Measured Approach

7 Dividend Paying ADRs Worth Considering

2011-05-03T16:39:00.001-07:00

http://seekingalpha.com/article/266899-7-dividend-paying-adrs-worth-considering

The Best in Generic Drug Companies

2011-02-13T04:35:00.001-08:00

Prescription pharmaceutical products in the U.S. generally are marketed as either generic or brand pharmaceuticals. Generic pharmaceutical products are bioequivalent (also known as biosimilar) of their respective brand products and provide a cost-efficient alternative to brand products. Brand pharmaceutical products are marketed under brand names through programs that are designed to generate physician and consumer loyalty.

Generic drug makers are hopeful that they will thrive over the next four or five years as some $60 billion in annual sales of branded drugs go off patent. Sandoz, the market leader for biosimilar drugs expects this market to grow to $20 billion by 2020, up from a current $250 million. There is also a second class of generic drugs, small molecule chemical drugs. Biological drugs are made of larger molecules than chemical drugs. Since generics of chemical drugs, which are made of small molecules, are relatively simple to copy, the market for generic drugs attracted a flurry of players.

The complete article can be found HERE.

Disclosure: The author has a long position in IPXL.

Semiconductor Automated Test Equipment

2011-02-07T16:47:00.001-08:00

Today, most electronic products contain a combination of integrated circuits (ICs). As technology continues to penetrate most aspects of daily life, semiconductor devices are playing a more important role in a growing number and variety of products. Consequently, the global semiconductor industry, while experiencing significant cyclical fluctuations in its growth rate, has exhibited strong overall growth over the past 30 years.

The design and manufacture of semiconductor devices is a complex and capital-intensive multi-step process. The process involves different types of equipment used to manufacture, assemble and test semiconductor devices. Semiconductor test equipment and services are a critical part of this complex design and manufacturing process and are utilized in each of the key design and manufacturing stages. Each of these ICs has electrical circuitry that requires validation or testing during and after the manufacturing process. The final usability of the IC is determined by testing.

The complete article is here.

Paper & Paper Products Industry: Two Companies Stand Out

2011-01-30T07:54:00.000-08:00

The paper and paper products industry has numerous market segments ranging from facial tissue to the paperboard packaging segment. The paper and paper products industry provides some overlap with the container and packaging industry in that there are companies in both may produce paperboard. However, for the purpose of this article, we are producers of containerboard and corrugated containers.

The Paperboard Packaging Council has suggested that the packaging segment will continue to see weakness for the remainder of 2011 due to reduced consumer spending but that an uptick will occur in 2012-14. They also identify several end-use markets with growth potential: pharmaceuticals and frozen and take-out foods.

The full article is available at:

http://seekingalpha.com/article/249590-paper-paper-products-industry-two-companies-stand-out

The Best in Coal

2011-01-23T08:27:00.000-08:00

Coal is probably our most abundant energy resource. We have provable reserves, within our own borders, equal to a quarter of the world’s reserves and more coal than any other country in the world. Coal generates approximately 50% of our electricity, more than any other energy source. Coal can meet our domestic energy for the next 100 years. Coal also costs a fraction of alternative sources of energy such as natural gas.

The complete article is available at:

http://seekingalpha.com/article/248028-the-best-in-coal-15-stocks-worth-considering?source=hp_latest_articles

Disclosure: The author has no position in any company mentioned in this article and will not take a position within 72 hours of publication

DIY Investing

2011-01-09T08:55:00.000-08:00

The DIY investor has a bewildering range of styles to choose from, ranging from day trading to buy and forget. He or she has a decided advantage over the professional money manager. The private investor has flexibility whereas money managers are generally restricted to a particular style-box. The style-box, as far as I can tell, is no more than a marketing gimmick. Money managers have the additional pressure of meeting quarterly expectations.

The successful private investor chooses a strategy that works for them. Some folks like the action of momentum investing and others are much more risk averse and stick with large cap, dividend paying names. The market is big enough for everyone.

The approach that works well with us focuses on quantitative measures. We are not too interested in the “story” behind a name or management’s explanations or expectations. We rather let the numbers do the talking.

Our approach emphasizes valuation, cash flow generation, profitability and price momentum. Valuation and cash flow generation appear to be the most important drivers of excess returns.

One of our favorite valuation ratios is enterprise value to EBITDA. In the long run, no company succeeds without strong cash flow generation. The measure we look at is cash return on invested capital. There are several measures of profitability. Many investors are attracted to companies reporting high return on equity. The potential for excess returns is diminished if the market does not recognize the opportunity offered by a particular company. By combining low valuation as measured by EV/EBITDA, successful execution by the subject company (ROE and CFROI), and price momentum, we have the opportunity to generate excellent returns.

The companies listed here satisfy our criteria and are worth a close look.

		01/07/11
ticker	company	Price	CFROI	EV/EBITDA	ROE_12m	52W Price Range %
ALK	Alaska Air Group, Inc.	62.72	12.13	6.53	22.30	98.78
AGP	AMERIGROUP Corporation	46.83	15.84	4.29	22.40	98.74
ASMI	ASM International N.V. (USA)	34.45	19.21	6.85	25.30	86.63
CBPO	China Biologic Products Inc	16.06	25.45	5.40	62.00	85.60
CLW	Clearwater Paper Corp	81.20	23.38	7.06	21.60	92.77
CLD	Cloud Peak Energy Inc.	22.46	16.54	6.12	78.30	87.00
SOLR	GT Solar International, Inc.	10.50	17.45	6.91	64.80	97.22
IPXL	Impax Laboratories, Inc.	20.68	44.31	2.25	110.50	88.74
KS	KapStone Paper and Packaging C	16.10	22.89	6.63	21.00	96.72
NSR	Neustar, Inc	26.99	18.23	7.42	20.40	97.28
PZZA	Papa John's Int'l, Inc.	28.14	14.38	7.31	27.50	90.45
SNDK	SanDisk Corporation	52.37	19.47	7.64	25.90	96.35
TEO	Telecom Argentina S.A. (ADR)	25.65	26.23	6.95	30.70	87.86
TSP	Telecomunicacoes de Sao Paulo	24.27	15.68	4.09	24.50	83.27
TER	Teradyne, Inc.	13.70	27.76	5.41	40.00	86.79
USMO	USA Mobility, Inc.	18.33	42.53	3.12	25.20	90.12
WTI	W&T Offshore, Inc.	18.04	27.61	4.69	39.20	83.46

Disclosure: Author has long positions AGP, NSR, SNDK and TEO.

Starting Lineup for 2011

2011-01-02T08:33:00.000-08:00

At the start of the calendar year, there is a tradition of offering stock picks for the year. Our list totals nineteen names. There is no attempt to diversify across industry groups or to focus on market capitalization. The companies represent a narrow grouping of technology, retail, consumer and a smattering of industrial companies. Five of the companies are in the retail sector. They range in size (on the basis of market cap) from $271 million to $294,998 million.

The thread that binds all these companies is one of consistency. Each of these companies has been profitable in each of the past seven years; each has been free cash flow positive each year. They all have strong balance sheets and demonstrate the ability to grow sales, earnings from continuing operations, and free cash flow. Each company is expected to grow earnings going forward.

We believe each of the listed companies will show strong results in 2011. That being said, it is not a static list. Circumstances change as does our opinion. Readers should do their own due diligence and make up their own minds about each name.

Company	Ticker	Price	Comment
Advanced Auto Parts Inc.	AAP	$66.15	Advance Auto Parts, Inc. (Advance) is a specialty retailer of automotive aftermarket parts, accessories, batteries and maintenance items primarily operating within the United States.
Apple Inc.	AAPL	$322.56	Apple Inc. (Apple) designs, manufactures and markets a range of personal computers, mobile communication and media devices, and portable digital music players, and sells a range of related software, services, peripherals, networking solutions, and third-party digital content and applications.
Balchem Corporation	BCPC	$33.81	Balchem Corporation (Balchem) is engaged in the development, manufacture and marketing of specialty performance ingredients and products for the food, nutritional, feed, pharmaceutical and medical sterilization industries. It has three reportable segments: Specialty Products; Food, Pharma & Nutrition; and Animal Nutrition & Health.
Bed Bath & Beyond Inc.	BBBY	$49.15	Bed Bath & Beyond Inc., along with its subsidiaries, is a chain of retail stores, operating under the names Bed Bath & Beyond (BBB), Christmas Tree Shops (CTS), Harmon and Harmon Face Values (Harmon) and buybuy BABY
C.H. Robinson Worldwide Inc.	CHRW	$80.19	C.H. Robinson Worldwide, Inc. (C.H. Robinson) is a third party logistics company. It provides freight transportation services and logistics solutions to companies of all sizes, in a variety of industries.
Dollar Tree Inc.	DLTR	$56.08	Dollar Tree, Inc. (Dollar Tree) is an operator of discount variety stores offering merchandise at the fixed price of one dollar.
FactSet Research Systems Inc.	FDS	$93.76	FactSet Research Systems Inc. (FactSet) is a provider of global financial and economic information, including fundamental financial data on tens of thousands of companies worldwide.
Family Dollar Stores Inc.	FDO	$49.71	Family Dollar Stores, Inc. (Family Dollar) operates a chain of more than 6,800 general merchandise retail discount stores in 44 states, providing primarily consumers with a selection of priced merchandise in neighborhood stores.
Hanson Natural Corp.	HANS	$52.28	Hansen Natural Corporation (Hansen) is a holding company. The Company, through its subsidiaries develops, markets, sells and distributes alternative beverage category natural sodas, fruit juices, juice blends, juice drinks, energy drinks and energy sports drinks, fruit juice smoothies and functional drinks, non-carbonated ready-to-drink iced teas, children’s multi-vitamin juice drinks,
Joy Global Inc.	JOYG	$86.75	Joy Global Inc. is a manufacturer and servicer of mining equipment for the extraction of coal and other minerals, and ores.
NetApp Inc.	NTAP	$54.96	NetApp, Inc. (NetApp) is a provider of storage and data management solutions. The Company offers solutions for storing, managing, protecting and archiving business data.
Novo Nordisk A/S (ADR)	NVO	$112.57	Novo Nordisk A/S is a Denmark-based health care company. It also focuses within areas, such as haemostasis management, growth hormone therapy and hormone replacement therapy. The Company operates in two business segments: diabetes care and biopharmaceuticals.
NVE Corporation	NVEC	$57.83	NVE Corporation (NVE) develops and sells devices that use spintronics, a nanotechnology. The Company manufactures spintronic products, including sensors and couplers that are used to acquire and transmit data.
Oracle Corp.	ORCL	$31.30	Oracle Corporation is an enterprise software company. The Company develops, manufactures, markets, distributes and services database and middleware software, applications software and hardware systems, consisting primarily of computer server and storage products.
PetSmart Inc.	PETM	$39.82	PetSmart, Inc. (PetSmart) is a specialty provider of products, services and solutions for the lifetime needs of pets. The Company offers a line of products for all the life stages of pets, and offers various pet services, including professional grooming, training, boarding and day camp.
Priceline.com Inc.	PCLN	$399.55	priceline.com Incorporated (priceline.com) is an online travel company, which offers a range of travel services, including hotel rooms, car rentals, airline tickets, vacation packages, cruises and destination services.
Starbucks Corp.	SBUX	$32.13	Starbucks Corporation (Starbucks) is the roaster and retailer of specialty coffee in the world, operating in more than 50 countries. Starbucks purchases and roasts whole bean coffees and sells them, along with handcrafted coffee and tea beverages and a variety of fresh food items, through Company-operated retail stores.
USANA Health Sciences Inc.	USNA	$43.45	USANA Health Sciences, Inc. (USANA) develops and manufactures high-quality, science-based nutritional and personal care products, with a commitment to continuous product innovation and sound scientific research.
Varian Medical Systems Inc.	VAR	$69.28	Varian Medical Systems, Inc. is engaged in he design, manufacture, sale and service of equipment and software products for treating cancer with radiotherapy, stereotactic radiosurgery and brachytherapy.

Someone may argue that I missed the boat on this list and they may be right. The average 52 week gain for these stocks is 52%. Gains ranged from a low of 27% for BBBY to 83% for PCLN. These market beating gains are not the result of short-term fads. All of these companies are proven to be consistent winners.

Disclosure: Author has long positions in AAP, BCPC, FDS and NVEC.

2010: Win Some, Lose Some

2010-12-26T09:50:00.000-08:00

We found 2010 to be a challenging year for stock picking. We had more solid winners than losers. Overall, we are pleased with the opinions expressed on these pages. We finish the year with a lesson learned; stick to your discipline. We found that when we deviated from our discipline, the results were unprofitable.

We began 2010 with writing in January about three companies: Sorl Auto Parts (SORL), Fuqi International (FUQI), and Hormel Foods (HRL). Sorl Auto Parts is a Chinese company manufacturing air brakes. We expected Sorl to do well because the automotive and truck manufacturing sector in China is doing well. We were wrong. Sorl is down about 17% since we wrote about it. Fuqi is Chinese company in the jewelry business. We expressed caution with Fuqi though we expected the growing middle class in China to be a major driver of growth. The stock is trading down about 69% from January. Sorl and Fuqi are our biggest losers for the year. In both cases, we deviated from our discipline to benefit, we thought, from the explosive Chines market. Lesson learned; stick to what you know.

Our third topic in January was Hormel Food. We recommended Hormel based on its strong financials and moderate growth prospect. We were rewarded with a return of about 34%.

In February, we offered an opinion on Western Digital (WDC). At the time, Western Digital was trading at $39.43 and has since dropped about 14% to $33.83. We still think WDC is a great company in excellent financial condition. We expect that when the market projects greater future growth for this storage device maker, the stock will soar.

Our buy opinions from March have worked out extremely well. We recommended Endo Pharmaceuticals (ENDP) for the second time and have been rewarded with a 58% return. We also recommended Advanced Auto Parts (AAP). Advanced Auto has returned about 58% since we wrote about it and it remains on our buy list.

We expressed caution on the two companies we wrote about in March and our opinions have stood the test. We wrote about GameStop (GME) and Comtech Telecom (CMTL). We thought GameStop has a good business facing significant challenges from online gaming. The stock has remained essentially flat. Comtech had a decline in both sales and earnings. We recommended that readers wait until a pull-back to $27 before purchasing shares. CMTL has declines about 14%, from $32.55 to $27.90.

Our choices in May, Garmin (GRMN) and Core Laboratories (CLB), provided mixed results. We noted that Garmin faces increased competition cell phone-based GPS services. GRMN is trading down about 9% from when we wrote about it. On the other hand, we recommended CLB as a buy at $67.36. Shares are now trading at $90.27, 34% higher.

We offered no recommendations or opinions during June.

In July, we wrote about AstraZeneca (AZN). AstraZeneca is Big Pharma and reflects the problems common to those companies. We recommended AZN at $48.79n but have seen the shares decline about 6% to $46.03.

August was a productive month with two buy opinions and one speculation. We liked Hawkins, Inc. (HWKN), up about 29% and Tractor Supply Company (TSCO), up 41%. Our speculation was the solar power company, GT Solar International (SOLR). Investing in a solar tech company is much like investing in China, a lot of promise, a lot of hype. GT Solar is up about 15%.

September saw us write about Clearwater paper (CLW), decidedly unsexy company but one that provided returns of about 11% these last three months.

We managed more activity in October when we recommended Lubrizol (LZ) at $105.95 and Telecom Argentina (TEO) at $23.40. Lubrizol is up about 2% and TEO about 7%. We were also cautiously optimistic about InterDigital (IDCC). InterDigital is a telecom equipment manufacturer. The stock is now trading a stunning 45% higher than the $29.61 price it traded at when we wrote our story.

It is too early to draw any conclusions about the companies we wrote about in November and December. In November we wrote that Brinker International (EAT), the restaurant chain, was a hold. EAT is up about 13%. We also wrote about NeuStar (NSR) and Humana (HUM). Neustar provides services to the telecom industry and trades at $26.32, essentially no change during the past month. Humana is in the health insurance business. The potential here will play out with the changes in the healthcare law and regulations.

Finally, in December, we recommended Sandisk (SNDK), the manufacturer of solid state storage and flash memory. Our final recommendation is Amerigroup (AGP), the operator of healthcare facilities.

We look forward to a profitable 2011 and wish all our readers a happy, healthy and profitable new year.

Disclosure: Author has a long position in AAP, AGP, ENDP, HUM, IDCC, NSR, SNDK, and TEO.

A Small Cap Healthcare Pick

2010-12-19T09:50:00.000-08:00

Arguably, small caps are the place to be when the economy gets back on its feet. Notwithstanding any changes to healthcare policy in the coming years, healthcare is a growth industry. Amerigroup Corporation (AGP) is a multi-state managed healthcare company that we think will do will in the future. The Company focuses on serving people who receive healthcare benefits through publically sponsored programs, including Medicaid, Children’s Health Insurance Program (CHIP), Medicaid expansion programs and Medicare Advantage.

On December 1, 2010, AMERIGROUP Corporation, through its subsidiary, AMGP Georgia Managed Care Company, Inc., received notice that Amendment #9 to its State of Georgia Department of Community Health contract for the provision of HMO services to Georgia Families is effective following approval by the Centers for Medicare & Medicaid Services.

The most recently reported quarter closed September 30, 2010. Membership increased to approximately 1.9 million representing an increase year-over-year and from the prior quarter. Third quarter revenues were $1,494.9 million, a 14.6% increase y-o-y revenues of $1,304.3 million. The Company repurchased approximately 1.9 million shares of common stock during the quarter for approximately $70.5 million.

The Company has a strong balance sheet. Cash and ST investments totaled $741.1 million while LT debt is $243.1 million. The equity to capital ratio is 82% confirming the low long term debt ratio. The current ratio is 1.2X, about in-line with the industry. LT debt to free cash flow is 1.2X. LT debt to working capital is 145.6%; somewhat higher than we usually like to see.

AGP is a consistent generator of free cash flow. For the trailing twelve months ending 09/10, the Company reported $4.23 per share in free cash flow. The seven year growth rate for free cash flow is flat to down slightly. The Company consistently reports positive operating profit margins. The seven year growth rate for earnings per share from continuing operations is 13.8%. Looking forward, the earnings are projected to growth at the rate of 16.0%. Sales have grown over the past seven years at the rate of 23.9%.

There are sixteen analyst EPS projections. The projections range from $4.63 to $5.10 with a mean of $4.90 for FY ending 12/10. Because of the uncertainty surrounding healthcare reform, seventeen analyst projections forecast a decrease is earnings. The projections range from $3.60 to $4.12 and average $3.87. In the last two quarters, actual reported earnings were more than 100% higher than consensus estimates.

AGP’s valuation metrics appear to be low. The P/E ratio is about 10X vs. 14.5X for the industry. Price to book is aligned with the industry at 2.0X. The price to sales ratio is a low 0.40X and price to free cash flow is 10.9X. The PEG estimated EPS and growth is 0.6X.

By most of the metrics we use, Amerigroup is a strong company with excellent prospects. We think it is well positioned.

Disclosure: Author has a long position in AGP.

Company Focus: SanDisk Corporation

2010-12-05T10:00:00.000-08:00

Prognosticating the future using crystal balls, tea leaves or entrails is only a little less risky than forecasting paradigm shifts in technology. I believe we are at the cusp of change in regard to where we store our ever growing cache of files. As I see it, there are two competing technologies emerging. On the one hand, there is the almost limitless capacity of the cloud; on the other hand, flash memory. The advantage of the cloud is the previously unlimited capacity. The downside of the cloud includes issues of security and privacy. Flash memory offers greater security but, as of today, greater cost. Both of these technologies will expand in the future. For the foreseeable future, the old fashioned hard disk drive will remain the dominant form of mass storage.

Any discussion of flash memory and the emerging technology of solid state drives must include SanDisk Corporation (SNDK). SanDisk describes itself as “the world's largest supplier of flash data storage card products, designs, manufactures and markets industry-standard, solid-state data, digital imaging and audio storage products using its patented, high-density flash memory and controller technology.”

The Company’s products are ubiquitous in such consumer products as digital cameras, digital camcorders, GPS devices, MP3 players, gaming consoles, USB flash drives and the new, dedicated e-books. Sandisk products also are prominent is the fast growing smartphone market. The new market for flash memory resides in the various computer form factors. The here today, gone tomorrow netbooks, notebooks and tablet computers.

At the present time, the mobile and imaging markets are the largest growth drivers for SanDisk. These segments, combined, account for 70% of the company’s growth. Looking to the future, will SSD be a mega-trend? It is still too early to tell. The technology needs to develop further and costs must decrease substantially for SSD to really take off. If tablets become this decade’s major product innovation, then SSD price/GB will decline as storage capacity builds. Let us not forget that SanDisk partners with both Apple (AAPL) and Samsung by supplying the memory for the Ipad and Galaxy tablets. SanDisk also supplies the memory for the Iphone and other smartphones.

Is SanDisk in a financial position to exploit these developments?

We will start with the balance sheet. The Company ended 3Q10 with $2,903.8 million in cash and short-term investments and $1,687.8 million in long-term debt. Long-term debt to equity is 32.5%. Long-term debt to capital is 24.6%. Interest coverage is 83.6X. The current ratio is 4.4X and the quick ratio is 3.8X. Total liabilities/free cash flow is about 2X. SanDisk is not overleveraged and can easily meet its short-term cash requirements. The Company has grown equity by 14.5% over the past seven years. ROE is 25.9% and ROA is 17.1%.

For the twelve month period ending October 2010, SanDisk reported sales of $4,741.0 million and EPS diluted of $4.85. Earlier this year, the Company provided some guidance on sales. They project FY11 sales in the range of $4.75billion to $4.825 billion. Thomson Reuters reports analyst revenue estimates for FYE 12/10 to range from $4,693 million to $4,797 million and for FYE 12/11, $4,308.8 million to $5,866 million. Earnings estimates for FYE 12/10 range from $4.31 to $4.56; for FYE 12/11, $2.45 to 4.88.

Year-over-Year, sales have grown nearly 49% and EPS diluted about 164.9%. Long term, the Company’s sales and EPS have been erratic as has free cash flow. Profit margins have been all over the place with 2008 being a disaster.

SanDisk is a healthy company well positioned to benefit from the smartphone and tablet wars. They offer leading-edge technology strong partnerships with industry leaders. At a recent price of $48.31, SanDisk has a PE of 10X, a PB of 2.1X and PS of 2.3X. With an estimated future growth rate of 14.33%, the PEG Estimated EPS is 0.8X. By these measures, SanDisk appears to be a growth stock masquerading as a value stock.

Disclosure: Author has a long position in SanDisk and no position in Apple or Samsung.

The Long Term Case for Humana

2010-11-21T08:59:00.000-08:00

As a result of the healthcare reform initiatives recently enacted, the health insurance industry is poised for fundamental change. We can be fairly certain about some things: Obamacare is the law of the land, Obamacare will not be repealed and, finally, Obamacare will be changed with the new Congress. Just what the changes will be and what the impact of those changes will be are anyone’s guess.

Humana Inc. (HUM) is a big player in this market. The Company is a benefits solutions company, offering an array of health and supplemental benefit products for employer groups, government benefit programs, and individuals. Humana operates in two segments: Government and Commercial. The Government segment consists of beneficiaries of government benefit programs, and includes three lines of business: Medicare, Military and Medicaid. The Commercial segment consists of members enrolled in its medical and specialty products marketed to employer groups and individuals. The Company provides health insurance benefits under health maintenance organization (HMO), private fee-for-service (PFFS) and preferred provider organization (PPO) plans.

Short-term, the greatest uncertainties are related to the Government segment of the business. The Company’s TRICARE contract with the government is expected to be extended for one year, through March 2012. There are no guarantees this contract will be extended this date. If it is not, Humana will book expenses related to the program’s termination.

The most significant uncertainty involves changes in the Medicare program. Humana is a big player in the Medicare Advantage program. Many health insurers are already closing Medicare Advantage programs and Humana is no exception. There will be consolidation within the industry and we expect Humana to benefit from this trend. Another trend is undeniable; the Baby Boom generation has begun applying for Medicare. This trend will continue for some years to come as the population continues to age.

Another strong point for HUM is its pharmacy benefits management business. This is an area that continues to demonstrate growth. We expect Medicaid reimbursement rates to experience downward pressure as states grapple with their own deficits. Medicaid is a huge cost for most states.

The Commercial segment is also in for significant change. Many smaller employers are dropping health insurance for their employees’ altogether. They find that paying the government a penalty for not providing insurance is less costly than providing insurance. This is an example of market forces at work.

The Company reported revenues of $8.42 billion for the quarter ended September 30, 2010 (3Q10). Humana’s revenue for the quarter ended September 30, 2009 (3Q09) was $7.72 billion. Earnings per common share (EPS) for 3Q10 is $2.32 and compared to $1.78 for 3Q09. Analyst projections for FY10 earnings range from $5.70 to $7.31 and average $6.91. The Company’s guidance is for EPS of $6.40 to $6.50, disappointing analysts.

Humana reports growth in revenues and operating profits across all segments of its business and reduced operating expenses. The balance sheet is reasonable. At September 30, 2010, the Company had cash, cash equivalents, and short-term investments of $11.54 billion, up 12 percent from $10.29 billion at June 30, 2010. The long-term debt to capital ratio is down to 19.4 percent in 3Q10 from 22.5 percent at FYE09.

The Company reports strong free cash flow. For the 3Q10, free cash flow per share was $6.77 as compared to $1.60 at 2Q10. Humana has a share repurchase plan in place. During 3Q10, the Company repurchased 968,000 of its outstanding shares. Approximately $150 million remains on the authorization.

There is a lot going for Humana as a mid or long term investment. The Company is well run, profitable and continues to grow. We think Humana offers a good opportunity for the patient investor.

Disclosure: Author has a long position in Humana.

NeuStar Inc.: A Telecom Monopoly

2010-11-14T09:37:00.000-08:00

NeuStar Inc. (NSR) is a telecom industry monopoly. The Company provides clearinghouse services to the telecom industry, making interoperability possible for competing communication service providers. It operates the authoritative directories containing all the phone area codes and numbers in North America, facilitates the routing of calls among competing providers, manages top-level Internet domain name services (.biz and .us), and administers U.S. common short codes (shorter phone numbers used for value-added services).

Unlike most monopolies, NeuStar does not seem to have a great deal of pricing power. There appears to be a history of the Company renegotiating contracts for lower rates. That being said, NeuStar is consistently profitable and maintains a very strong balance sheet.

In a press release dated October 28, 2010, the Company reported results for the third quarter 2010.

Highlights from that release are as follows:

· Revenue increased 11% from 3Q09 to $130.5 million.

· Net income increased 22% from 3Q09 to $29.9 million.

· Earnings per diluted share increased 22% from 3Q09 to $0.39.

· EBITDA increased 16% from 3Q09 to $57.9 million, representing a 44% margin

· Cash, cash equivalents and short-term investments totaled $377.5 million as of September 30^th.

The Company reports for two operating segments: Carrier Services and Enterprise Services. Carrier Services include Numbering Services, Order Management Services and IP Services. The Enterprise Services segment includes internet infrastructure and registry services. The third quarter report shows revenue and earnings growth in both operating segments.

Historically, the Company shows consistency in its growth profile.

Growth %	3 Year	5 Year
Sales	13.0	23.8
Gross Income	14.1	26.0
Net Income	11.0	23.1
EPS Diluted	12.5	16.3

For the seven fiscal years ending 12/31/2009, the gross profit margin averaged 73.76%. In the twelve month period ending 09/30/2010, the gross margin was 77.00%. The seven year average operating margin is 29.77% as compared to 35.40% for the trailing twelve months. The net profit margin for the TTM 09/30/2010 is 21.30% whereas the average net profit margin for the prior seven fiscal years is 17.31%. Both operating and net margins have been strong during each of the past seven years with the notable exception of 2008.

EPS diluted have grown from $0.72 in FY05 to $1.34 in FY09. The lone exception is 2008 when EPS diluted declined to $0.06. For the TTM ending 09/10, EPS diluted rose to $1.47. There are ten analyst estimates for FY10. The estimates range from $1.50 to $1.54 per share. The analysts estimate FY11 EPS to range from $1.65 to $1.74; the consensus is $1.74.

The balance sheet is clean and strong. Cash, cash equivalents and short-term investments total $377.50 million as of September 30, 2010. On the other hand, total liabilities are reported at $114.9 million. Long term debt is $5.4 million. Current liabilities include $26.117 million in deferred revenue. The Company also books $8.923 million in long term deferred revenue. The current ratio is 5.1X and times interest earned is 116.6X. The Company should have no difficulties is covering their short term obligations. Return on equity and return on assets are 20.4% and 16.6% respectively.

NeuStar does not pay a dividend though the Company’s free cash flow of $1.44 per share could support one. NeuStar has in place a three year, $300 million share repurchase plan.

We think NeuStar has the potential to appreciate to $40 in the next twelve months.

Disclosure: The author has a long position in NSR.

Brinker International: Challenge for Casual Dining

2010-11-07T09:16:00.000-08:00

Brinker International, Inc. owns, develops, operates and franchises the Chili’s and Maggiano chains and has a minority interest in the Macaroni Grill chain of casual dining restaurants. The Company describes itself as “one of the world’s leading casual dining restaurant companies. With more than 1,700 restaurants and over 125,000 team members in 27 countries and two territories, Brinker and its brands welcome more than one million guests into our restaurants every day.”

Brinker’s recently announced results for the fiscal first quarter ended September 29, 2010.

“Highlights for the first quarter of fiscal 2011 include the following:

Earnings per diluted share, before special items, increased to $0.21 compared to $0.12 for the first quarter of fiscal 2010 (see non-GAAP reconciliation below)
On a GAAP basis, earnings per diluted share increased to $0.21 from $0.15 in the first quarter of the prior year
Restaurant operating margin(1) improved 190 basis points to 15.0 percent
Total revenues decreased 6.0 percent to $654.9 million
Same restaurant sales at company-owned restaurants decreased 4.2 percent consisting of a 5.0 percent decrease at Chili's and a 1.4 percent increase at Maggiano's
Cash flows used in operating activities were $6.6 million and capital expenditures totaled $15.6 million
The Company repurchased approximately 5.3 million shares of its common stock for $92.7 million in the first quarter and repurchased an additional 4.3 million shares of its common stock for $83.1 million subsequent to the end of the quarter
The Company paid a dividend of 14 cents per share in the first quarter, an increase of 27.3 percent over the prior year quarter”

(1) Restaurant operating margin is defined as Revenues less Cost of sales, Restaurant labor and Restaurant expenses.

Brinker reports declining gross revenues at Chili’s. This is, at least in part, because the company shed 21 Chili’s restaurants in sales to franchisees and closed nine additional locations. Maggiano’s showed a 1.4% increase in same store sales due to increased traffic.

On the positive side, Brinker has consistently reported positive free cash flow. What is not so good is that free cash flow has been all over the place. Since FYE June 2004, free cash flow has ranged from a low of $0.11 per share to a high of $2.34 in FY10. For the trailing four quarters ending September 2010, free cash flow was $1.58 or 12X the recent stock price.

Depending on how you evaluate debt, we think Brinker has a problem. We find that long term debt is greater than working capital though it is a modest 3.26X free cash flow. The current ratio, at 1.0, is in line with the industry, as is times interest earned at 4.8X. Long term debt to equity is a heavy 80.4%.

The company’s long term growth rates are not impressive. Annualized seven-year growth rate for sales is negative at -1.3%. Similarly, the seven-year growth rate for EPS from continuing operations is -1.8%. Reported EPS for 1Q11 at $0.21 is 40% higher than for 1Q10 at $0.15. EPS for the trailing four quarters, at $1.21, is 42% higher than the year-ago period.

As previously mentioned, sales is a concern. In the quarter ending 9/10, sales were $654.9 million as compared to $778.1 million for the quarter ending 9/09. The TTM ending 9/10 has revenues at $3,513.5 million as compared to $4,054.5, year-over-year.

The company is widely followed by the investment community. Twenty analysts estimate earning for FYE 6/11 in the $1.28 to $1.45 and average $1.38. Some 18 analysts project FYE 6/12 earnings as being in the $1.38 to $2.19 range; the consensus is $1.63.

Brinker pays a dividend of $0.50 per share which provides a yield of 3.0%. This may be sufficient reason to hold Brinker a bit longer while the company gets its house in order.

Disclosure: Author is long EAT.

Dialing for Dollars in Argentina

2010-10-31T11:00:00.000-07:00

Telecom Argentina S.S. (TEO) focuses its efforts in offering a full range of integrated fixed and wireless services. The company’s mobile strategy is oriented towards improving the mix of postpaid users by promoting 3G services, better customer service and high-end handsets. Mobile data services have room for growth despite VAS accounting for 38% of service revenue, as most revenue from VAS relates to text messaging. The strategy on fixed business continues to center on bundle offerings that include voice and broadband services.

TEO has strong operating performance driven by mobile services, solid market positions, diversified portfolio of services with multiple platforms and a strong financial profile. There are certain risks in investing in Argentina. Among the risks are political instability, an unfavorable regulatory environment and currency risk, among others.

In a recent development, Telecom Italia (TI) is to take control of TEO. Under the plan, TI will have a controlling stake in Sofora, a holding company that in turn has a controlling stake in Telecom Argentina.

The company’s favorable prospects are borne out by the financial statements. The statements show consistent growth built on a stable and strong balance sheet.

Sales for 2Q10 came in at $877.6 million or 18.6% more than the $740.2 million reported in 2Q09. Sales for the TTM totaled $3,337.7 million as compared to $2,862.4 in the year-ago period and $3,094.0 million for FY09. The average growth rate for sales over the past five years is 22.2%. Six analysts make sales projections for TEO. The consensus projection for FY10 is $3,648.02 million and $3,702.55 million for FY11.

EPS for 2Q10 was $0.58 as compared to $0.45 in the year-ago period. EPS TTM is $2.01 as compared to $1.35 for the year-ago period and $1.60 for the year ending December 2009. Analyst forecasts for FY10 range from $2.26 to $2.59 with an average of $2.39. Projections for FY11 range from $2.34 to $2.73 with a consensus of $2.47. Y-O-Y, EPS grew at 48.9% and 25.6% when compared with FY11. EPS has grown at the rate of 29% over the past five years.

Free Cash Flow has been much more volatile over the years. At $1.46 TTM, it is down (25.1%) from the year-ago period. The five year growth rate for FCF is a paltry 0.6%.

A big plus for TEO is the dividend. It is currently paying a dividend of $2.15 per share, providing a yield of about 7.9%. Clearly, a dividend in excess of earnings or cash flow is unsustainable and represents a red flag.

The balance sheet reflects strength. Cash and ST investments total $301.9 million whereas long term debt is $18.7 million and other long term liabilities add another $249.3 million to the tab. Total liabilities are less than 5X free cash flow.

The company has steadily increased its gross profit margin. The normalized margin is 43.02%. For TTM, the gross margin rose to 50.1%. This compares favorably with the industry median of 48.9%. We see even better improvement in operating margins. The normalized operating margin for TEO is 14.85%. The most recent operating margin is 21.9% whereas the industry median declined to (0.8%). Net margins have been up and own over the years. In FY05, the margin was 20.1%. The following year, the margin declined to 7.8%. Since then, net margin has grown to 11.9%; better than the industry median of 0.3%.

TEO reports a return on equity of 29.1%, as compared to the industry median of 14.4%. However, reported ROE has steadily declined as the company deleveraged. Return on assets have steadily grown and is now at 14.4%.

Deleveraging clearly shows up in the debt management ratios. Total liabilities to total assets are 51.1% compared to the normalized ratio of 65.78% and the industry median of 74.5%. Lon term debt to equity has declined to 1.4% from 242.9% in 2004. Long term debt to capital is also 1.4%.

The company is better managing its assets. Receivable turnover is up to 9.7X compared to a five year average of 8.78X and the industry median of 7.7X. Asset turnover improved to 1.2X from 0.3X in 2003 and is better than the industry median of 0.7X. Finally, inventory turnover stands at 24.5X as compared to the industry median of 16.9X.

With a P/E TTM of 11.9X and a P/E est. EPS of 10X, TEO does not look expensive when compared to the industry PE of 14.4X.

DISCLOSURE: Author is long TEO.

InterDigital, Inc.: The Future in Cellular Communications

2010-10-17T10:07:00.000-07:00

InterDigital, Inc. (IDCC) is basically a R&D outfit specializing in developing cellular and wireless technologies. If you use a cell phone, PDA or tablet, you probably use IDCC technology. The Company is not a manufacturer. Its business model relies upon licensing patented technology to manufacturers such as Nokia and Samsung. InterDigital is an early entrant to this industry and has been around for many years. Its technology innovations are found in every area from 2G to the latest 4G and LTE products. The customer base is global though most manufacturing takes place in Asia. The Company sells its products in dollars so there is little currency risk.

Highlights from the 2Q10 are as follows:

· Net income of $35 million, or $0.78 per diluted share, a 32 percent increase over 2Q09 EPS of $0.59;

· Revenue of $91.2 million, a 22 percent increase over 2Q09 sales of $74.9 million;

Looking at the trailing twelve months ending June 30, 2010:

· EPS of $3.39 as compared to $1.95 in FY09

· Restated revenues of $359.3 million as compared to $259.3 million in the 12 month period ending 06/09

· Net income (TTM) of $182.1 million compared to $86 million in FY09

· Operating margins (TTM) of 51.9 percent, ROE of 92.5 percent and ROA of 19.7%

· Net margin of 50.7 percent

· CFROI of 38.17 percent

The Company has a strong balance sheet:

· As of 2Q10, reported cash and short term investments of $485.8 million

· Virtually no long term debt but $426.4 million in other long term liabilities

· Current ratio of 2.9X

· Liabilities to Assets of 71.9 percent

· Long term debt to capital 0.1 percent

· Book value of $6.04 per share and TBV of $3.18

· Total liabilities to average free cash flow is less than 3X

On a valuation basis, the company looks undervalued.

· P/E (TTM) is 8.7X and the forward looking P/E to estimated EPS is 9.2X

· The PEG based on estimated EPS and growth is a low 0.6X

· Low EV/EBITDA of 4.98X

· For the FY ending 12/10, four analysts project EPS in the range of $2.83 to $3.44, providing a consensus of $3.22

· Four analysts also project EPS for FYE 2011. Here, the range is $1.70 to $3.68 with an average of $2.58

· The June 10 reported earnings was 28 percent higher than analyst consensus forecasts.

The fortunes of IDCC are tied closely with the worldwide market for cellular devices. Handset sales have declined in the recent past but will rebound, we think, with the roll-out of 4G devices. IDCC will benefit from the popularity of tablet computers. The company’s strength lies in not having capital tied-up in inventory or capital equipment. It can use its excess cash to continue the stock repurchase program started in 2009 but suspended thus far, in 2010, provide a dividend or find an accretive acquisition. It cannot sit on the cash indefinitely; it must do something to increase shareholder value.

IDCC will be releasing its third quarter results at the end of October. It would be prudent to wait until then before prognosticating further.

Disclosure: Author has a long position in IDCC

Company Focus: Lubrizol Corporation

2010-10-03T09:02:00.000-07:00

The Lubrizol Corporation (LZ) is an innovative specialty chemical company that produces and supplies technologies to customers in the global transportation, industrial and consumer markets. These technologies include lubricant additives for engine oils, other transportation-related fluids and industrial lubricants, as well as fuel additives for gasoline and diesel fuel. In addition, Lubrizol makes ingredients and additives for personal care products and pharmaceuticals; specialty materials, including plastics technology and performance coatings in the form of specialty resins and additives. Lubrizol's industry-leading technologies in additives, ingredients and compounds enhance the quality, performance and value of customers' products, while reducing their environmental impact.

Lubrizol has a broad geographic footprint in that it has manufacturing and research facilities in 27 countries. Sales are made to more than 100 countries, basically the whole world. The Company has two operating segments: Additives and Advanced Materials. The Additives segment produces engine additives and driveline and industrial additives. The Advanced Materials segment produces engineered polymers, a product line called Noveon and performance coatings.

Sales for the quarter ending June 2010 totaled $1,401.2 million or 26.1% greater than the year-ago quarter of $1,111.0 million. Similarly, sales for the trailing twelve months ending June 2010 of $5,179.6 million were 12.9% greater than the $4,586.3 million reported for FY09 ending December 2009.

Quarterly EPS 2Q10 is $2.89 as compared to $1.92 for the year-ago period. This is a 50.5% increase in EPS. EPS diluted for the trailing twelve months ending June 2010 is $9.59, or 32.1% greater than FY09 EPS diluted of $7.26. Reported net income for TTM ending 06/10 is $668.4 million, or 33.5% greater than FY09 reported net of $500.8 million.

Along with greater levels of sales and increases in reported net income, we are seeing expansion of gross margins. GM expanded for 34.2% in 2Q10 as compared to 33.0% in FY09 and 22.3% in FY08. Operating margins continue to improve, as well. For 2Q10, OPM is 19.2% compared to 17.9% in FY09 and 1.3% in FY08. Having squeezed out efficiencies, net margin increased in 2Q10 to 12.9% from 10.9% in year-end 09.

The balance sheet appears to be strong and stable. Cash and short-term investments total $972.2 million while current liabilities total $669.7 million for the quarter ending June 2010. The quick ratio is 2.8X and the current ratio is 3.8X. These indicate that the Company has no problems meeting its short term obligations.

Looking at long term obligations, we find that Lubrizol has long term debt of $1,351.6 million and other long term liabilities of $691.5 million. Total liabilities to total assets are 56.1%, less than the industry median of 58.9%. Long term debt to capital is 38.9%, greater than the industry median of 23.3%. Long term debt to equity is 63.6% whereas the industry median is 21.8%. Total liabilities to the four year average free cash flow is approximately 5X.

Lubrizol pays an indicated dividend of $1.29 per share providing a yield, at current prices, of 1.4%. The dividend represents a payout ratio of 13.2%.

Looking ahead, analysts are projecting FY10 EPS ranging from $9.85 to $10.15 with a consensus forecast of $10.05 per share. Reuters reports that five analysts estimate sales in the range of $5,294.8 million to $5,555.0 million with a consensus of $5,418.4 million. Analysts are optimistic for FY11, as well. They project EPS ranging from $9.20 per share to $11.00 per share averaging $10.25. These projections are based on sales estimates of $5,322.3 million to 5,856.0 million and a consensus forecast of $5,597.4 million. The FY10 sales estimate represents a 18.1% increase over FY09 sales. Analysts expect a slowdown in earnings growth though they have been surprised in the last two reported quarters.

Shares of Lubrizol are currently selling at 11.1X trailing twelve month earnings of $9.59 per share and 10.6X estimated EPS. Forward looking EPS growth is estimated at 23.4%. The Company pays a dividend and has been buying back stock. Given that Lubrizol is selling at a discount to the market, has good prospects, pays a well-covered dividend and is buying back stock, we believe Lubrizol is worth a close look.

DISCLOSURE: The author holds a long position in Lubrizol.

Company Focus: Clearwater Paper Corporation

2010-09-12T10:13:00.001-07:00

Clearwater Paper Corporation (New York: CLW) is a 2008 spin-off from Potlach Corporation. Clearwater is a producer of private label tissue and paperboard products. Their products are American-made and utilize primarily wood pulp. The Company is organized around three operating segments: Consumer Products; Pulp and Paperboard; and Wood Products. The private label tissue segment includes products such as facial and toilet tissue, paper towels and napkins. Paperboard products are sold to the packaging industry. The Company also participates in the lumber segment selling wood products including clear cedar and other dimensional lumber products.

Clearwater’s strategic plan is to grow the consumer products division by expanding capacity and product offerings and to become the low-cost producer of high-end pulp and paperboard products.

Part of Clearwater’s attraction, as an investment, is that it is a well run company in an out-of-favor industry. However, there are caveats. Sales are concentrated. In the Consumer Products segment, three customers represent 60% of net sales for the segment and 27% of total net sales. Additionally, the Company’s pension plan is underfunded. As of December 31, 2009, the pension plan was underfunded by $95.9 million. Clearwater has made additional payments to the pension plan. These company specific risks and problems are in addition to the normal and expected risks associated with a cyclical, commodity-based business.

The Company has a fiscal year ending December and recently reported its 2Q10 results. For the quarter, net earnings were $20.6 million, or $1.75 per diluted share, compared with net earnings of $75.4 million, or $6.43 per diluted share for 2Q09. The prior year results included special items totaling $4.60 per share for alternative fuel mixture tax credits, renewable energy tax credits and debt retirement costs. Excluding those items, 2Q09 diluted earnings were $1.83 per share.

For FY09, net income was $182.5 million, or $15.50 per diluted share. This compares with net income of $114.5 million, or $9.72 per diluted share for the twelve month period ending June 2010.

Net sales for 2Q10 were $343.86 million, 8.5% higher than 2Q09 sales of $316.91million. Operating income was lower due to higher raw material costs. Net sales in FY09 totaled $1,250.1 million compared to $1,320.9 million for the trailing twelve months ending June 2010.

Free cash flow is considered by many a superior measure to earnings. For FY09, Clearwater reported free cash flow of $17.45 per share. For the trailing twelve months ending June 2010, free cash increased to $21.96 per share.

Clearwater has a very solid balance sheet. As of 2Q10, the Company reported cash and short term investments of $333.0 million and long term debt of $148.4 million. Cash and short term investments represent about 40% of the recent stock price. Clearwater does not report any goodwill or other intangibles on its balance sheet making the Price/TBV ratio 2.11.

The Company is both profitable and efficient. Return on Equity is 31.6% as compared to the industry median of 11.2%. similarly, return on assets, at 12.2% compares very favorably with the industry median of 2.6%.

Clearwater has long term debt of $148.4 million, as of June 2010. The long term debt to capital ration is 27.3% and long term debt to equity is 37.6% as compared to the industry medians of 35.8% and 60.8%, respectively.

In its short history, the Company has provided us with a number of earnings surprises.

Earnings Surprises Last Qtr. 2Qtrs Ago 3Qtrs Ago 4Qtrs Ago
Estimate 1.32 0.14 1.33 1.21
Actual 1.75 0.41 1.48 1.40

Three analysts currently cover Clearwater and provide earnings estimates. The estimates range from $4.79 to $5.27 per share for FY10 providing an average estimate of $5.03 per share. In FY11, the analysts provide a range of $5.15 to $6.01 and an average of $5.48. The shares are trading now at a forward PE of 14.4X, a premium to the industry median TTM PE 10.9X. On the other hand, the industry median EV/EBITDA ratio is 8.02X and the industry median EV/FCF ratio is 5.47X whereas Clearwater has an EV/EBITDA ratio of 4.95X and EV/FCF ratio of 3.74X.

Our overall conclusion is that Clearwater is a well run company in an out-of-favor industry. We believe it is undervalued and offers an attractive return.

Disclosure: The author has a long position in Clearwater paper Corporation.

Company Focus: GT Solar International, Inc.

2010-08-30T15:49:00.000-07:00

GT Solar International, Inc. (Nasdaq: SOLR) is a provider of polysilicon production technology, and sapphire and silicon crystalline growth systems and materials for the solar, LED and other specialty markets. The Company’s principal products are:

*Chemical vapor deposition (CVD) reactors and related equipment used to produce polysilicon, the key raw material used in silicon-based solar wafers and cells; and

*Directional solidification systems (DSS) furnaces and related equipment used to cast multicrystalline ingots by melting and cooling polisilicon in a precisely controlled process. These ingots are used to make photovoltaic (PV) wafers which are, in turn, used to make solar cells.

GT Solar recently acquired the privately-held Crystal Systems, Inc. Crystal Systems is a crystalline growth technology company that manufactures large area sapphire substrates used in the LED, defense, medical and aerospace industries.

GT Solar’s 1Q11 ended July 3, 2010. Revenue for this quarter totaled $135.2 million, compared to $194.7 million in 4Q10, a 30.5% sequential decline and $71.8 million in 1Q10, an 88.3% increase. Revenue for the first quarter included $23.7 million in the polysilicon segment and $111.5 million in the photovoltaic (PV) segment. In the twelve month period ending July 2010, sales rose to $607.6 million from the FY10 total of $544.2 million, an 11.6% change. The consensus estimate of nine analysts following SOLR is for FY11 revenues to come in at $735.32 million. Estimates range from $596.3 million to $782.7 million.

The Company had net income of $16.5 million in 1Q11, as compared to $33.3 million in 4Q10 and $7.8 million in 1Q10. Earnings per share in 1Q11 on a fully diluted basis were $0.11, versus $0.23 in 4Q10 and $0.05 in 1Q10. The consensus forecast for FY11 is $0.93. The estimates range from $0.85 to $0.97. Analysts are revising their estimates both up and down.

The balance sheet is strong with cash and short term investments totaling $276.5 million at the end of 1Q11. The Company reports no long term debt. Total liabilities are $545.5 million. GT Solar reports strong and growing free cash flow per share. As of 1Q11, GT Solar reported trailing twelve month FCF of $0.78/share as compared to $0.98/share in FY10 and $0.57 in FY09.

The Company is consistent in generating gross profits. Since FY06, the gross margin has ranged from 37.8% to 40.2% with an average of 39.11%. Operating margins have improved from a low of -44.0% in FY06 to 26.4% in FY10 and 25.6% for the twelve month period ending 7/10. Net margins have also changed from a low of -46.6% in FY06 to 16.0$ in FY10 and 15.8% in the trailing twelve months. The company does not pay a dividend.

Risk Factors

At first glance, GT Solar is an attractive investment for the long-term investor. They are engaged in what is perceived as a growth industry. The Company has a healthy balance sheet, a history of sales and earnings growth and generates free cash flow. Capex is not a major factor as the Company outsources most manufacturing activities. A look under the hood, however, reveals a number of significant risks.

At the macro level, the solar energy industry relies upon government subsidies to compete with hydrocarbon based sources of energy. Until this disparity in cost is rectified, solar energy will never be as widespread as many people think. Another macro issue is China. The majority of sales come from Chinese companies. Any slowdown in the Chinese economy, changes in exchange rates and political/military instability will have a damaging effect.

More importantly, we think, are the company specific risk factors. SOLR depends on a very small number of customers. In FY10, one customer accounted for 34% of revenue. In FY09, four customers represented 62% of sales and in FY08, one customer accounted for 62% of revenue. Clearly, the loss of one customer would have a devastating effect on the Company. Additionally, GT Solar has a very small product line. Sales of the CVD reactors, DSS furnaces and STC converters accounted for 91% of revenues in FY10.

All-in-all, GT Solar may be an attractive speculative investment. The operative word here is speculative.

Disclosure: The author has a long position in SOLR.

Company Focus: Tractor Supply Company

2010-08-15T09:43:00.000-07:00

The term, “gentleman farmer”, evokes for me an image of the English countryside. I see tidy villages and thatch roofs. Closer to home, I see the retail farm and ranch stores operated by Tractor Supply Company (Nasdaq: TSCO). Tractor Supply is the largest retail farm and ranch store chain in the United States. The Company operates more than 900 retail stores in 44 states in town’s outlying metropolitan markets and rural communities. It also sells through a website.
Tractor Supply is a niche retail operation. Its stores compete with the big-box home centers Home Depot and Lowes but provide a more specialized experience and product line. The Company sells equine, pet and small animal products, including health-related products and feed, among others; hardware and seasonal products including lawn and garden supplies and equipment; clothing for the entire family; and, maintenance products for the farm.
For FY10, the Company anticipates net sales to range from $3.49 billion to $3.53 billion and EPS to range from $4.00 to $4.10. Analyst estimates range from $4.03 to $4.23. The consensus forecast is for FY10 EPS of $4.11. It seems the analysts are a bit more optimistic than the Company. In 2Q10, net sales increased 12.6% to $1.07 billion from $946.5 million in the prior year second quarter. For the first six months of 2010, net sales increased 11.3% to $1.78 billion from $1.60 billion in the first six months of 2009.
In the second quarter, net income was $76.5 million, or $2.05 per diluted share, compared to $54.8 million, or $1.50 per diluted share in the prior year period. The first half of FY10 saw net income growth. Net income during the first six months of 2010 was $85.8 million or $2.31 per diluted share compared to net income of $55.2 million or $1.51 per diluted share for the first six months of 2009.
We are seeing growth in the top line sales and in diluted EPS. We also see expansion of gross margins. Gross margin increased in 2Q10 to $358.8 million or 33.7% of sales, compared to $301.2 million or 31.9% of sales in the prior year quarter. For the trailing twelve month period ending 6/2010, gross margin is 33.1%; higher than any prior fiscal year back to 2005. Similarly, the operating margin of 6.8% was higher than in previous years.
The Company reports very high levels of efficiency. Return on equity is 19.6% and return on assets is 11.3%. The current ratio is a healthy 2.1X the liabilities to assets ratio is a moderate 40.1%. The Company reports a nominal $1.2 million in long term debt. TSCO has cash flow of $2.41 per share and free cash flow of $2.78 per share. Tractor Supply is funding organic growth through the prudent use of cash flow. During the first six months of 2010, Tractor Supply opened 38 new stores and closed one store.
The Company declared a quarterly cash dividend of $0.14 per share and the board of directors approved a two-for-one stock split. Annualized, the dividend is $0.28 per share and represents a payout ratio of 7.0%. The dividend yield is approximately 0.8%.
With a TTM price-earnings ratio of 17.4X and a forward PE of 16.7X, TSCO is trading at a premium to the market. The long-term average PE is about 20X so TSCO is selling at a discount to its historical average. The EV/EBITDA ratio is about 7.75X; a relatively modest ratio.
Disclosure: Author has a long position with TSCO.

Company Focus: Hawkins, Inc.

2010-08-06T15:28:00.000-07:00

Hawkins, Inc. (HWKN) distributes bulk chemicals and blends, manufactures and distributes specialty chemicals. Hawkins currently divides its business into two broad segments: industrial and water treatment.
The industrial segment provides industrial chemicals, products and services primarily to the agriculture, energy, electronics, food, chemical processing, pulp and paper, pharmaceutical, medical device and plating industries. This segment’s principal products are acids, alkalis and industrial and food-grade salts. For the quarter ending 1Q11, sales for this industrial segment increased $0.1 million, or 0.2% to $49.8 million as compared to the same period of the prior year. Reduced selling prices in response to lower raw material costs offset the impact of increased sales across product lines.
The water treatment group specializes in providing chemicals, equipment and solutions for potable water, municipal and industrial wastewater, industrial process water and non-residential swimming pool water. Water treatment sales increased $1.0 million, or 4.2%, to $24.9 million for the three months ending June 30, 2010 as compared to the same period in the prior year. The sales increase is primarily due to increased sales of manufactured and specialty chemical products, partially offset by lower prices due to lower raw material costs.
Investment Thesis
Hawkins is a small player in a fragmented, competitive cyclical commodity business. Its competitive advantages include flexible, value-added services; strong financials and effective management. Sales for the first quarter ending June 30, 2010 were $74.7 million and represented an increase of 1.5% from $73.6 million in sales for the first quarter of fiscal 2010. Net income for the quarter was $7.3 million, or $0.71 per share, compared to net income of $6.1 million, or $0.59 per share in the same period of the prior year. For the trailing twelve months ending June 30, 2010, the company reports EPS of $2.46 compared to $2.33 for FYE 3/10. Two analysts provide estimates for FY11. They estimate EPS to range from $2.29 to $2.34 and average $2.31. Only one analyst provides an estimate for FY12 and that is $2.56 per share.
The current PE is about 13.6X based on trailing earnings and the forward PE is about 14.3X. Both of these multiples is in line with the historical average multiples. Price-to-Book, at 2.65X is somewhat higher than the historical average as is Price-to-Sales at 1.32X .
Hawkins has a strong balance sheet. As of 1Q11, the company reported cash and equivalents at $46.9 million and total liabilities at $32.6 million. There is no long-term debt. The management is doing a good job in controlling costs. Gross margin, at 26.0% is higher than it has been in any year since FY06. The operating margin is a 16.0% and again at its highest levels in years. Return on equity has grown from 12.0% in FY06 to 20.8% in 1Q11. Similarly, ROA has grown from 9.8% to 16.4%. Both of these metrics are far better than the industry medians.
The company has announced its regular semi-annual dividend to be $0.30 representing a 7.0% increase over its last regular dividend and a special dividend of $0.10 per share. This is the 26th consecutive that Hawkins has paid a dividend. At recent prices, the Company is providing a yield of about 1.8%.
Hawkins is a small, nimble company successfully executing its mission. It has a consistent history of growth and dividends; a strong balance sheet; and, effective management. Notable investors including Charles Royce, Mario Gabelli and T. Rowe Price, among others, hold shares of HWKN.

Disclosure: The author has a long position in HWKN.

Company Focus: AstraZeneca

2010-07-18T17:20:00.001-07:00

The biotechnology and drug industry has come a long way in recent years. Formally filled with small, one product companies without sales and earnings, the industry now has major players. AstraZeneca (New York: AZN) is one such player.

AZN has a rich product line focusing on six areas of healthcare: gastrointestinal, cardiovascular, respiratory, oncology, neuroscience and infection. The leading drugs in each category are: Nexium, Crestor, Symbicort, Arimidex, Seroquel, and Synagis, respectively.

For FY 2009, Nexium accounted for approximately 15% of sales; Crestor 14%; Symbicort 7%, Arimidex 6%, Seroquel 15% and Synagis 3%. Total sales for FY 2009 totaled $32,804 billion.

Despite the difficult worldwide financial situation, AZN continues to grow. Sales for the 12 month period ending 03/10 grew 6.5%. For 1Q10, sales grew 11% over the year-ago period. Long term, sales grow at more than 7%.

Earnings growth remains robust. EPS basic grew at the rate of 21.1% during the 12 month period ending 03/10. In 1Q10, EPS grew 28% to $1.90 as compared to $1.48 in 1Q09. Long term, EPS is growing at about 19.9%.

The company consistently reports positive free cash flow and pays a dividend of $3.42 per share. At a recent trading price of $48.79, the dividend yield is about 7.0%.

AZN has a strong balance sheet. Cash and short term investments total $9,396.0 billion. Long term debt is $9,055.0 billion.

On a valuation basis, the shares of AZN look very cheap particularly when compared to its peers. The PE TTM is 8.7X trailing earnings of $5.61 and 7.8X estimated 2010 earnings of $6.29. Five analysts follow AZN. Their earnings estimates range from a low of $6.25 to a high of $6.31. This very tight range indicates a very high confidence level for the estimates. We estimate EV/EBITDA to be about 6.5X.

Looking at profitability ratios, we see strength. The current ROE at 41.5% exceeds the long term average ROE of 34.28%. Gross margin is at 82.0% is down only slightly from FY09 when the gross margin was 83%. The gross margin remains significantly about the long term average of 79.23%.

Similarly, operating margins are better now than in the past. The most recently reported operating margin is 35.7%, slightly better than FY09 and dramatically better than the long term average of 25.98%.

Disclosure: Author is long AZN.

Core Laboratories: An Oil Patch Opportunity

2010-05-31T09:34:00.001-07:00

Problems in the oil patch generally result in new opportunities. The Gulf oil spill will, no doubt, have a short-term impact on off-shore drilling in the Gulf and elsewhere. However, long-term, there are no viable alternatives to continued off-shore drill. Another area worth investigating is oil and gas production from shale deposits.

One key factor in both oil and gas production is an accurate reservoir description. Core Laboratories, NV, is probably the leading provider of reservoir description, production enhancement and reservoir management services.

According to Eric Nuttall, an energy analyst at Sprout Asset Management, new fracking technology makes recovering natural gas from shale economically feasible. Nuttall has stated "The Barnett Shale was really the first to take off commercially. That led then to the Marcellus Shale, Fayetteville Shale, and then most recently the Haynesville Shale, which is being touted as probably the most economic shale play."

The Company describes itself as "Core Laboratories is a leading provider of proprietary and patented reservoir description, production enhancement and reservoir management services for the global petroleum industry.

These services enable the Company's clients to optimize reservoir performance and maximize hydrocarbon recovery from their producing fields.

The Company has over 70 offices in more than 50 countries and is located in every major oil-producing province in the world. The Company provides its services to the world's major, national and independent oil companies."

"Core Laboratories reports results under three operating segments: Reservoir Description, Production Enhancement, and Reservoir Management.

Reservoir Description

Reservoir Description operations posted first quarter 2010 revenue of $104,093,000 and operating income of $25,084,000 yielding operating margins of 24%, equal to those posted in the year-earlier quarter. During the quarter, large-scale core analyses and reservoir fluids phase-behavior studies continued for deep-water fields offshore West Africa and eastern Brazil and also for the Middle East and Asia-Pacific regions.

From offshore West Africa, core analyses projects were conducted for the Cuanza basin of Angola and the Tano and Liberian basins of Guinea and Liberia, respectively. The measured petro physical data sets were being used to determine reservoir quality and to plan further exploitation and development of both producing and recently discovered fields. Reservoir fluids data sets from reservoirs offshore Brazil were being used to help determine initial hydrocarbon recovery rates and the economic value of the crude oil

being produced from pre-salt and post-salt reservoirs.

The Company continues to conduct high-margin reservoir studies of reservoir rocks and fluids in the northern and southern regions of Iraq. In the north, Core is mostly working for independent companies developing fields around the super-giant Kirkuk oilfield.

Projects include both core analyses and reservoir fluids phase-behavior studies aimed at exploitation of recent discoveries. In the south, Core is working for large multinationals that will be redeveloping the major and giant fields awarded in recent licensing rounds. The key to success for the multinationals in these southern field projects will be to increase ultimate hydrocarbon recovery rates from relatively low levels by 3 to 5 percentage points over time. Continuing projects in Kuwait, Qatar, Saudi Arabia, and

Oman are chiefly aimed at expanding production capacities. Asia-Pacific projects included combinations of reservoir rock and fluids studies from various fields in Malaysia, Indonesia, China, India, and Australia.

Production Enhancement

Production Enhancement operations posted first quarter 2010 revenue that increased 9% over year-earlier quarterly totals to $68,844,000 and operating income that was up 14% year-over-year to $20,943,000. Operating margins reached 30%, while year-over-year quarterly incremental margins exceeded 45%.

Production Enhancement realized unprecedented demand for its ZeroWash® and SpectraChem® Plus+ fracture diagnostics technologies used to optimize multistage fracture-stimulation programs. Operating companies are combining proprietary core analyses data sets, including rock mechanics, and fracture diagnostics technologies provided by Core Lab to fracture and stimulate unconventional natural gas and oil shale reservoirs. Rock mechanics data from cored intervals yield information on how strata will react to differing hydraulic stress fields that can be applied to the reservoir during complex frac programs. Fracture-stimulation programs based on measured petrophysical and geological data sets are proving to be much more effective than programs based on low-tech geometric designs. Once a formation has been fracture stimulated,Core's SpectraScan® technology is being employed to determine which specific perforations did, or did not, have enough proppant injected to hold the producing formation open and permit hydrocarbon flow into the wellbore.

In addition, the Company's patented and proprietary HEROTM High Efficiency Reservoir Optimization line of perforating charges and gun systems has increased market share in North American natural gas and oil shale reservoirs. These low-debris, deep penetrating charges and gun systems deliver higher initial hydrocarbon flows to the wellbore, but more importantly, they enable higher ultimate hydrocarbon recovery rates from natural gas and crude oil reservoirs. Increased demand for HERO technology in

Middle East and Asia-Pacific perforating markets added to strong first quarter results.

Reservoir Management

Reservoir Management operations produced its second most profitable quarter in Company history. First quarter 2010 revenue increased to $15,400,000, up 16% from 2009 first quarter totals, and operating income increased 62% to $5,620,000. Operating margin exceeded 36%.

In addition to expanding joint-industry projects evaluating the Eagle Ford, Haynesville, and Marcellus shales and the Granite Wash tight gas sands, the Company was requested by a number of oil companies to initiate joint-industry projects in the Montney shale in northeastern British Columbia and northwestern Alberta, Canada. Prospective Montney shale and mudstone sections will be analyzed for geological, petrophysical, geochemical, and geomechanical properties. The resultant data sets will be used to optimize completion and stimulation programs in the Montney, ranging from selection of the most effective perforating charges to optimizing geological and petrophysical modeling of multistage fracture-stimulation designs. Current industry participants include EnCana, Devon, ConocoPhillips, Shell, Husky, Talisman, and Suncor, among others. Core also was requested to initiate a joint-industry project in the fractured and oil-prone Niobrara formation, which is located in the northern sections of the Denver-Julesburg basin of Colorado and the Powder River basin in Wyoming. Several established fields in the region already produce from the Niobrara, and the joint-industry project will help determine the lateral extent of the play."

Core Laboratories N.V. reported first quarter 2010 earnings per diluted share (EPS) of $1.38, an increase of 10% over the year-earlier total of $1.26. First quarter 2010 net income increased 10% to $32,205,000, while year-over-year first quarter revenue increased 5% to $188,337,000. These EPS, net income, and revenue figures were the highest first quarter totals ever reported by Core. Free cash flow (FCF), defined as cash from operations minus capital expenditures, totaled an all-time quarterly record of $56,211,000, equal to $2.40 per diluted share. The Company purchased 703,902 shares for $86,467,000 during the first quarter of 2010, and quarter-ending, year-over-year cash balances increased $65,732,000 to $138,768,000.

Operating income, also a record for any first quarter, increased to $51,413,000, a 10% increase over the year-earlier total. Operating margins, defined as operating income divided by revenue, were 27%, an increase of 100 basis points over year-ago first quarter margins. Sequential first quarter 2010 incremental margins, defined as the change in operating income divided by the change in revenue, exceeded 50%.

Summary

The Company has announced a 2:1 stock split effective in July 2010. This should help the Company's liquidity and trading volume. Core Laboratories pays a dividend of $0.48 per share.

By most measures, the balance sheet is solid. CLB reports no long-term debt and Times Interest Earned of 12.1X. The payout ratio is a low 8.2% providing plenty of room for growth from a healthy and expanding free cash flow.

We consider CLB a BUY.

Disclosure: Author is long CLB.

Navigate With Garmin

2010-05-16T09:01:00.001-07:00

The global leader in satellite navigation, Garmin Ltd. and its subsidiaries have designed, manufactured, marketed and sold navigation, communication and information devices and applications since 1989 – most of which are enabled by GPS technology. Garmin’s products serve automotive, mobile, wireless, outdoor recreation, marine, aviation, and OEM applications.

Garmin is a difficult company to evaluate. Analysts generally consider the company a “hold.” Investor sentiment, as recorded by Motley Fools is much more positive.

The negatives appear to be obvious. Garmin participates in a highly competitive market. Some say that Personal Navigation Devices have seen their day in the sun. The press release accompanying 1Q10, extracted below, results talks about the changing market dynamic. To be sure, 1Q10 is not encouraging. The company reports a continued decline in overall revenue though not as dramatic as 2009, continued bad news for the PND segment and mixed results geographically.

On a positive note, sales in Europe and Asia continue to expand and the marine/aviation sectors and fitness sectors show strong growth.

· Total revenue of $431 million, down 1% from $437 million in first quarter 2009

Automotive/Mobile segment revenue decreased 15% to $221 million

Outdoor/Fitness segment revenue increased 28% to $103 million

Marine segment revenue increased 9% to $41 million

Aviation segment revenue increased 12% to $66 million

· Europe and Asia revenues grew, while North America revenues declined:

North America revenue was $243 million compared to $265 million, down 8%

Europe revenue was $145 million compared to $144 million, up 1%

Asia revenue was $43 million compared to $28 million, up 54%

· Gross margin increased both sequentially and year‐over‐year to 54% for first quarter 2010 from 46% in fourth quarter 2009 and 45% in first quarter 2009

· Operating margin increased year‐over‐year to 19%, compared to 13% in first quarter 2009

· Earnings per share decreased 21% to $0.19 from $0.24 in first quarter 2009; pro forma EPS increased 52% to $0.38 from $0.25 in the same quarter in 2009 (Pro forma earnings per share excludes the impact of foreign currency transaction gain or loss)

· Generated $196 million of free cash flow in first quarter 2010

Business Highlights:

· Improved margins allowing us to post pro forma earnings growth in a period of declining revenue.

· Posted strong growth in the outdoor/fitness segment as we continued to expand the product category in this market.

· Recorded year‐over‐year growth in both aviation and marine as these markets have begun to show signs of stabilization.

· Announced the Forerunner® 110 – the newest of our fitness watches which provides essential real‐time workout data at an affordable price for runners, joggers and walkers.

· Launched the GPSMAP 6000 and 7000 series chartplotters featuring Garmin G Motion™ technology with superior map panning and zooming

· Announced our proposed redomestication to Switzerland pending shareholder approval on May 20th.

· Announced our 2010 annual cash dividend in the amount of $1.50 per share representing a one‐time increase from $0.75 per share.

· Repurchased 1.4 million shares of GRMN in the first quarter.

There is no catalyst indicating the potential for a turnaround. Garmin is competing with Google in two of its segments: PND and the new Android-based telephone. Garmin is also showing interest in using its cash to make acquisitions. It just lost a bid to FLIR, to acquire Raymarine, a small, U.K. maker of marine radar systems.

Garmin’s valuation is compelling. The balance sheet is rock solid. The current indicated dividend, $1.50, yields nearly 4.5% and represents a payout ratio of 65%. The five-year growth rate for dividends is about 24.5%.

In spite of the downturn in revenues, the company is very profitable. ROE is a robust 28%. The current PE is about 9.8X. The forward PE is about 11.7X on analyst consensus earnings of $2.88. We are projecting earnings of $3.47 over the coming twelve months which suggests a forward PE 9.66X.

We think Garmin offers much potential on the upside and not an unacceptable risk to the downside. They have many obstacles to overcome. The immediate future for Garmin is not bright and therein lies the opportunity.

Disclosure: Author is long GRMN.

Comtech Telecomm Corp.

2010-04-25T08:49:00.001-07:00

Comtech Telecommunications Corporation “designs, develops, produces and markets innovative products, systems and services for advanced communications solutions. The Company conducts business through three complementary segments: Telecommunications Transmission, Mobile Data Communications, and RF Microwave Amplifiers.”

The telecommunications transmission segment consists of satellite earth station equipment with satellite modems and over-the-horizon microwave systems. In 2Q10, telecom transmissions contributed 34.1% to total revenue.

The mobile data communications segment consists primarily of MTS and BFT real-time and secure systems sold to the U.S. Army. This segment also includes microsatellite systems and related components. Mobile data contributed 49.2% to total revenue in 2Q10.

The last segment, RF microwave amplifiers contributed an additional 16.7% to total revenue.

Overall, 64.7% of total sales was derived from the U.S. government and an additional 29.2% came from international sales. The balance, 6.1%, came from domestic commercial sales.

Recent Developments

Comtech Telecommunications Corp announced on April 5, 2010 that its Santa Clara, California-based subsidiary, Comtech Xicom Technology, Inc. and its Tempe, Arizona-based subsidiary, Comtech EF Data Corp., received satellite communications equipment orders totaling $12.1 million from a major government prime contractor.

The orders are for follow-on procurements of high-power tri-band amplifiers, high-power Ka-band amplifiers and satellite earth station modems for transportable USAF satellite terminals and will be utilized to expand an existing military network. Deployed throughout the world, these terminals offer users the flexibility of accessing both military and commercial satellites.

On March 31, Comtech Telecommunications Corp. announced that Comtech Systems, Inc., its Florida-based subsidiary, received a $35.4 million contract from a domestic prime contractor to provide system design and telecommunications transmission equipment for use in a North African government's communications network.

Comtech Telecommunications Corp. announced today that its Maryland-based subsidiary, Comtech Mobile Datacom Corporation, received an order totaling $1.4 million under its Movement Tracking System, or MTS contract, with the U.S. Army. Total orders received to date against the $605.1 million MTS contract increased to $595.2 million.

The order is Phase II of ongoing efforts to complete migration of all RFID processes to the new international standard ISO/IEC 18000-7. Whereas Phase I migration efforts involved modifications to the transceiver's firmware to enable it to read RFID tags operating under the ISO 18000-7 standard, Phase II encompasses modifications to the MTS platform application program, network, and other interfaces. Upon completion of the migration, the MTS mobile RFID capability will extend to all active RFID tags built to comply with the international standard.

By The Numbers

Sales for the TTM ending 1/10 are down to $555.5 million for FY09 levels of $586.6 million. Y-O-Y, sales are down 7.5%. However, we are beginning to see pick-up. In the quarter ending 1/10, sales were $171.1 million as compared to the year-ago quarter of $143.9 million.

At the segment level, we are seeing changes too. In 2Q10, sales in the telecom transmission segment declined to $58,463 million from $69,523 million in 2Q09. There was a dramatic increase in the mobile data segment. Sales increased from $38,871 million in 2Q09 to $84,186 million in 2Q10. There was a 20% decrease in the RF microwave segment. In 2Q10, sales decreased to $28,483 million from $35,492 in 2Q09.

EPS for the TTM ending 01/10 are down to $1.31 compared to the year-ago level of $2.57. In 2Q10, EPS was $0.51 as compared to $0.46 in 2Q09.

Earnings estimates for FY10 range from a low of $1.88 to a high of $2.28 with a mean of $1.95. The Company provides guidance with a range of $1.85 to $1.95. Estimates for FY11 range from $1.88 to $2.69 and average $2.20.

Gross margins for fiscal years 2005 to 2009 range from 40.7% to 44.2% and average 42.16%. The gross margin for the TTM ending 01/10 is down to 37.4%. We see similar patterns for operating margins and net margins.

The Company has a very strong balance sheet. The Company reports $514 million in cash which also represents approximately 55% of the current market cap. With so much cash on hand, it is no surprise the Company has announced its interest in making acquisitions.

The Company carries about $200 million in long term debt and $310.0 million in total liabilities. The total liabilities to total assets ratio of 32%; long term debt to capitalization ratio of 23.3% and long term debt to equity ratio of 30.3%.

At current EPS levels, valuation seems a little high at 24.8X. If the Company can hit the average EPS estimate of $1.95, then the P/E of 16.7X seems reasonable. Price to Book is 1.3X and Price to Tangible Book is 2.0X.

Conclusion

The Company has good fundamentals and upside of about 27% from current levels. We think the current price is a little ahead of itself. We would wait for a pullback to about $27 before buying.

Disclosure: Author has no financial interest in CMTL.

The Game Is Not Over For GameStop Corp.

2010-04-04T09:53:00.001-07:00

Company Profile

GameStop is the world's largest video game retailer. The company operates 6,450 retail stores throughout the United States, Austria, Australia, Canada, Denmark, Finland, France, Germany, Italy, Ireland, New Zealand, Norway, Portugal, Puerto Rico, Spain, Sweden, Switzerland and the United Kingdom. The company also operates an e-commerce site, GameStop.com, and publishes Game Informer(R) magazine, a leading multi-platform video game publication. GameStop Corp. sells new and used video game software, hardware and accessories for video game systems from Sony, Nintendo, and Microsoft. In addition, the company sells PC entertainment software, related accessories, and other merchandise.

Investment Thesis

The big question is whether GameStop is a value trap. The videogame industry suffered through most of 2009. During the first nine months of 2009, sales dropped 8 percent below 2008 levels. The holiday season saw a major uptick in sales and the industry was able to report Y-O-Y sales 4 percent higher than 2008. Hardware sales were particularly strong with revenue growth of 16 percent. The major beneficiary in this category was Nintendo’s Wii. Significantly, Sony’s Playstation outsold Microsoft’s Xbox 360.

GameStop has provided us with guidance for 2010.

For fiscal 2010, based on current market trends, GameStop expects the following:

Total sales growth between +4.0% and +6.0%
Comparable store sales of 0.0% to +2.0%
Diluted earnings per share ranging from $2.58 to $2.68, an annual increase of +14% to +18%, based on expected outstanding diluted shares of 155,000,000.

During the year, GameStop intends to execute our previously announced capital allocation plan, which includes the following cash deployment:

$75 million in the opening of 400 new stores
$125 million in store improvements, information system support, refurbishment upgrades, distribution expansion and loyalty program enhancements
$100 million reserved for acquisition and investments
$300 million for share repurchases

Based on our current financial projections, the company forecasts it will end fiscal 2010 with $900 million cash on hand.

For the first quarter of fiscal 2010, the company expects comparable store sales to range from -3.0% to 0.0%, driven by reduced hardware price points compared to last year. Diluted earnings per share are expected to range from $0.46 to $0.48, a 7% to 12% increase over the prior year quarter.

Note that guidance does not include debt retirement costs.

The Company also embarked on a $300 million share buyback program. GameStop has already purchased 12,642,200 shares at a cost of $247 million.

By The Numbers

Y-O-Y, sales grew 3.1% from $8,805.9 million to $9,078.0 million. For the quarter ending 1/10, sales reached $3,524.0 million as compared to $3,492.1 million for the quarter ending 1/09. As reported by Thomson Reuters, analysts project FY 11 sales in the range of $9,222.3 million to $9,613.8 million with a mean of $9,431.22 million. Based on our own analysis, Measured Approach estimates FY 11 sales of $10,589.59. Our sales growth estimate reflects a 16.6% growth rate. This compares with a three growth rate of 19.5%, a five year growth rate of 37.6% and a seven year growth rate of 31.3%.

Historically, GameStop’s sales growth rates have outpaced its industry median. The industry median company has grown sales at the rate of 1.2%, 3.7%, 7.5% and 9.4% over the past one year, three year, five year and seven year periods, respectively.

Operating income declined in FY 10 to $631.7 million from $672.8 million in FY 09. Net income also fell. Net income fell from $398.3 million in FY 09 to $377.2 million in FY 10 or 5.3%. The Company reported EPS of $1.29 (MRQ) as compared to $1.39 in the comparable year-ago quarter. This represents a 7.2% decline in quarterly earnings.

Analysts are estimating FY 11 EPS in the range of $2.55 to $2.70 with a consensus estimate of $$2.63. Based on this estimate, the forward-looking PE is approximately 8.5X. Measured Approach’s estimate of FY 11 EPS is consistent with the analysts at $2.69. If Measured Approach is correct, we will see a 17.5% growth in EPS which would be supported by our estimate of sales growth.

With the increase in sales in FY 10, we were pleased to see that inventory to sales decreased to 11.16% from the FY 09 level of 12.22%. This is an indication that the Company is not expanding its inventory beyond what is necessary to maintain product in its stores.

GameStop reported a dramatic increase in cash and short-term investments in FY 10. Cash and short-term investments grew to $905.4 million in FY 10 as compared to $578.1 million in FY 09. As stated above, the Company is using this cash to buy back stock which increases shareholder value. The company is also paying down long-term debt. The long-term debt to capital ratio has declined to 14.1% as reported for the quarter ending 1/10 in comparison to 19.4% as reported in the quarter ending 1/09. These are good uses the excess cash. Long-term debt decreased to $447.3 million from $545.7 million. Overall, the balance sheet is solid.

Valuation

GME is currently trading at about 8X projected earnings, a significant discount to the S&P 500. The current multiple of 10X is below the industry median. GME has historically traded at a premium to its industry median. If we applied the industry median of 13.8X to GME’s TTM’s EPS of $2.29, we get a value of $31.60.

On a price to book basis, again GME is selling at a discount to the industry median. If we apply the industry median PB to the Company’s book value for the MRQ, we get a value of $29.85. Historically, GME has a PB ratio in line with the industry median.

GME has a current price to sales ratio of 0.4X. The current industry median PSR is 0.7X. Applying this metric to GME, we get a value of $38.68.

Conclusion

We need to answer the question asked earlier. Is GameStop a value trap? We do not think so. We think the huge installed base of video games provides a foundation for continued growth for GME. We also think that as long as Nintendo, Microsoft, Sony and the other major players continue to introduce new hardware with more features, the base will continue to expand. Online gaming is a danger going forward that dampers our enthusiasm. Our target price of $31.35 is about 11.65X our FY 11 EPS estimate and about 10.X our estimate of free cash flow.

Disclosure: At the time this article is written, the author has no position in GME.