royalty Trust, this company’s fortunes are tied to the price of natural gas.

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