Sunday, December 26, 2010

2010: Win Some, Lose Some

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.

Sunday, December 19, 2010

A Small Cap Healthcare Pick

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.

Sunday, December 5, 2010

Company Focus: SanDisk Corporation

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.

Sunday, November 21, 2010

The Long Term Case for Humana

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.

Sunday, November 14, 2010

NeuStar Inc.: A Telecom Monopoly

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 30th.
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
Gross Income
Net Income
EPS Diluted

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.
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