Sunday, November 11, 2007

Industry Review (continued.......)

Metal Fabricating: Insteel Industries (IIIN)
This industry supplies to the construction, automotive, and manufacturing sectors. Thanks to the strength of manufacturing, companies in this industry have posted solid gains of late. Some companies are using creative ways to stay profitable, such as The Timken Co. restructuring its automotive segment to convert some of this capacity to serve the growing energy segment. Companies in this industry are obviously dependent on the health of the customer’s they serve so results will vary across the industry.

One example of a profitable company not getting positive results recently is Insteel Industries (IIIN). The stock has dropped from its 52-week high in August of above $23 per share to its current price today of $10.92. Insteel makes steel-wire reinforcing products for concrete construction. It recently reported its net income fell by 49 percent to $5.2 million, or 28 cents per share, from $10.1 million, or 55 cents per share, a year earlier. The company has no long-term debt and should survive this housing market downturn, but 2008 will probably not be anymore fun for this company than 2007.

Heathcare Information Services: National Research Corp (NRCI)
This industry seems to have solid long-term potential due to the ability of companies in this industry to provide solutions to the healthcare industry that streamlines operations and reduces errors. However, evidence that these products provide savings and increase efficiency is still mostly subjective. This is still an emerging field and time will tell if healthcare organizations will spend the money required to implement these systems. However, it looks promising which should produce some profitable companies in this industry.

National Research Corporation provides ongoing survey-based performance measurement, analysis, tracking, and improvement services to the healthcare industry in the United States and Canada. It addresses healthcare organizations' need to track their performance at the enterprise-wide, departmental, and physician/caregiver levels. The company develops tools that enable healthcare organizations to obtain performance measurement information necessary to improve their business practices. The company reported record revenues and net income in its latest quarter but was disappointed its growth wasn’t better. The stock is trading near its 52 week high but its success makes it a company to keep an eye on for the future.

Specialty Chemicals: Terra Nitrogen (TNH)
For reasons gone over already ad nausea, companies in this industry are better served offering products to a diversified base of customers since the downturns in the housing market are effecting sales of chemicals used for home construction. One segment within this industry doing well is electronic chemicals as demand from China is strong for manufacturing electronic products. Companies in this industry are facing rising input costs but have been able to pass this on to customers so far but increased competition could threaten that in the future.

Terra Nitrogen (TNH) engages in the production and distribution of nitrogen fertilizer products for use in agricultural and industrial markets. The company has benefited recently from continued strong U.S. nitrogen demand for corn and wheat plantings. The stock price has reflected this strong growth. It traded a year ago at around $28 per share and traded as high as $140 per share in August before trading today at $106 per share. The money seems to have been made for this stock but what a nice run it was.

Power: VeraSun Energy (VSE)
Alternative energy companies are looking for solutions for a non-petroleum-based world and are spending significant amounts of research and development to find it. There is little put forth so far in the way of commercial products for today’s market. It will be interesting to see if these companies can continue to find external financing to pay for this R&D if liquidity dries up further. Merchant power generation companies typically have large amounts of debts and thus face risks of meeting its obligations. This industry is very volatile and the inherent risks need to be understood before investing in one of these companies.

VeraSun Energy (VSE) is the nation's second-largest ethanol producer. Ethanol is primarily used as a blend component in the gasoline fuel market. The company's ethanol co-products include wet and dry distillers grains with solubles, which are used as animal feed; and Corn oil, which is used as an animal feed, as well as to produce biodiesel, a clean burning alternative fuel. In addition, it offers ethanol-blended VE85 fuel to gas distributors and retailers. The company is increasing its capital expenditures to increase its production and has tripled its long-term debt in the last year to over $650 million. Investors seem unimpressed as the stock has dropped from over $26 per share early in the year to just under $13 a share today.

Saturday, November 10, 2007

Industry Review (continued......)

Entertainment: Lin TV Corp. (TVL)
This is a diverse industry and currently different segments within the industry are doing better than others. Cable television and outdoor advertising (companies involved in this area are Clear Channel and CBS Corp.) are two niches leading the way lately while overall broadcast television and radio has lagged. Companies such as Viacom, Time Warner, and New Corp are benefiting from increased Cable TV ownership. There are always new niches opening in this industry and companies are investing in online, digital, and gaming assets to grow profits and preserve long-term prospects.

The company in focus for this sector is Lin TV Corp (TVL). The company owns and operates 29 television stations to 9% of U.S. television homes, reaching an average of 11.5 million households per week. The company enjoyed a healthy 2006 due to heavy political advertising which has subsequently decreased in 2007 and hurt results. The company is expanding its internet efforts and internet-only revenues increased by 58% in the latest quarter. New Internet products in development include search optimization tools; political micro-sites; hyper-local high school football websites; local automotive classified advertising services, and other community driven, hyper-local micro-sites. The stock, which hit a high of over $20 per share, is trading at just above $11 per share today. There does seem to be an opportunity to buy at this lower price and wait until the 2008 elections to drive advertising revenues, and hopefully the stock price, back up for Lin TV.

Chemical/Diversified: Westlake Chemical Corp (WLK)
The Chemical/Diversified Industry has performed well recently benefiting from nine consecutive months of expansion from the manufacturing sector and general consensus is this should continue for a little longer. Companies serving the commercial aerospace sector such as Cytec Industries and Excel are enjoying strong demand right now from Airbus and Boeing. The agricultural sector is also doing well for the benefit of companies such as Monsanto. The U.S. auto and housing sectors are obviously not faring as well effecting companies such as PEG Industries and Cabot. Overall, this industry is tied to the different industries it serves and thus different for each company within it.

Westlake Chemical Corporation (WLK) is an example of a company being hurt by the downturn in the housing sector. This company is facing margin pressure due to increasing costs which it is unable to pass the price increase to its customers due to the housing market downturn. This has hurt net income and the stock has been steadily decreasing all year. S&P also recently downgraded the company due to the company’s $457 million in debt and questioned its ability to weather the housing downturn if conditions worsen. It will be interesting to see how companies like this without any real product differentiation respond if the housing market continues to worsen.

Machinery: Middleby Corp. (MIDD)
Companies in this industry that service the energy, mining, commercial construction, power, and agricultural markets are having real success right now, especially those not as dependent on the U.S. market. Companies such as AGCO, Manitowoc and Robbins & Myers are having success from increased demand for agricultural equipment due to high crop prices. Stock prices for many companies in this industry have increased substantially recently to reflect the generally positive prospects for the industry in the long-term.

Middleby Corporation (MIDD) provides cooking equipment such conveyor ovens, convection ovens, fryers, ranges, toasters, and broilers to the commercial foodservice industry including restaurants, hotels, resorts, schools, hospitals, long-term care and correctional facilities, stadiums, airports, cafeterias, military facilities, and government agencies. The stock price recently jumped close to 15% due to higher than expected revenue and income growth attributed to recent acquisitions. The company has a return on capital of over 27% and increasing revenues and margins. Seems like an interesting company since it is so successful and still relatively unknown and under-followed.

Trucking: Knight Transportation Inc (KNX)
This is a highly cyclical industry and is currently near the bottom of the cycle. The trucking industry is facing high fuel prices, intense competition and low customer demand. More than 66% of all manufactured and retailed goods in the U.S. are transported by truck. The industry is thus highly dependent on the health of the U.S. economy and is hurt by decreasing consumer confidence and slowing GDP growth. Stricter emission standards means there are more trucks on the road but the lower demand for them has led to aggressive price-cutting. Analysts are saying the downturn in this trucking industry is the most severe of the last four over the past twenty years. Key terms in this industry include truckload (TL) and less-than-truckload (LTL). TLs carry freight directly from origin to destination, while LTLs transport small shipments, typically through a network of terminals.

Knight Transportation, Inc. (KNX) provides asset-based dry van truckload and temperature controlled truckload carrier services primarily to short-to-medium lengths of haul. It operates 3,412 company-owned tractors; 249 contract tractors; and 8,761 high cube trailers, including 626 temperature controlled trailers. The company recently reported a decrease in net profit of 23% attributed to weak demand and low equipment utilization which caused them to have to cut prices. The company has no long-term debt so it should have no trouble surviving this downturn.

Air Transport: Uti Worldwide Inc (UTIW)
This sector is enjoying growth outside the United States and facing increasing price pressures within it. High fuel costs continue to pressure the bottom line. Competition is fierce in this industry and companies like Jet Blue that offer low fares have had success. Whenever I think of this industry I think of Branson’s line that if you want to be a millionaire you should start as a billionaire and buy an airline. Regardless, airlines like Southwest have shown that it is possible to have a great investment with an airline.

An interesting company in this industry is UTi Worldwide (UTIW). This company provides a global freight forwarding and logistics network capable of serving as its clients' single-source international shipping solution. From Morningstar, UTI provides a service for “Transporting goods for a component manufactured in the Midwest, bound for an assembly plant in Romania. A pallet must be trucked to a consolidation facility to be packed into an ocean container, driven to a sea port, and loaded on a ship. Upon arrival in Romania, appropriate trucks are contracted for delivery to a deconsolidation center, warehouse, or client. Along the route, reliable pickups and deliveries must be arranged in advance to avoid delays, and appropriate tariffs and import/export documentation have to be compiled in the appropriate languages and currencies. Throughout this process, timeliness, status visibility, and the ability to divert a delivery are essential. A third-party logistics firm removes this hassle by establishing relationships with air and ocean lines, trucking firms and warehouses and developing know-how for negotiating legal import and export in nations spread throughout the world.” The company has a diverse customer base with no customer contributing more than 3% of revenues. This diverse network provides the company with a competitive advantage that should serve them well in future years.

Sunday, November 4, 2007

Industry Review (continued.....)

Restaurants: AFC Enterprises Inc (AFCE)
The health of the restaurant industry is typically associated with the health of consumer spending since going out to a restaurant requires spending discretionary income. Higher gasoline prices and mortgage payments are causing concern for investors in this industry. Recent news in this industry include IHOP Corporations purchase of Applebee’s and a group of investors just bought Outback Steakhouse. Rising prices of corn, mean, and dairy has hurt operating margins in addition to the increase in minimum wage. Regardless, American’s inclination towards a prepared meal and expansion opportunities in Asia could make some companies in this industry a solid long-term investment.

AFC Enterprises, Inc. develops, operates, and franchises quick-service restaurants under the Popeyes Chicken & Biscuits trade name. It is a profitable company with profit margins over 14% and a return on assets of 18%. However the company is saddled with debt and same store sales are decreasing so the outlook is not rosy for this company. Once trading over $21 earlier this year, the stock now trades under $13. Despite the recent profitability for this company, it will be interesting to see if they created any franchise value that can provide sustainable competitive advantages in the years ahead.

Gold: Royal Gold (RGLD)
The price has gold has risen considerable lately due primarily to the influx of capital by central banks to provide liquidity in the markets. This is seen as potentially inflationary and so demand for gold as a hedge to inflation has increased. Significant demand for gold comes from India, China, and the Middle East, who each purchase gold as both a storage of wealth and for jewelry. Gold supply, which necessitates mining it out of the Earth, is not expanding as fast as paper currency is increasing, so the effect is a rising price in gold.

Royal Gold, Inc. engages in the acquisition and management of precious metals royalties. The company is different from traditional mining companies in that they acquire existing royalties or finance projects that are in production or near production in exchange for royalty interests. This royalty approach helps limit the risks inherent with mining stocks and limits capital spending requirements. Revenue grew 70% to $48.4 million in 2007, while net income rose 73% to $19.7 million, or $0.79 a share.

Shoes: Crocs, Inc. (CROX)

Despite the perception that shoes are always needed and thus the shoe industry is non-cyclical, the shoe industry is actually volatile due to the fashion trends associated with it. Thus, companies tend to be rising and falling at different times and when they turn, it is a sharp turn in the other direction. Shoe companies sporting products in fashion can be extremely profitable but ‘buyer beware’, because the price appreciation that can occur during good times can be wiped out very quickly at the first sign of trouble. Nobody wants to be the last one holding on to a stock whose product just went out of fashion.

This brings us to a company that personifies this industry: Crocs, Inc. Fueled by the popularity of its trendy shoes, the stock price had been on a tear the past year appreciating over 277%. This attracted all types of investors looking to play this stock, including short sellers and momentum investors. Today, November 1, Crocs announced their latest quarterly results and the stock proceeded to drop 36%. What happened? The company beat analyst expectations for earnings and raised earnings and revenue guidance for the year. But growth and projections were not enough to satisfy its investor base, and the stock dropped as a result. The stock is still up for the year, but the volatility of this stock underscores the dangerous game played in investing on the latest trend.

Computer and Peripherals: Intevac Inc (IVAC)
Not unlike most of the industries discussed, this industry is dependent on healthy consumer and business spending for health. OK, that sounded way too obvious. Regardless, many of the products sold by companies in this industry require discretionary spending which can dry up quickly if the money needs to go instead to higher mortgage payments and other rising costs. The good thing is most of these products improve consumer efficiencies which should drive some demand even in weaker times.

Intevac, Inc. (IVAC) is a profitable company in this industry providing disk sputtering equipment to manufacturers of magnetic media used in hard disk drives worldwide. The company operates through two segments, Equipment and Imaging. The Equipment segment designs, manufactures, markets, and services capital equipment used in the sputtering or deposition of engineered thin-films of material onto magnetic disks, which are used in hard disk drives. The Imaging segment develops and manufactures electro-optical sensors, cameras, and systems that permit sensitive detection of photons in the visible and near infrared portions of the spectrum, allowing vision in extreme low-light situations. In July, Intevac launched its new Lean Etch(TM) semiconductor manufacturing system. The company had been experiencing impressive revenue growth but a decrease in equipment spending from hard disk manufacturers may bring that growth to a sudden end. The company has no long-term debt and during the recent growth period, margins were impressive. However, Intevac will always have trouble differentiating themselves from their competition. What’s worse, their customers are hard disk drive manufacturers, such as Seagate Technology and Hitachi, who have much greater bargaining power than their suppliers like Intevac. This all adds up to situation where Intevac seems like an investment to pass on for now.

Telecommunications Equipment: Sonus Networks Inc (SONS)

Telecommunication service providers, the main customer for telecommunication equipment providers, are investing heavily in new infrastructure such as third-generation networks. Telecommunication equipment manufacturers hope to secure large contracts to help companies accomplish any of the following:
1) DSL Internet service upgrades for traditional telecoms
2) 3G networks for mobile phone service providers
3) Broadband expansion for cable companies
4) Voice over IP for large businesses replacing their PBX-based telephone systems.
The industry is dominated by companies like Cisco and Alcatel-Lucent who enjoy large economies of scale. Smaller companies find niches to compete and usually partner with their larger competitors who enter into the relationship to not have to develop it in-house. One risk of these companies, especially the smaller ones, is they usually have to choose between different technologies and if they choose the wrong technology than they are left in the cold. The other ever looming risk is developing a product that is inferior to your competitor and having your customers flock to your other competitor. This industry has lots of possibilities for impressive returns on investments, it is just important to weigh the risks inherent in the investment and a little luck could go a long way.

Sonus Networks is a good example of one of these smaller companies that may be a leader in the emerging next-generation packet-based switching equipment market. Sonus has set the benchmark for call reliability against the industry behemoths such as Alcatel-Lucent, Nortel, and Cisco. Despite its early success, the risks are abundant for this company as it has very little bargaining power with its more concentrated customers (Sonus’ top 5 customers account for about 60% of sales) and is dealing with intense competition from much bigger rivals. It will be interesting to see if Sonus can maintain its technological lead as better financed competition races to catch up in the huge potential market.

Tobacco: Vector Group Ltd. (VGR)

The Tobacco Industry faces many challenges going forward. I guess selling a product that gives your customers cancer will do that eventually. Domestically, demand for tobacco is decreasing which is turning more attention to foreign markets for growth. The government is also actively pursuing increasing its excise tax on cigarettes which would make the price of cigarettes substantially higher. There are also issues with the marketing of cigarettes that these companies deal with. It seems like the government will soon have to start marketing cigarettes themselves if they want to make sure their excise tax revenue keeps coming in. An emerging product offering in this industry is smokeless tobacco; time will tell how successful it will be. There are definitely many obstacles for the companies in this industry, but expect these companies to survive, even if their customers do not. (drum roll)

Vector Group, Ltd., through its subsidiaries, engages primarily in the manufacture and sale of cigarettes in the United States. The company produces cigarettes in approximately 270 combinations of length, style, and packaging. Its principal brand portfolio includes LIGGETT SELECT, GRAND PRIX, EVE, PYRAMID, USA, and various Partner Brands and private-label brands. Vector also develops and markets the low-nicotine and nicotine-free cigarette products, as well as develops reduced-risk cigarette products. The company currently sports a dividend yield of 7.3%. The company also has insider ownership of over 13%. I do not think it is a compelling value at this point, but Carl Icahn is an investor and he seems to know what he is doing.

Water Utilities: York Water (YORW)

This industry has historically been appealing to income-oriented investors for its payout ratio but there has recently been an overall decline in the dividend payout of companies in this industry. Water utilities are highly dependent on weather conditions and earnings can be quite volatile. Also, infrastructure is aging which should require significant capital expenditures in the coming years. The Environmental Protection Agency (EPA) is also enacting tougher regulations which will increase costs. Since many of the companies in this industry do not have the on-hand cash to pay for these future costs, expect debt and equity financing to further dilute the shares of today’s shareholders. The industry is benefiting recently from faster and more favorable decisions by regulatory agencies but it will probably not be enough to make many of these companies appealing in the long-term.

The York Water Company (YORW) engages in the impounding, purification, and distribution of water in York County and Adams County, Pennsylvania. It owns two reservoirs, Lake Williams and Lake Redman, which together holds approximately 2.2 billion gallons of water. The company also owns a 15-mile pipeline from the Susquehanna River to Lake Redman that provides access to an additional supply of water. As of December 31, 2006, The York Water Company served approximately 57,578 residential, commercial, industrial, and other customers in 34 municipalities in York County and 4 municipalities in Adams County. The dividend yield is currently 2.9%. The company had its best year in 2006 as it posted its highest ever operating revenues, operating income, earnings and earnings per share. This company has net margins over 20% and a return on equity of over 10%. The company has also increased its dividend for ten straight years and more impressively, has an uninterrupted dividend streak of 544 periods. This company has definitely proven its staying power.

Electrical Equipment: KOSS Corporation (KOSS)
There is a high correlation between the overall economic health of the economy and the performance of this industry. The deterioration of the housing market is affecting demand for its products which has forced many companies to focus on cost containment. However, it is critical to continue to refresh your product portfolio with new product offerings so successful Research & Development is crucial in this industry. Growth in foreign markets such as Asia and Latin America are also important opportunities these companies are looking to capture.

Koss Corporation (KOSS) designs, manufactures, and sells stereo headphones and related accessory products. It markets its products under Koss brand through audio specialty stores, the Internet, direct mail catalogs, regional department store chains, discount department stores, military exchanges, prisons, and national retailers. The company also sells its products to distributors for resale to school systems, and directly to other manufactures. Koss Corporation distributes its products internationally through sales representatives and independent distributors. The Koss family still runs the company and owns a substantial part of it. Despite having no debt, the company has a return on shareholder’s equity of over 20%. However, in its most recent quarter, the company reported a 5% decline in net sales and posted a 21% decline in net income which they blamed due to a plunge in the European market. They are confident this is a one-time setback so this recent dip in sales price may be an opportunity.

Retail (Special Lines): Marlin Business Svcs Inc (MRLN)
So far the best retailers who are enjoying the best success in this current economic climate are those targeting the young, affluent shoppers. Tiffany and Coach are two good examples. This industry is obviously dependent on the discretionary spending of consumers but a company that offers a differentiated product, keeps costs contained, and deftly expands into new markets will succeed in just about any economic climate.

Marlin Business Services Corp. (MRLN) provides equipment financing solutions primarily to small and mid-size independent equipment dealers in the United States. The stock currently trades at about $12.35 per share after hitting a high of $24.40 earlier in the year. Despite a return on equity of about 13% and profit margins over 28%, the company is trading close to book value. The stock recently reported a drop in earnings per share in its latest quarter which is misleading due to a one-time gain in 2006. This may deserve a closer look to estimate how much free cash flow the company can generate going forward, something it hasn’t been able to do to date due to its expansion.