I am looking for advantaged companies with excellent long-term prospects trading at an attractive price. Doesn’t everyone? I believe there are certain assets with “excellent long-term prospects”, despite the feeling in the market today. I am expecting the current global slowdown to go well into 2010, but the opportunities will open themselves before the turnaround. Private industry is in a period of mass-deleveraging which is driving down the prices of almost all asset classes. This deleveraging period will cause a deep recession in the United States throughout 2009 (at least) and the Fed will leverage up their own balance sheet and dump massive amounts of money into the system to try to get banks lending and businesses/consumers spending again. But the deleveraging process will take a long time to work itself out. Investors fearing a sustained period of deflation have flocked to US Treasuries in what is being characterized as a “flight to safety” causing a rally in the USD. This reflation and fear in the markets has made the US Treasuries the next investment bubble. Expect the US and other trade deficit countries in Europe to impose some type of trade restrictions in 2009 to increase the price of imports and devalue their currency to increase their exports. The trade relationship between China and the US make these two countries intimately linked and the severe recession in the United States may cause a full depression in China. China has a problem of over-capacity by producing greater than domestic demand and exporting the rest out of the country. If Chinese consumption does not expand, then production contraction will have to make up for the entire shortfall which will wreak havoc in China soon. The age of the US consumer driving the global economy is dead, and the next engine of consumption will eventually be the rising middle class of emerging economies, in particular China, but this will be a long transition that will play out over decades. In the short-term this global contraction will hurt China more than the United States. However, currency debasing and trade protectionism will hurt the United States in the long-term. It will be a painful transition, but expect China to come out of this contraction better than the United States with a stronger currency and an expanding middle-class. At some point, money will stop flooding into the United States government and Treasuries will be the next bubble to burst. The Fed and Treasury policy to reflate our way out of this problem will be too excessive which will result in inflation once the velocity of money returns to more historical levels. Instead of trying to time this perfectly by buying dollars, I will look to buy assets attractively priced in the long-term. I expect commodities such as oil and fertilizer to benefit once the deleveraging process slows. I will therefore look for opportunities in the near future to be long on oil and fertilizer, and short on US Treasuries.
Advantaged companies possess competitive advantages that are not easily replicated. Ideally I look for a large (potential) installed customer base in which the company sells a recurring, rapidly depleted product/service leading to significant free cash flow while competitors can't enter due either to high customer switching costs, (geographical) monopoly, government regulations, patents, or superior brand image. The more protected this advantage is for the company, obviously more appealing the company will be viewed.
An attractive priced company will determined based on multiple factors including conservative capital structure, high returns on capital, and earnings power to arrive at an intrinsic value for the company. If this intrinsic value is estimated to be significantly higher than the current share price (at least 2x), then the stock will be considered attactively priced.
This blog will seek to find these offerings and will focus on the underfollowed and generally distrusted Over-The Counter market, to find the opportunities no one is looking at right now or just too afraid to go near in today's market conditions.
Sunday, January 4, 2009
Tuesday, October 21, 2008
Is Gulf Resources Really Undervalued?
It seems a fair question, probably one that is being asked by every shareholder in the company during the midst of its current steep decline in share price. Gulf Resources (GFRE.OB), the largest bromine producer in China and fourth largest in the world, is expected to earn $0.20-$0.23 per share this year despite a temporary 3Q disruption in demand due to the Olympics. The company just announced that 4Q revenue demand is strong as customers have renewed orders following the restriction of certain industrial activities during the Olympics. Despite no obvious impairments to its future earning capabilities specific to the company, the current price of the stock is still just $0.23. Is it just the fact that Chinese companies are currently out-of-favor, especially over-the-counter stocks with low liquidity, coupled with the drop in commodity prices which is causing this stock to trade at slightly over 1x 2008 earnings? Despite the pessimism in the marketplace and the de-leveraging of the investment community, this seems like an extremely depressed price even at today’s standards. What is the investment community seeing? First, here are some questions for consideration.
Does the company have any competitive advantages?
Yes, it has gained 20% market share in Chinese bromine industry as one of only six companies in the country with a bromine exploration license. China has stated they will no longer issue any future licenses and are shutting down unlicensed production facilities giving Gulf Resources a significant barrier to entry. Gulf Resources is taking advantage of this opportunity by investigating potential acquisitions of unlicensed bromine production facilities to expand its market share. The company also has a profitable subsidiary specializing in chemical products to the oil & gas industry and paper making industry offering some growth potential.
Is bromine an element that is in demand?
Yes, China is a net importer of bromine as only 160,000 tons were produced within the PRC to meet the country’s demand of 190,000 tons.
Does the company have a sustainable source of bromine?
Yes, the company maintains 50-year mineral rights with reserves of approximately 2 million tons and annual production of just over 30,000 tons per year, giving it over 60 years worth of production potential.
Is the company in financial trouble?
The company currently has about $6.3M in cash and $21M in debt. The first installment of the $21M debt is due May, 2009. This $3M payment is interest-free and can be covered with existing cash. The other $18.2M is due no earlier than December, 2009. The company generated about $20M in cash flow from operations in the trailing twelve months and should be able to service this debt with cash flow from operations.
So why is it selling so low?
In June of this year, the price per share of Gulf Resources was over $2 per share. The main reason for the recent free-fall in share price cited by the company is a sell-off by a large stakeholder, presumably China Finance which owns 3.3M shares as of 6/30/2008. These shares were received as payment for surety guarantee services provided by China Finance for Gulf Resources’ 2006 merger and it is largely speculated (largely being a relative term since only a few people seem to follow this stock) that China Finance is selling its 3.3M shares now that the shares are qualified for sale. It is now anyone’s guess if the sell-off is being caused by a large shareholder and when the sell-off will be done.
Latest statistics show China has slowed to 9% growth. While many people are focused on a slowdown in the global economy, this is one stock that seems to have been battered down way too much. This company possesses clear barriers to entry, generates solid cash flow from operations, and has appealing growth potential in a domestic marketplace that has greater demand than supply. Trading at 1x 2008 earnings and 0.60 P/BV, there is enough margin of safety at this price to counter the risks in this micro-cap.
Does the company have any competitive advantages?
Yes, it has gained 20% market share in Chinese bromine industry as one of only six companies in the country with a bromine exploration license. China has stated they will no longer issue any future licenses and are shutting down unlicensed production facilities giving Gulf Resources a significant barrier to entry. Gulf Resources is taking advantage of this opportunity by investigating potential acquisitions of unlicensed bromine production facilities to expand its market share. The company also has a profitable subsidiary specializing in chemical products to the oil & gas industry and paper making industry offering some growth potential.
Is bromine an element that is in demand?
Yes, China is a net importer of bromine as only 160,000 tons were produced within the PRC to meet the country’s demand of 190,000 tons.
Does the company have a sustainable source of bromine?
Yes, the company maintains 50-year mineral rights with reserves of approximately 2 million tons and annual production of just over 30,000 tons per year, giving it over 60 years worth of production potential.
Is the company in financial trouble?
The company currently has about $6.3M in cash and $21M in debt. The first installment of the $21M debt is due May, 2009. This $3M payment is interest-free and can be covered with existing cash. The other $18.2M is due no earlier than December, 2009. The company generated about $20M in cash flow from operations in the trailing twelve months and should be able to service this debt with cash flow from operations.
So why is it selling so low?
In June of this year, the price per share of Gulf Resources was over $2 per share. The main reason for the recent free-fall in share price cited by the company is a sell-off by a large stakeholder, presumably China Finance which owns 3.3M shares as of 6/30/2008. These shares were received as payment for surety guarantee services provided by China Finance for Gulf Resources’ 2006 merger and it is largely speculated (largely being a relative term since only a few people seem to follow this stock) that China Finance is selling its 3.3M shares now that the shares are qualified for sale. It is now anyone’s guess if the sell-off is being caused by a large shareholder and when the sell-off will be done.
Latest statistics show China has slowed to 9% growth. While many people are focused on a slowdown in the global economy, this is one stock that seems to have been battered down way too much. This company possesses clear barriers to entry, generates solid cash flow from operations, and has appealing growth potential in a domestic marketplace that has greater demand than supply. Trading at 1x 2008 earnings and 0.60 P/BV, there is enough margin of safety at this price to counter the risks in this micro-cap.
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.
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.
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.
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.
Sunday, October 28, 2007
Industry Review (continued....)
Securities Brokerage: Diamond Hill Investment Group, Inc. (DHIL)
The woes of subprime mortgages are well-documented including the collapse of the Bear Stearns hedge of fund of mortgage-backed securities. However, also occurring was an inventory write-down of $940 million by Morgan Stanley mostly related to loans related to leveraged buyouts of below investment grade companies. Securities Brokerage companies benefited from the recent Federal Reserve rate cut because it helped stimulate the equity markets and increase trading. However, problems such as continued housing deterioration and lower consumer spending may affect future commissions revenues. Of note, the New York Stock Exchange and Euronext have combined to form NYSE Euronext. The CME Group is integrating the Chicago Board of Trade into its operations and NASDAQ acquired the Nordic exchange OMX AB.
Diamond Hill Investment Group, Inc. (DHIL) is a company to keep an eye on in this sector. DHIL provides investment management services to individuals and institutions by offering seven mutual funds. In the latest quarter (2Q2007), net income rose 76%, revenues increased 66% and assets under management increased to $4.5 billion from $2.7 billion. The company also announced plans to repurchase 15% of its common shares. What’s even better, their investment philosophy is based on the teaching of Benjamin Graham and the methods of Warren Buffett and all Portfolio Managers are significant investors in the same portfolios in which they manage.
Food Processing: Nutrisystem, Inc. (NTRI)
This is a traditionally defensive sector since food is not a luxury item. However, profits for companies in this industry are being effected by the rise in commodity prices, most notably in record highs for milk and corn. Higher milk prices have affected dairy-based food providers such Dean Foods, Kraft Foods, and Hershey Company. Corn prices are rising due partly to the increased demand for ethanol as a fuel alternative. These prices are cyclical and corn prices should come back down now that farmers are devoting more land to increase corn supplies.
Maybe not a traditional company in this sector, but one that was just too good to pass up is Nutrisystem (NTRI). I mention it is too good to pass up because I did own this stock briefly before selling out of it. While I probably deserved to take the beating that would soon ensure, I feel I still learned a lesson nonetheless. Basically, it is easy to fall in love with numbers for this weight management company. The company has net margins of about 15% and even with no debt, their return on equity is close to 60%. For the first half of 2007 they were growing customers at about 50%. Beyond those numbers, the story is not as nice. I basically sold the stock because after I re-visted my intrinsic value calculation, I was no longer comfortable with the assumptions I made. Basically, I did not really think their product was very good and became convinced their retention rates would deteriorate. I basically became too uncomfortable owning a stock I really didn’t believe in. That was my reason for selling but the reason it landed up dropping from the $50’s to the low $30’s in one day in October was because the new Alli diet drug affected their revenues and growth projections. Why go on a diet when you can pop a pill? Bottom line, Nutrisystem has no established moat for providing weight loss solutions so even after the precipitous drop, the stock still does not seem like a screaming buy. By the way, I also had a similar situation with Prepaid Legal (PPD). I came close to buying it recently after a major drop in stock price but the company seems too much like a giant marketing pyramid. Instead of NTRI, Prepaid has done quite well since I passed on it. But I am convinced it is a matter of time before the house of cards falls on that one too.
Homebuilding: Avatar Holdings (AVTR)
This industry is what you would call in a “downturn”. After years of a rapidly increasing housing market, this industry is in a freefall with no end in sight at the moment. The main problem right now is excess supplies (as I know all too well in San Diego), and high inventories are causing new builders to get creative on how to sell them. It is estimated there is a 9.6 month supply of houses right now. Tighter lending standards are also reducing the number of potential buyers. This has led many homebuilders to take significant impairment charges and write-offs which has sent many into the red. The question now is when will the housing market return? As mentioned in the Countrywide post, industry is expecting a return to price appreciation at the end of 2009 with a bottom in late 2008. What a nice graduation present for me. The Federal Discount rate cut was hoping to provide some relief and potentially make it easier for homeowners adjustable rate mortgage is set to reset. The near-term outlook is bleak for this industry but it should definitely offer opportunities for investors willing to weather this storm.
Avatar Holdings Inc. (AVTR) is a still profitable (for now) real estate operator in Florida and Arizona. It is focused on the development of lifestyle communities, including active adult (55 years and older) and primary residential communities. Despite the near-term turmoil, this should have promising long-term trends on its side with baby boomers retiring. It recently reported 2Q net income of $5.3 million, down from $27.2 million for the same quarter last year. It is currently trading at less than 80% of its book value. A profitable homebuilder in 2007 with favorable long-term trends supporting its business model is worth keeping on a watch list.
Biotechnology: Amer. Oriental Bioengineering (AOB)
Andy Kessler once described the research of biotechnology companies like they were throwing pasta against a wall and seeing what stuck. A company in this industry can obviously become immensely profitable if it can get a winning drug approved with patent protection. There are legislative risks for biotechnology companies in regards to generic alternatives but it will be hard to complete this legislation because the process would have to be established for a generic alternative (“biosimilar”) to prove its molecular structure is the same as the original and the clinical effects are the same. The bottom line is many of the stocks in this industry are speculative and still years from making actual profit. Tread carefully.
American Oriental Bioengineering, Inc. (AOB) is based in Shenzhen, China to engage in the development, manufacture, and commercialization of plant-based pharmaceutical (PBP) and plant-based nutraceutical (PBN) products for the treatment of a variety of conditions and diseases including but not limited to respiratory diseases, incontinence, pelvic inflammations, and neurosis. The company is profitable sporting net margins over 26% and returns on assets over 14%. Also, EPS has grown from $0.15 in 2003 to $0.46 in 2006, a compound annual growth rate of 46.5%. This stock is appealing for both its impressive growth and the fact it is selling in China. Or for some people, it is appealing because it has the word “China” associated with it at all. While the results have been impressive, there is just too much optimism already priced n the stock for me at the moment.
Cable Television: New Frontier Media (NOOF)
Cable television companies can be extremely appealing investments at certain stages because once the high capital expenditures required to install the infrastructure are in place, free cash flows increase rapidly. However, investors tend to punish a stock at the first sign of slowing growth which should be taken into consideration. One interesting company in this industry is LodgeNet, whose shares have dropped considerably recently due to its competitor On Command being acquired by Hilton and Marriott hotels. In general, the industry seems to be have slow basic-cable subscriber growth maybe partly due to the downturn in the housing market. Broadband adoption has also not been as rapid as some expected but the long-term growth potential still seems intact.
New Frontier Media (NOOF) is the stock in focus for this industry. NOOF engages in the production and distribution of adult themed and general motion picture entertainment. It operates in three segments: Pay TV Group, Film Production Group, and Internet Group. Proving the wide belief that catering to the vices of others is profitable, New Frontier is extremely profitable with net profit margins over 17% and returns on assets over 11%. A recent drop in 2Q revenues of over 20% have sent the price of the stock downward and this cash-generating firm now offers an 8.3% dividend yield. It would need to be further investigated to see why the revenues are dropping and if this is a long-term trend or just a bump in the road. But I have limited time and a girlfriend so I will look for other potentially undervalued companies.
The woes of subprime mortgages are well-documented including the collapse of the Bear Stearns hedge of fund of mortgage-backed securities. However, also occurring was an inventory write-down of $940 million by Morgan Stanley mostly related to loans related to leveraged buyouts of below investment grade companies. Securities Brokerage companies benefited from the recent Federal Reserve rate cut because it helped stimulate the equity markets and increase trading. However, problems such as continued housing deterioration and lower consumer spending may affect future commissions revenues. Of note, the New York Stock Exchange and Euronext have combined to form NYSE Euronext. The CME Group is integrating the Chicago Board of Trade into its operations and NASDAQ acquired the Nordic exchange OMX AB.
Diamond Hill Investment Group, Inc. (DHIL) is a company to keep an eye on in this sector. DHIL provides investment management services to individuals and institutions by offering seven mutual funds. In the latest quarter (2Q2007), net income rose 76%, revenues increased 66% and assets under management increased to $4.5 billion from $2.7 billion. The company also announced plans to repurchase 15% of its common shares. What’s even better, their investment philosophy is based on the teaching of Benjamin Graham and the methods of Warren Buffett and all Portfolio Managers are significant investors in the same portfolios in which they manage.
Food Processing: Nutrisystem, Inc. (NTRI)
This is a traditionally defensive sector since food is not a luxury item. However, profits for companies in this industry are being effected by the rise in commodity prices, most notably in record highs for milk and corn. Higher milk prices have affected dairy-based food providers such Dean Foods, Kraft Foods, and Hershey Company. Corn prices are rising due partly to the increased demand for ethanol as a fuel alternative. These prices are cyclical and corn prices should come back down now that farmers are devoting more land to increase corn supplies.
Maybe not a traditional company in this sector, but one that was just too good to pass up is Nutrisystem (NTRI). I mention it is too good to pass up because I did own this stock briefly before selling out of it. While I probably deserved to take the beating that would soon ensure, I feel I still learned a lesson nonetheless. Basically, it is easy to fall in love with numbers for this weight management company. The company has net margins of about 15% and even with no debt, their return on equity is close to 60%. For the first half of 2007 they were growing customers at about 50%. Beyond those numbers, the story is not as nice. I basically sold the stock because after I re-visted my intrinsic value calculation, I was no longer comfortable with the assumptions I made. Basically, I did not really think their product was very good and became convinced their retention rates would deteriorate. I basically became too uncomfortable owning a stock I really didn’t believe in. That was my reason for selling but the reason it landed up dropping from the $50’s to the low $30’s in one day in October was because the new Alli diet drug affected their revenues and growth projections. Why go on a diet when you can pop a pill? Bottom line, Nutrisystem has no established moat for providing weight loss solutions so even after the precipitous drop, the stock still does not seem like a screaming buy. By the way, I also had a similar situation with Prepaid Legal (PPD). I came close to buying it recently after a major drop in stock price but the company seems too much like a giant marketing pyramid. Instead of NTRI, Prepaid has done quite well since I passed on it. But I am convinced it is a matter of time before the house of cards falls on that one too.
Homebuilding: Avatar Holdings (AVTR)
This industry is what you would call in a “downturn”. After years of a rapidly increasing housing market, this industry is in a freefall with no end in sight at the moment. The main problem right now is excess supplies (as I know all too well in San Diego), and high inventories are causing new builders to get creative on how to sell them. It is estimated there is a 9.6 month supply of houses right now. Tighter lending standards are also reducing the number of potential buyers. This has led many homebuilders to take significant impairment charges and write-offs which has sent many into the red. The question now is when will the housing market return? As mentioned in the Countrywide post, industry is expecting a return to price appreciation at the end of 2009 with a bottom in late 2008. What a nice graduation present for me. The Federal Discount rate cut was hoping to provide some relief and potentially make it easier for homeowners adjustable rate mortgage is set to reset. The near-term outlook is bleak for this industry but it should definitely offer opportunities for investors willing to weather this storm.
Avatar Holdings Inc. (AVTR) is a still profitable (for now) real estate operator in Florida and Arizona. It is focused on the development of lifestyle communities, including active adult (55 years and older) and primary residential communities. Despite the near-term turmoil, this should have promising long-term trends on its side with baby boomers retiring. It recently reported 2Q net income of $5.3 million, down from $27.2 million for the same quarter last year. It is currently trading at less than 80% of its book value. A profitable homebuilder in 2007 with favorable long-term trends supporting its business model is worth keeping on a watch list.
Biotechnology: Amer. Oriental Bioengineering (AOB)
Andy Kessler once described the research of biotechnology companies like they were throwing pasta against a wall and seeing what stuck. A company in this industry can obviously become immensely profitable if it can get a winning drug approved with patent protection. There are legislative risks for biotechnology companies in regards to generic alternatives but it will be hard to complete this legislation because the process would have to be established for a generic alternative (“biosimilar”) to prove its molecular structure is the same as the original and the clinical effects are the same. The bottom line is many of the stocks in this industry are speculative and still years from making actual profit. Tread carefully.
American Oriental Bioengineering, Inc. (AOB) is based in Shenzhen, China to engage in the development, manufacture, and commercialization of plant-based pharmaceutical (PBP) and plant-based nutraceutical (PBN) products for the treatment of a variety of conditions and diseases including but not limited to respiratory diseases, incontinence, pelvic inflammations, and neurosis. The company is profitable sporting net margins over 26% and returns on assets over 14%. Also, EPS has grown from $0.15 in 2003 to $0.46 in 2006, a compound annual growth rate of 46.5%. This stock is appealing for both its impressive growth and the fact it is selling in China. Or for some people, it is appealing because it has the word “China” associated with it at all. While the results have been impressive, there is just too much optimism already priced n the stock for me at the moment.
Cable Television: New Frontier Media (NOOF)
Cable television companies can be extremely appealing investments at certain stages because once the high capital expenditures required to install the infrastructure are in place, free cash flows increase rapidly. However, investors tend to punish a stock at the first sign of slowing growth which should be taken into consideration. One interesting company in this industry is LodgeNet, whose shares have dropped considerably recently due to its competitor On Command being acquired by Hilton and Marriott hotels. In general, the industry seems to be have slow basic-cable subscriber growth maybe partly due to the downturn in the housing market. Broadband adoption has also not been as rapid as some expected but the long-term growth potential still seems intact.
New Frontier Media (NOOF) is the stock in focus for this industry. NOOF engages in the production and distribution of adult themed and general motion picture entertainment. It operates in three segments: Pay TV Group, Film Production Group, and Internet Group. Proving the wide belief that catering to the vices of others is profitable, New Frontier is extremely profitable with net profit margins over 17% and returns on assets over 11%. A recent drop in 2Q revenues of over 20% have sent the price of the stock downward and this cash-generating firm now offers an 8.3% dividend yield. It would need to be further investigated to see why the revenues are dropping and if this is a long-term trend or just a bump in the road. But I have limited time and a girlfriend so I will look for other potentially undervalued companies.
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.
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.
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