Sunday, August 30, 2009

Spotlight On: Restaurants

Spotlight On: Restaurants

The restaurant industry is experiencing significant damage from the contraction of the economy as consumers continue to cut back on discretionary spending. At the beginning of 2009, the food service industry consulting firm Technomic forecast industry nominal growth of -2.2 percent. That estimate is probably too conservative. In June, the National Restaurant Association confirmed that challenges persisted for this industry and that same store sales and traffic continued to soften. We can expect to see an increase in bankruptcy filings as over-leveraged chains begin to violate loan covenants.

The restaurant industry is composed of several segments: quick service restaurants (QSR) and the casual ding segment. Some would say the QSR segment is better positioned to weather the storm because of consumer perceptions of vale, lower priced menu items and the poaching of customers from full-service restaurants. In this segment, Burger King (BKC), McDonald's (MCD), and YUM Brands (YUM) appear to be the healthiest with significant liquidity and do not have near term maturities.

Our outlook for the casual dining segment is negative as costs continue to escalate and consumers are either trading down to the QSR segment or just staying home. Several companies have engaged in large debt-financed acquisitions or share repurchases and are now feeling the pinch. Examples include Darden Restaurants (DRI) and Brinker International (EAT). These companies may experience credit downgrades as they struggle with their debt. 

Market capitalizations of most major restaurant operators have declined drastically on the past 12-18 months. However, because of lack of access to low cost debt and free cash flow pressure, we do not expect much in the way of share repurchases or restaurant acquisitions. An increase in the number of bankruptcy-related closures will reduce industry capacity. Buffet's, Vicorp, and Metromedia Restaurant Group all filed for bankruptcy this year and are closing hundreds of restaurants.

In this challenging environment, we find one company, Rick's Cabaret International (RICK) as an interesting prospect. Rick's is an operator of "adult" nightclubs and bars. From Reuter's:

"Rick's Cabaret International, Inc. incorporated in 1994, owns and/or operates a total of 19 adult nightclubs that offers live adult entertainment, restaurant and bar operations. Nine of its clubs operate under the name Rick's Cabaret; four operate under the name Club Onyx, upscale venues that welcome all customers but cater especially to urban professionals, businessmen and professional athletes; four operate under the name XTC Cabaret; one club that operates as Encounters; and one club that operates as Tootsie’s. The Company’s nightclubs are in Houston, Austin, San Antonio, Dallas and Fort Worth, Texas; Charlotte, North Carolina; Minneapolis, Minnesota; New York, New York; Miami Gardens, Florida; Philadelphia, Pennsylvania and Las Vegas, Nevada. The Company owns and operates adult entertainment Internet Websites. The Company’s online entertainment sites include, and In April 2008, the Company acquired a media division, including the trade magazine serving the multi-billion dollar adult nightclubs industry. As part of the transaction the Company also acquired two industry trade shows, two other industry trade publications and more than 25 industry Websites."
What makes Rick's a standout in this industry? For one thing, it is profitable. Sex sells. Rick's has a current P/E of 12.4 vs a three year average of 23.5x. Other valuation ratios are similarly depressed. Price to Book is now 0.96 vs 2.54 and Price to Sales is 0.98 vs a three year average of 2.15. The company's gross margin is a strong 65.9 percent for the training twelve months (TTM) vs 65.3 for FY2008. TTM operating margins are down to -2.0 as compared to 22.9 percent in 2008 but net margins are about 7.6 percent.

Debt is not an overwhelming problem for Rick's. Total liabilities to total assets are 45 percent; long term debt to capital is 30.2 percent and long term debt to equity is 43.4 percent. sales growth is strong at 45 percent y-o-y and continuing strength in gross profit which grew 19.8 percent y-o-y. There is weakness in net income which declined .8.5 percent y-o-y.

At current prices, RICK is trading at 12.22X FY09 consensus of $0.64, 8.19X FY10 consensus of $0.955 and 5.47X FY11 consensus of $1.43. The June 2009 quarter actual of $0.20 beat the Street consensus of $0.19 and the March 09 actuals of $0.16 beat the consensus of $0.11.

Disclaimer: Author holds no position in any company mentioned in this article.

Sunday, August 23, 2009

Spotlight On: Retail-Apparel

Spotlight On: Retail-Apparel

The U.S. retail clothing industry includes approximately 11,000 stores nationwide and accumulates a combined $150 billion in revenues each year. The retail clothing industry is very concentrated and the 50 largest companies bring in 65% of the total industry revenue. Most companies in the retail clothing industry are specialized and have found a niche market of customers to appeal to such as women's wear, sporting apparel, maternity, men's clothing, or children's clothing. The size of retail clothing companies range from small independently owned boutique shops to large department stores.

Trends in the retail clothing industry have changed dramatically over the past couple of years, especially in response to the recent economic turmoil. A few of the most significant for 2009 and upcoming years are:

  1. Reduction in Advertising Spending
  2. Increase in Coupons and Sales
  3. Fewer Premium-Priced Products Introduced

There are approximately 48 publicly traded clothing retailers in the U.S. As of 08/21/2009, the retail -  apparel industry's public companies have a median P/E ratio of 18.1, a median price to free cash flow ratio of 14.2 and a median price to sales ratio of 0.5. We screen our database for companies with a minimum market capitalization of $1 billion and some evidence of balance sheet strength. Our screen produces a list of 16 companies. Sales values for these 16 companies range from $999.1 million to $19,243.13 billion dollars.

The top five publicly traded retail clothing companies ranked by sales are:

  1. TJX Companies Inc. (TJX)
  2. The Gap, Inc. (GPS)
  3. Ross Stores (ROST)
  4. Foot Locker (FL)
  5. Coach (COH)

Reuters published an article on August 21, 2009 by Alexandria Sage in which Sage speaks directly to this topic. Relative to the companies mentioned above, she states that last week Gap posted "grim second-quarter sales." She goes on to say, "2009 has been a year of cost-cutting, as retailers have lowered inventory, curtailed capital spending and streamlined their operations in order to offset the lingering sales slump caused by shoppers' aversion to spending in the downturn."

In this environment, it is difficult to get too excited about retail apparel companies. Of the five companies listed above, we are most optimistic about Foot Locker and find the company attractive on a price to sales basis. From Reuters,

"Foot Locker, Inc., incorporated in 1989, is a global retailer of athletic footwear and apparel, which operated 3,641 primarily mall-based stores in the United States, Canada, Europe, Australia and New Zealand as of January 31, 2009. The Company, through its subsidiaries, operates in two segments: Athletic Stores and Direct-to-Customers. The Athletic Stores segment is an athletic footwear and apparel retailer, whose formats include Foot Locker, Lady Foot Locker, Kids Foot Locker, Champs Sports and Footaction. The Direct-to-Customers segment reflects, Inc., which sells, through its affiliates, including Eastbay, Inc., to customers through catalogs and Internet Websites. The Foot Locker brand is the Company’s principal brand. On November 5, 2008, the Company acquired CCS from dELiA*s, Inc. CCS is a direct-to-customer retailer that sells skateboard equipment, apparel, footwear and accessories through catalogs and the Internet."  
Foot Locker has a current PSR of about 0.33 which is low for the industry and low for Foot Locker. Though sales growth is negative and the company is losing money, free cash flow remains strong, debt is at low levels, and the company has $415 million in cash. We believe the company has the wherewithal to weather the current turbulence and return to a more normalized target price of $17.00.

Disclosure: No positions.

Sunday, August 16, 2009

Spotlight On: Software and Programming

Spotlight On: Software and Programming

The software industry is ever changing and subject to new mergers, acquisitions, partnerships and strategic alliances between vendors. The industry can be fairly described as consisting of tiers. 

Tier I vendors serve the upper end of the market. Their products are for the Fortune 500, multi-location, and multi-national companies. These companies have complex needs and rely upon ERP systems. The major Tier I players are SAP and Oracle. Tier II vendors focus on companies that are fairly complex and large and require significant work but are not as large as the the Fortune 500. This may be the sweet spot of the software industry. The market is fairly large and the customers require fairly sophisticated product and support. Leaders in this market are Lawson, Infor, and IFS.

The mid-market is represented by Tier III companies such as Epicor, Consona, and Tyler. This is a huge market serving customers with revenues in the $25-$250 million range. The lower tiers, IV and V, serve small companies and the shrink wrap market. Vendors in this market, such as Sage, serve the small company. The SOHO market is includes vendors such as Sage and Intuit.

The Tier I vendors are moving down market by offering scaled-down pre-configured versions of their products and using new distribution channels. They are also acquiring Tier II and Tier III vendors. On the other hand, Tier III and Tier IV vendors are trying to move upstream into the Tier II market. The vendors have significantly improved the functionality and scalability of their products.

The newest trend in software distribution is Software as a Service (SaaS) and cloud computing. This model is gaining market acceptance and is particularly appealing to the smaller customer that have limited in-house technical support. SaaS applications for certain types of applications such as Customer Relationship Management (CRM), HR/Payroll, Project Management, and low end accounting software have been growing. ERP systems for large and mid sized companies have not seen widespread acceptance yet due to cost and security concerns.

The software industry is not immune to the economic downturn. Technology spending has been cut and the market may not see any significant increase in spending for some years to come. Forrester Research is projecting that overall business IT sales will grow 6 percent in 2009.

While most software companies are implementing a series of internal cost-cutting measures -  reducing staff, cutting travel budgets, etc., these measures have an uneven effect on the software company. For some companies, reducing the cost of doing business enables the company to stay in the game. For others, it increases margins and makes this company a more attractive investment.

We screened our database for software companies with a market capitalization of $1 billion or more and for some measures of balance sheet strength. We were looking for companies with the wherewithal for surviving this down turn and came up with more than 40 names. We think the following companies are fairly priced today: Adobe Systems (ADBE), Check Point Software Technology (CHKP), Microsoft (MSFT), Novell (NOVL), Oracle (ORCL), Quest Software (QSFT) and Sybase (SY). We consider the following companies significantly over valued today: Cognizant Technology Solutions (CTSH), Concur Technologies (CNQR), Longtop Financial Technologies (LFT), McAfee (MFE), Quality Systems (QSII), Red Hat (RHT) and (CRM).

We find Synopsis, Inc. (SNPS) very attractive at the current market price. "Synopsys, Inc. (Synopsys), incorporated in 1986, is engaged in the electronic design automation (EDA) software and related services for semiconductor design companies. The Company provides semiconductor design and verification software platforms and integrated circuit (IC) manufacturing software products to the global electronics market, enabling the development and production of systems-on-chips (SoCs). In addition, the Company provides intellectual property (IP), system-level design hardware and software products, and design services for the design process and accelerate time-to-market for the customers. Synopsys provide software and services that help customers prepare and optimize their designs for manufacturing. The products and services are divided into five common groupings: Galaxy Design Platform and Discovery Verification Platform (which are sold and reported together as Core EDA), Intellectual Property (IP) and System-Level Solutions, Manufacturing Solutions, and Professional Services. In May 2009, MIPS Technologies, Inc. announced the divestiture of its Analog Business Group to Synopsys, Inc."

The company has no long term debt and margins better than its own five year averages. sales are up about 9 percent y-o-y and for the most recent quarter as compared to the prior year. EPS for the trailing 12 months are up 38 percent y-o-y and are up for the MRQ 22 percent as compared to the prior year. The company surprises the analysts each quarter with better than expected sales and earnings.

Based on our analysis, we place a target value of $30.32 on the shares of SNPS.

Disclosure: Author is long CHKP.

Saturday, August 8, 2009

Spotlight On: Biotech

Spotlight On: Biotech

The U.S. biotechnology industry includes about 1,000 companies, of all sizes, with combined annual revenues close to $50 billion. Large companies include Amgen, Biogen Idec, Genetech, Genzyme, Life Technologies and Monsanto. Because so many drugs are now developed using biotechnology, the biotech and pharmaceutical industries overlap.

Demand for biotechnology products and services is driven primarily by the willingness of insurers to pay for new medical treatments. With the pending introduction of Obamacare, new uncertainties are introduced to this industry. Biotech products and treatments tend to be expensive and the drive to reduce costs through rationing will no doubt effect this industry. The profitability of individual companies depends on the discovery and effective marketing of new products. Because the market for potential products is so large, small biotech companies can co-exist successfully with large ones if they have expertise in a particular line of research.

The most successful uses of biotechnology so far have been in the production of therapeutic drugs (biologics); genetically modified plants and medical diagnostic tools such as DNA testing.

Biotechnology is a high risk venture. Failure may result from poor results during clinical trials, issues involving patents, competition from other companies and government regulation. Biotech companies burn cash until their product comes to market and even then if there is not widespread acceptance of the product. Investing in biotech companies is more often an act of speculation than one of investment.

We screened our database for biotech companies with market capitalizations of $1.0 billion or more and some degree of balance sheet strength. Of the companies mentioned below, we especially like Biogen Idec. We recommend that you perform your own due diligence of the following companies which we find promising:

Biogen Idec (BIIB): "Biogen Idec Inc. is engaged in the development, manufacturing, and commercialization of therapies. The Company’s products address diseases such as multiple sclerosis, non-Hodgkin’s lymphoma (NHL), rheumatoid arthritis (RA), crohn’s disease (CD) and psoriasis. The Company has four products: AVONEX (interferon beta-1a), RITUXAN (rituximab), TYSABRI (natalizumab) and FUMADERM (dimethylfumarate and monoethylfumarate salts). AVONEX is used in the treatment of relapsing forms of multiple sclerosis (MS). RITUXAN is one of the selling oncology therapeutics. In the United States, RITUXAN is approved for NHL. TYSABRI is approved for the treatment of relapsing forms of MS. FUMADERM acts as an immunomudulator. The Company also has product candidates, such as BG-12, which is a oral fumarate; ANTI-CD80 monoclonal antibody (MAb)(galiximab); ANTI-CD23 MAb (lumiliximab); Humanized Anti-CD20 MAb (ocrelizumab), Lixivaptan, an oral compound for the potential treatment of hyponatremia, and ADENTRI, which is an adenosine A1 receptor antagonist, being developed under a licensing agreement with CV Therapeutics, Inc."

Covance (CVD): "Covance Inc. is a drug development services company providing a range of early-stage and late-stage product development services on a worldwide basis primarily to the pharmaceutical, biotechnology and medical device industries. The Company also provides laboratory testing services to the chemical, agrochemical and food industries. Covance maintains offices in more than 20 countries. The services it provides constitute two segments: early development services, which include preclinical services and clinical pharmacology services, and late-stage development services, which include central laboratory, clinical development, periapproval and market access services. Covance Inc. provides product development services on a global basis to, among others, the pharmaceutical and biotechnology industries. During the year ended December 31, 2008, the Company served in excess of 300 biopharmaceutical companies. In March 2009, the Company acquired Swiss Pharma Contract, a 50-bed clinical research company based in Basel, Switzerland."

Forest Laboratories (FRX): "Forest Laboratories, Inc. and its subsidiaries develop, manufacture and sell both branded and generic forms of ethical drug products, which require a physician’s prescription. The Company’s products in the United States consist of branded ethical drug specialties marketed directly or detailed to physicians by its Forest Pharmaceuticals, Forest Therapeutics, Forest Healthcare, Forest Ethicare and Forest Specialty Sales. Its products include Lexapro, the Company’s selective serotonium reuptake inhibitor (SSRI) for the treatment of major depression and generalized anxiety disorder (GAD); Namenda, its N-methyl-D-aspartate (NMDA) antagonist for the treatment of moderate and severe Alzheimer’s disease; Bystolic, its beta-blocker for the treatment of hypertension, and Savella, a dual reuptake inhibitor for the treatment of fibromyalgia."

Genzyme (GENZ): "Genzyme Corporation (Genzyme) is a biotechnology company. The Company’s product and service portfolio is focused on rare disorders, renal diseases, orthopaedics, cancer, transplant and immune disease, and diagnostic and predictive testing. Genzyme operates in four segments: Genetic Diseases, Cardiometabolic and Renal, Biosurgery and Hematologic Oncology. Genetic Diseases unit develops, manufactures and distributes therapeutic products, with a focus on products to treat patients suffering from genetic diseases and other chronic debilitating diseases, including a family of diseases known as lysosomal storage disorders (LSDs). Cardiometabolic and Renal segment develops, manufactures and distributes products that treat patients suffering from renal diseases, including chronic renal failure and endocrine and cardiovascular diseases. Biosurgery develops, manufactures and distributes biotherapeutics and biomaterial-based products, with a focus on products that meet medical needs in the orthopaedics and broader surgical areas. Hematologic Oncology develops, manufactures and distributes products for the treatment of cancer."

Myriad Genetics (MYGN): "Myriad Genetics, Inc. is a healthcare company focused on the development and marketing of molecular diagnostic products. The Company has seven marketed products: BRACAnalysis (breast and ovarian cancer predisposition), COLARIS (colorectal and uterine cancer predisposition), COLARIS AP (colon polyp forming syndrome predisposition), MELARIS (melanoma predisposition), TheraGuide 5-FU (chemotherapy selection), PREZEON (chemotherapy selection) and OnDose (chemotherapy dosing). In July 2009, the Company announced the completion of the spin off of Myriad Pharmaceuticals, Inc., which comprised research and drug development businesses."

Novo Nordisk A/S (NVO): "Novo Nordisk A/S, incorporated on November 28, 1931, is a Denmark-based healthcare company. The Company provides diabetes care and is engaged in haemostasis management, growth hormone therapy and hormone replacement therapy. The Company manufactures and markets pharmaceutical products and services to patients, the medical profession and society. The Company is organized in two segments: diabetes care and biopharmaceuticals. Diabetes care includes discovery, development, manufacturing and marketing of products within the areas of insulin, glucagon-like peptide (GLP)-1 and related delivery systems, as well as oral antidiabetic products (OAD). Biopharmaceuticals includes discovery, development, manufacturing and marketing of products within the therapy areas haemostasis management, growth hormone therapy, hormone replacement therapy, inflammation therapy and other therapy areas."

Pharmaceutical Product Development (PPDI: "Pharmaceutical Product Development, Inc. is a global contract research organization engaged in providing drug discovery and development services, post-approval expertise and compound partnering programs. The Company’s customers and partners include pharmaceutical, biotechnology, medical device, academic and government organizations. It operates in two segments: Discovery Sciences and Development. The Discovery Sciences Group focuses on the discovery research segment of the biopharmaceutical research and development outsourcing market. The Development Group provides a range of development services, either individually or as an integrated package. In April 2009, the Company acquired Magen BioSciences, Inc. In April 2009, the Company completed the acquisition of AbC.R.O., Inc. (AbCRO)."

Techne Corporation (TECH): "echne Corporation, incorporated on July 17, 1981, along with its subsidiaries, is engaged in the development and manufacture of biotechnology products and hematology calibrators and controls. These activities are conducted through its wholly owned subsidiary, Research and Diagnostic Systems, Inc (R&D Systems). It distributes biotechnology products in Europe through its wholly owned subsidiary, R&D Systems Europe Ltd. (R&D Europe). R&D Systems Europe Ltd. has a sales subsidiary, R&D Systems GmbH, in Germany. Techne Corporation operates in three segments: biotechnology, R&D Systems Europe and hematology. The biotechnology segment consists of R&D Systems Biotechnology Division, Fortron Bio Science, Inc. (Fortron), BiosPacific, Inc. and R&D Systems China Co. Ltd. (R&D China), which develop, manufacture and sell biotechnology research and diagnostic products worldwide. R&D Systems Europe distributes Biotechnology Division products throughout Europe. The hematology segment develops and manufactures hematology controls and calibrators for sale worldwide. During the fiscal year ended June 30, 2007, the Company established a subsidiary, R&D Systems China Co. Ltd. (R&D China), in Shanghai, China, to distribute biotechnology products throughout China."

Teva Pharmaceutical Industries Limited (Teva), incorporated on February 13, 1944, is a global pharmaceutical company that develops, produces and markets generic drugs covering all treatment categories. The Company has a pharmaceutical business, whose principal products are Copaxone for multiple sclerosis and Azilect for Parkinson’s disease and respiratory products. Teva’s active pharmaceutical ingredient (API) business provides vertical integration to Teva’s own pharmaceutical production and sells to third party manufacturers. The Company’s global operations are conducted in North America, Europe, Latin America, Asia and Israel. Teva has operations in more than 60 countries, as well as 38 finished dosage pharmaceutical manufacturing sites in 17 countries, 20 generic research and development (R&D) centers operating mostly within certain manufacturing sites and 20 API manufacturing sites around the world. During the year ended December 31, 2008, Teva generated approximately 60% of its sales in North America, 25% in Europe and 15% in other regions (primarily Latin America, including Mexico, Israel and Central and Eastern Europe). In July 2008, Teva completed the acquisition of Bentley Pharmaceuticals, Inc. In December 2008, the Company completed the acquisition of Barr Pharmaceuticals, Inc. (Barr) In January 2009, Phibro Animal Health Corporation completed the acquisition of the Abic Animal Health business (Abic) from the Company."

Warner Chilcott (WCRX): "Warner Chilcott Limited is a Bermuda-based specialty pharmaceutical company focused on the women’s healthcare and dermatology segments of the United States pharmaceutical market. It is an integrated company with internal resources dedicated to the development, manufacturing and promotion of its products. Its operations are carried through its wholly-owned subsidiaries in the United States, Puerto Rico, the Republic of Ireland and Northern Ireland. The Companies franchises are comprised of complementary portfolios of established branded and development-stage products."

Disclaimer: Author is long FRX.

Saturday, August 1, 2009

Spotlight On: Advertising

Spotlight On: Advertising

In today's market, the advertising industry is adapting to new business models and broadening their offerings. Traditional advertising agencies are accustomed to mass media advertising. Digital advertising represents a new paradigm as advertising is customized for each consumer. Though mass advertising will not disappear, the trend will be to consumer-centric advertising.

We see the emergence of new advertising models driven by the growth in online advertising revenues. Online advertising involves many different formats including, but not limited to, search, games, online directories and other permission-based models.

The biggest question for today is what effect the global financial crisis will have on advertising expenditures. We have already seen advertising budget cuts for 2008 and 2009. 

There are not many players in this sector; we reckon about twenty or so if you eliminate over-the-counter stocks. Of these twenty, only several have market caps of $1.0 billion or more. Even fewer companies have solid balance sheets; they appear to be highly leveraged.

We would focus our efforts on Daktronics (DAKT). Daktronics has a market cap of about $340 million. The company reported earnings of $0.01 for the quarter ending 05/02/09 and $0.65 for the year. Daktronics reports $36.5 million in cash and $10.5 million in long term debt. We think Daktronics is a buy up to $12.82.

Disclosure:  No position

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