Monday, July 28, 2008

earnings updates

Lots of interesting earnings news --- several have reported so far and here are the highlights:

ILMN -- great numbers -- demand is very strong as they beat revenues by 8% and raised forward revenue estimates by about 6%. Cowen had worried that the quarter may not be as strong as usual so the stock sold off pre-report to the low to mid $80's. The stock has soared since to the $93 range. I sold some Sep 100 calls when the stock was $92 so I'm down a bit on the trade so far but remember the delta is low so I'm making more on the stock's rise than I am losing on the option's rise.

FLIR -- Prior to the report Axsys Tech reported blow out numbers. They are a smaller competitor so I think that got a few folks excited. FLIR's report was strong but the guidance wasn't as high as people were hoping for -- stock dropped double digits of course that only takes it back to where it was a few months ago. Business trends remain very strong -- I bought some more at $38. I will buy more if it drops.

CME -- interesting comments about the slowing volumes -- they claim its caused by certain trades not being profitable right now for various reasons that they believe are temporary. As the reasons lift, that should cause volumes to rebound. They are also working on introducing new products especially within fixed income. The NYMEX deal should close now that various issues have been renegotiated. I don't think energy is done with in terms of futures volumes.

AB -- when value is out of style it appears their value funds relative performance stinks. when growth is in style it appears their growth funds relative performance is great. consistency in that sense is cool -- clients know that Bernstein is going to provide style consistent results. Obviously having more exposure to value funds now than during the last downturn say 6 years ago is hurting results but they grew alternative assets under management; private client -- higher margin, more stickier business is a bigger % of revenues and profits now. if the market drops from here than AB will drop with it. that said there is nothing structurally wrong with AB.

LH -- a good and bad story that right now is hurting the stock. The good news is that the DNA testing and personalized medicine story is playing out -- continues to play out. That means good growth in testing volumes for the higher priced tests. They talked about testing for vitamin D deficiency as an important driver for volume growth. There is also the new ovarian cancer screen test.

The bad news is that there is less insurance coverage now than a few years ago. That means less of other people's money to spend and more money has to come from the patient.

Everyone looks at demographics and points to health care's secular trend. Yes its true that the older ages are the fastest growing age groups. Its also true that you can't pay for your medical bills using demographics -- they take cash. The main trend from the early 90's to about 2001 was increased insurance coverage -- not just enrollment growth but dollars available to pay doctor bills. Today its the opposite as enrollment is declining (see managed care stock prices) and copays and deductibles are rising -- I believe the peak was when the employee share of health care cost reached about 20% vs. the historical average closer to 33%.

My hope is that the good news outweighs the bad news over time but certainly this quarter it didn't. Quest Diagnostics, the main competitor, had better results but that was probably better in terms of expectations -- their absolute growth rates were similar.

CLB -- amazingly consistent -- they beat and raised slightly but the key is that incremental operating margins were 47% -- still well above this quarter's 27% (around there anyway). strong free cash flow, rising margins, mid teens revenue growth and its all available for a high teens PE ratio. That's not bad given the quality of the business. People are nervous about all things energy related. I am confident about CLB but regular energy is likely done for awhile -- commodity not rising anymore means its harder for E&P to grow earnings unless they are growing production.

so to me the answer is likely an oil services company like CLB, nat gas plays because the price of nat gas is so cheap on a btu basis; and a bet on electricity demand such as mxwl or WGOV, AZZ, EMR, or etc.

POWI -- so far that trade is looking horrible -- sell BLUD before a $4 increase in price and buy POWI before a $5 decline in price. Power integrations reported last week and they lowered guidance due to less visibility of orders this quarter. continue to think this is temporary and that longer term the number of apps using their tech is growing.

getting late -- time to call it a night. so far earnings season is OK for me but some big dogs are reporting in August. I am becoming more convinced that in the current environment you need to have the falling prices rising volume aspect like FLIR has and like AXYS might have; MXWL might have too. that's the strongest secular growth and probably the one whose investors underestimate.

Monday, July 21, 2008

Electricity and market thoughts

Well the near term bottom occurred last tues/wed when the S&P was around 1200 -- and we rallied 60 points over the next couple of days. Lots of signs that the bottom was near -- too much depression talk on; one of two things had to change -- either financials had to rally or the rest of the stocks had to drop because there is no way the rest of the market can make their numbers if last week's prices are correct for financials -- there isn't enough of a financial services industry at those prices to finance our economy anywhere near what current non-financial prices suggest.

Internally, my chief of compliance reminded everyone they were not allowed to speculate in the company stock and that included shorting it -- they had received several inquiries about it.

Now what? Well no way the financials have bottomed -- we are going to head back down although I doubt every financial will hit new lows -- some won't. But many will for one simple truth -- housing prices are still declining which is pushing more and more homeowners to be underwater in their homes, which encourages them to walk away or default.

More defaults means more bank loan losses, means more capital required means lower stock prices. The key question remains what does this mean for non-financials? tough to answer that question. If we are headed back to the lows of last week then my guess is that the economy is going to get uglier -- worry is a true credit crunch where deserving businesses and consumers are denied credit, which impacts their ability to grow or spend which has a cascading effect on the economy. that's the worry. in the meantime its back to secular growth stories -- the biggest one of all that I have found is the growth in electricity.

We continue to see growth of electricity demand for electronics as well as from one of the largest users of electricity -- oil and gas industry!

Efficiency does not reduce demand it merely transforms it. So even though people tout LEDs to save on lighting costs or in my own case my new 13 SEER ac unit which has helped my electric bill -- the savings get spent elsewhere.

Even bigger than the use of electricity for electronics will be the use of electricity for transportation -- think hybrid cars. Plus think about the growth in electricity demands from overseas as emerging markets continue to develop at a rapid pace. So electrical infrastructure would seem to be a safe bet given that in the US is operating close to capacity; the grid/transmission net is old; and emerging markets are building new infrastructure like crazy. I think of companies like Emerson Electric, ABB, Siemens, AZZ, Cooper Industries, Eaton, etc. when I think of infrastructure.

Then there are demand management or efficiency plays such as Comverge and Eneroc or Echelon or Itron or others that are making smart grid appliances like automated meters.

I have looked at many of these plays and I'm sure that there are plenty of winners but for me the most interesting idea outside of Power Integrations is Maxwell Technologies (MXWL) which makes ultracapacitors -- they are complementary to batteries. While batteries are able to store lots of energy they can only discharge a little bit power at a time and it takes them forever to recharge and there are only so many times a battery can charge before it stops working.

Ultracapacitors store only about 10% of the power that a battery can store but it can release all of that power within a second or two. They can also be recharged quickly and can cycle through charging and discharging a million times before they are finished. They claim the ultracapacitors will last the life of the product they are loaded into.

So what can you do with one? they are used in wind turbines for temp storage of power as well as for use in realigning the blades to get maximum coverage from the wind. They can be used in combo with batteries to reduce the number of times the batteries are used which extends battery life. They can be loaded on to a bus so that the energy from braking the bus can be temp stored in the capacitor and then used to restart the bus or reaccelerate the bus -- that saves energy from batteries or fuel. There are lots of potential applications all of which are about improving efficiency and deploying electrical power in more places than today.

Maxwell is the main developer of ultracapacitors and has been trying to get them used in various applications to date. They have lowered the cost of a farad (capacitance measure) from $2700 in 1996 to $30 today. That reminds me of FLIR -- say 10 or more years ago. They are trying to lower costs so that more applications will find ultracapacitors to be economical. As costs drop volumes soar and margins improve -- last few quarters Maxwell has reported incremental gross margins near 100%. Most analysts that are following the stock have been there for awhile and have been disappointed in how long this process has taken -- they are waiting for the volume inflection point and it keeps getting pushed out.

There are two ways of playing this -- buy it for the long term knowing that over time the economics are only going to get better in terms of capacitance use or wait until profitability and a demand inflection occurs and while you will give up some on the stock you could save a fortune if demand keeps getting pushed out. Batteries are the main form of competition -- flywheels too.

the company has announced they have won a deal to be included in a 100-200k annual volume car for use as a temp store of power to help manage overload situations -- i.e. when every electrical part of the car is operating at once. they have $100 per car so about $10 mill in new revenues starting in 2010. The ultimate potential is enormous -- they could easily reach a billion in revenues in 10 years or so. My hope is that if this is truly successful would be for the company to be worth $10 bill up from $270 mill now. That will take 10 years or so.

still speculative so I won't buy much but at least some. I sold my MCO last friday at $34.85 so I was basically flat on the stock over the last several months including the options.

Sunday, July 13, 2008

when will it end?

No idea --despite the straight down nature of the decline there has been little panic. Too many have waited for a rally to sell only to regret and sell at a lower price. It reminds me of late 2000 or 2001. On the other hand the volume on friday was enormous -- freddie mac traded over half of its shares outstanding! In one day almost 400 mill shares traded in that stock -- granted I think they are insolvent and a bail out is coming but anyone that wanted out could have easily gotten out on Friday.

Freddie wasn't the only one either -- MCO traded about 4 times their average volume. The stock broke to new lows so the trading range doesn't appear to be holding. If I had any discipline to my investing I would have bought the puts and sold the stock on friday but I didn't based on the idea that Friday was a washout and that this week will bring a respite.

PHX -- can you believe that stock? I didn't buy any yet because I was still trying to figure out what to sell to buy it but man did it take off -- going from near $31 to almost $37 in a week when the markets were crushed! ugh!!!! no news other than the idea they are shifting to the NYSE, which granted should help their exposure. still going to try to figure out getting into that one.

FLIR keeps pumping out new wins yet the stock paused -- I know the estimates are going up the question is how much. lot of expectations there. Its finally getting to a size that matters a little more to me -- I would still love to have that stock be a bigger position in the portfolio but I continue to struggle to find the right sale candidate or the right time -- when I think about selling one I look at FLIR and the stock is up big -- looking for that time when my candidate is up big and FLIR is pulling back some. Perhaps this week -- I'm pretty sure my candidate is reporting -- its GOOG -- I think the world of GOOG but I could also see trimming it some to pay for more FLIR. I think FLIR has more opportunity given its smaller size.

Looking at LH I learned a couple of reasons why the stock is flagging -- economy hurting volume growth -- not surprising that its an issue but they have some offsets like the growth in esoteric testing. The other issue is they have tied themselves to managed care through contracts and yet managed care appears to be struggling -- their stocks certainly are struggling -- wow. UNH though is also seeing membership declines so that hurts Lab Corp's prospects given that UNH is almost 10% of revenues. I continue to see the promise of dna or molecular testing helping LH's growth.

I did finally do the trade between BLUD and POWI. I did it because I think POWI is a better fit with my secular strategy -- the growth in electricity and the need for energy efficiency. Its true that BLUD is benefiting from market share gains but the market itself isn't growing. in POWI's case the market is growing and they have the potential to gain share too. market growth occurs both in terms of unit growth, new applications and market share gains. That plus the business model allows for margin expansion whereas BLUD has peaked. Also the valuations were very different -- POWI is much cheaper.

TSRA -- no resolution yet to their cases although on Monday the ITC case gets started. the Amkor arbitration should get wrapped up soon in terms of a decision. There is talk that the case cared about whether the patents were good or not -- this is a contract dispute so the patents should be considered a given.

The risk to TSRA -- Amkor bought a company that had bought a license from TSRA but as far as Amkor was concerned they didn't use TSRA's technology and therefore they stopped paying. TSRA argues they are owed not only on the one subsidiary that was a licensee but on the rest of the company's volume too. So I can see Amkor arguing that since they themselves didn't sign the license, that they didn't agree to TSRA's patents and therefore the patent questions are eligible for discussion. Don't know if the judges will let them get away with that or not. Reality is the patents are in force regardless of what Amkor thinks. Then its a matter of proving that Amkor packages chips using CSP technologies. If they do, then they owe. Some argue that TSRA is a house of cards just waiting to fall -- I don't see it that way -- I think they have a great franchise. in the next few months we should figure out who is right -- stock will either be $10 or $40 in my mind.

UEPS -- still getting the delay from south africa -- hopefully they will get an answer sometime soon. I still fervently believe in this story.

The trouble for me with TSRA and UEPS is that in my past whenever I have thought something was so attractive I have realized later that there were problems with the story I either ignored or didn't know about. Whenever I have averaged down over time -- as in over years to buy more of a story whose stock just doesn't seem to keep up with the fundamentals I have usually never done really well. My best ideas have usually been stocks that I have had to average up in -- ILMN, FLIR, LH, etc.

That's my caveat to TSRA and UEPS -- and potentially CME and others.

AB -- their assets under management fell 7% in the month of June -- that's a bigger hit than I expected but its still roughly in line with the market meaning their cash flows aren't hurting them too bad. This stock follows the market -- when its up the stock is up and when its down the stock is down. I reinvest dividends to have this longer term volatility working for me. I bought shares at $90+ near the peak and I will buy shares near $40-50 this time. For me the dividend purchases are considered free shares -- I don't consider this putting more money into the stock because the money is coming from the company in the first place. Economically speaking that's wrong -- I could easily reinvest the dividend into another company. Still I believe this is one of my best opportunities -- I think AB is well managed and that over time they have been a winner in the market. Getting hurt now but that just means buying more shares that will be worth a lot more later. During the tech bubble burst I bought shares in the $30s only to see the stock hit $90 a few years later. I think the same thing will happen this time -- I believe the stock will bottom higher than last cycle and the next peak will be meaningfully higher than $94. If I had to guess, I am thinking the next cyclical peak will be near $150.

good luck this week

Monday, July 7, 2008

bottom or heading for new lows?

that's the big question now that the S&P 500 is near the march lows again. are we stopping here or are we heading much lower? My thought is I have no idea. What I do know is to focus on individual stocks that are attractive based on their secular growth prospects, competitive barriers to entry, good or improving profitability and reasonable valuation.

Heard about an interesting nat gas company to compliment Contango. Its symbol is PHX --Panhandle. They have 18 employees and they own the mineral rights in thousands of acres in Oklahoma, Texas and Arkansas. They are moving from just taking the mineral right royalty to having a working interest in the wells drilled on their property. Its more risk but if they choose wisely they can make a lot more . Just like Contango these guys outsource everything to actual operators.

There are a few issues to consider with PHX -- natgas prices are very cheap relative to oil (6 to 1 btu ratio between oil to gas). If nat gas prices reach $20, this stock is very cheap but so are most other nat gas companies. The next key is how much reserves they are going to add in the next couple of years. reserves have been growing at 20% or so a year -- there are billions of mcf in probable reserves plus plenty in possible reserves. Management talks about thousands of potential wells, which gives you some idea of future potential.

spent some time reading over the rails this weekend too. not sure I want to buy one but I am still learning the ins and outs of what drives the rail company earnings. I am intrigued by kansas city southern because of the mexican link especially to a seaport where they are the only rail connection. I also like the fact that they only have 10% of revenues from coal -- while Burlington Northern is convinced that coal will be powering utilities or years to come as the largest electricity fuel -- I'm not as convinced. many of the other rails get 20% of revenues from coal.

MCO -- planning on selling some put options -- betting that the trading range for MCO holds based on their business not really being able to get much worse and buffett owns 20% and presumably would buy more at the right price. if I sell a $30 put for August then I have the chance to make $2-3 per option assuming the stock stays above $30 for another 6 weeks. I am pretty confident that MCO will rally along with the rest of the market so unless the market just tanks, we should get a rally in MCO back towards $40. My plan is to sell puts at this price and calls if we get closer to $40. This way I can make money at both ends of the trading range.

I did sell a aug $95 call on ILMN last week -- the stock has done very well but the valuation is getting a little high.

Wednesday, July 2, 2008

CME and market

Buy and Sell Discipline -- key to buy discipline is to have some kind of disciplined view of a stock's attractiveness for purchase. It could be based on valuation, the chart pattern, earnings momentum or other factors or a combination of everything. Point is to have a plan; use factors that you are able to identify that lead to strong performance and then be consistent.

Discipline is what its called when you turn away tons of potential candidates because they don't meet your criteria for what is an attractive opportunity.

Sell discipline is also critical to investment success -- you have to know when to take profits -- to realize that an investment has either reached its peak potential or is about to have fundamental troubles or you have to be able to admit a mistake -- that your original thesis was wrong and you need to sell before you lose a lot of money. The key is to be dispassionate in your analysis -- to base your decisions on the best info available at the time without emotion -- as if you didn't have a bunch of money riding on the decision.

Key in these two processes is to understand critical factors that will impact a stock's future potential -- what are the drivers of a company's future profitability? Key metrics to follow and understand how they will change over time.

In CME's case one critical variable that I should have known was that interest rate futures made up about 50% of the daily contract volumes. Then I should have made the jump that with the fixed income market imploding it was inevitable that volumes would drop. The breakdown though was in the sell discipline -- deciding not to sell some shares when the stock was $700 and I even mentioned in this blog it was fully valued. Had plenty of chances to sell the stock for roughly what I paid for it yet didn't -- kept buying into the idea that volumes would continue to grow. Now estimates are dropping because volumes have dropped -- the PE has plummeted from 35 to around 20. I refuse to sell now because its too cheap but I'm kicking myself for not dumping some when it spiked to $440 on the buyback news.

Now in the past their volume issues have been temporary but I'm guessing the shrinking of financials will lead to a volume plateau that will keep a lid on the stock.

I still believe FDS is going to make it through this downturn without too many issues -- its that good of a business. I do plan on selling calls when it is near its high end of range -- something I just missed doing when the stock was $66 a couple of weeks ago. best not to try to top tick these things -- close enough still works.

MCO -- recent investigation into the "cover up" ratings on those european instruments resolved favorably so that removes an issue from the stock. important to realize the story is about international growth and non-ratings growth. that should allow them to grow from the 2008 base at a 10% rate, which is made easier by the fact that up to 5% of the stock is repurchased each year.

AB -- obviously in a bear market the earnings get hit as asset values drop but haven't seen anything that would lead me to believe they are in trouble like legg mason or any of the brokers/banks.

I still think sometimes about MXB (MSCI Inc.) but reality is I should have less exposure to financials -- even the non-endangered ones that I have -- because the opportunities elsewhere are so much better -- utilities, railroads, energy, technology, genetic analysis, etc.

FLIR -- impressive new contract wins adds visibility to the 2009 growth story which is boosting the multiple. Obviously I nailed this story but didn't buy enough of it. Little secret -- often times the stocks that I really like that don't seem to go anywhere but I keep adding to them -- they almost never work out but the ones I keep averaging up on -- they work out great. FLIR would be a candidate for averaging up because I don't see the stock getting back into the 20's unless we have a really bad recession.

ILMN -- wow. saw some stats on their latest product offerings -- the innovation they are producing is astounding. that should drive their growth but the expectations on that stock are huge -- even bigger than for FLIR. I have almost sold calls on the stock -- aug 95 for over $3 but haven't yet because we are so close to a potential rally -- although EVERYONE is expecting a rally so there is a high chance it won't happen until we go lower. Continue to struggle with this one given the stock's strength and its valuation but so far holding on has been the right choice.

TSRA and UEPS -- still holding pattern but nothing has changed -- sure am hoping these two don't fizzle out -- they look like incredible opportunities, which means they are likely not that good.

LH -- this one boggles my mind probably the most -- they have some risks in terms of slower volume growth and bad debt expense given the slow economy but the stock is at 13x next 12 months estimates -- in the past they have gotten as low as a 10% free cash flow yield. At that valuation it sure makes you wonder why they don't just go private. LH tries to do deals with their free cash flow but if they have none that look attractive, they buy back shares. at current values they should be able to retire close to 7-8% of the stock each year. That's a huge amount.

TECH -- last 2 quarters beaten by about 10 cents each time yet they keep saying its due to unsustainable factors so the estimates don't go too crazy afterward. will this be the third quarter in a row or are they finally going to be right that the upside was temp.

BLUD -- hoping they report earnings this week or early next -- they usually report around the 1st of the month following their quarter end -- May 30th in this case so they should be reporting now but haven't. hoping for big upsides driven by pricing. that might get the stock up towards $30. Still comparing BLUD with POWI -- blud has higher margins now but POWI's are rising. similar revenue growth prospects and similar story in that they are selling integration/automation. POWI has very little non-cash assets so their returns are huge. I don't like the fact that there is little growth in blood typing market -- its huge already. most of power integrations growth is market share but I believe their market should be growing due to growth in electricity and their ability to produce new products that can increase their served market.

S&P 500 -- looked at the chart today and what did I see? downward sloping 200 day moving average which will put downward pressure on prices until the 50 day flattens out -- see 2002's price pattern on the S&P for an example. that means hope for a rally is just to get near 1400 -- more likely the next rally takes us to 1350 or so -- basically where we were only a week or two ago.