AB Analytical Services

2010: Most Stocks Are Up So Far

I am firmly on the record saying that this is a year for stockpickers.  So far, they are winning.  While the overall averages may be down, depending upon how one looks at it, most stocks are up.  While the S&P 500 is down still slightly, the Russell 2000 is up on the year to date, reflecting the strength among smaller names.  Interestingly, even in the S&P 500, where the losers edge the winners by just 6 and the price return is -0.95%, the equal-weighted index is up 0.72% YTD.  I think we can chalk up the discrepancy to these 5 stocks that are all in excess of $50 billion market cap and total 5% of the S&P 500 and are down more than 10% YTD:

• AT&T (T): - 11.5%
• Amazon.com (AMZN): -12%
• Verizon (VZ): -12.7%
• Google (GOOG): -15%
• Qualcomm (QCOM): -20.7%

By my calculations, that's about a 65bps hair-cut to the market just there!

As you can see in the table below, certain trends in the sectors are emerging across market caps:

Looking at the S&P 500, the main culprit is actually Technology, as it represents about 19% of the index.  Materials, Telecom Services and Utilities add up to about 10%.  Industrials jumped out early in the year as I had highlighted.  While GE certainly accounts for a big chunk of it, it's not the sole driver.  Here are 5 Industrials >$25 billion up more than 5% YTD:

• Boeing (BA):  16.7%
• Emerson (EMR):  11.1%
• General Dynamics (GD):  6.4%
• General Electric (GE):  6.2%
• Union Pacific (UNP): 5.4%

I find it interesting that the strength in the larger-cap names isn't translating into interest yet for smaller companies, and I expect that this is most likely an opportunity.  I am finding lots of smaller industrials that look attractive.  Consumer Discretionary, on the other hand, is strong across market caps,similar to the way it started 2009 even in the downturn.  In the S&P 500, which is being hurt by AMZN, there are 5 names in excess of $25 billion market cap up more than 5%:

• Ford (F):  17.4%
• Carnival (CCL):  13.5%
• Home Depot (HD):  7.9%
• Target (TGT):  6.5%

Wrapping up the sectors, Utilities are an area that I find quite interesting now.  There have been some negative regulatory events, but I think that the sustainable dividend yield pushing 5% will prove increasingly tempting as the year progresses.  One underappreciated longer-term driver is that the return of industrial demand (notice those industrial stocks???) will help many of these Utilities.  If you are interested in some of my thoughts on the sector, I have shared them on my new blog.

The last area I want to cover is the Mid-Caps:  Why are they doing so well?  My hunch is that the improved environment for M&A really benefits this part of the market, as these companies can do accretive strategic acquisitions of private and smaller public companies and can also be acquired by larger ones.  While it looks like Consumer Staples is driving returns, it's just 4% of the index.  How odd that Energy and Materials are up in contrast to how they are both down in larger and smaller parts of the market.  Terra (TRA) is one of the Materials stocks, supporting the M&A angle.  Except for Industrials, as I mentioned above, every single sector is doing better for Mid-Caps than Large-Caps. 

A final note is that "Value" is beating "Growth" across all market caps, but especially in smaller names.  Yet another sign that this is a stockpicker's market.  When I look at my model portfolios and the portfolio I manage, I am definitely tilting them towards "small" and "value".

Disclosure:  No position in any names mentioned

Access Pharma (ACCP.OB) Product Development Update - Sponsored Post

Access Pharmaceuticals (OTC: ACCP.OB, “Access”) develops and commercializes products for the treatment and supportive care of cancer patients, including:

 - MuGard, an FDA-approved rinse for the management of patients with oral mucositis, a debilitating side effect of various cancer treatments

 - ProLindac, now in Phase II clinical testing of patients with ovarian cancer

 - The Cobalamin Platform, a drug delivery system for the oral administration of large molecules that are currently administered via injection (insulin, human growth hormone, fertility drugs, etc.)

MuGard has been commercially launched by Access' partner, SpePharm, in six European countries, including the UK, Germany, Italy, Norway, Greece and Sweden. Over 15,000 bottles of MuGard have been used by over 2,000 patients to date. Access is now conducting pre-marketing activities, including ramping of commercial production, with the goal of a U.S. commercial launch by April 2010.

ProLindac is a next-generation DACH platinum anti-cancer compound which includes a proprietary nano-polymer drug delivery vehicle that allows for over ten-times the dose of platinum to be delivered in a targeted manner to cancer cells, with a much better safety profile compared to standard platinum-based drugs which cause significant and cumulative neurotoxicity.

Access will conduct a combination study evaluating ProLindac with Taxol (paclitaxel) for second-line treatment of platinum pre-treated patients with advanced ovarian cancer. This is a multi-center study being conducted in Europe in up to 25 patients with primary efficacy endpoint goal of achieving at least a 63% response rate. Access expects to begin patient dosing by April 2010.

The Cobalamin Platform is a drug delivery technology that involves coating a nano-particle with a vitamin B-12 analog (cobalamin) that binds to intrinsic factor in the gut and triggers binding to cellular receptors which absorb the entire package, resulting in exponential increases in absorption through the gut of large molecule drugs/hormones typically administered by injection.

In June 2009, Access announced that two bio-pharmaceutical companies would conduct preclinical, proof-of-concept studies in animals (rat and dog models of diabetes) before proceeding to more formal negotiations for the Company's oral, long-acting (basal) insulin product candidate. Final results from the non-exclusive collaborators are possible during Q1 2010.

For more information on Access, visit the ProActive Capital Newsroom at www.proactivenewsroom.com.

This post was placed by IR GRO.

My Dog Has Turned Me into a Jackass: A Review of 7 Companion Animal Stocks

I spent over $600 at the veterinarian this week.  On Monday, Cocobella got her normal annual vaccinations.  Friday, she received her annual dental cleaning.  Before you judge my actions, you have to see the subject:

The economics of pets amazes me.  This beagle cost $150 (actually, it was a gift), but I figure it costs over $1000 a year to keep it fed and healthy.  That doesn't include the repairs we had to make to woodwork around the house or the clothes and shoes that needed replacing when she was an insatiable monster cute little puppy.  She survived and, like every other dog in my life, brings immense joy to me and my family that every dog owner can surely understand.

But what about the cost?  I always have approached expensive things in life as potential investment opportunities.  It worked for the health insurance companies, it worked for Coach (COH), etc.  I am well aware of several companies that should benefit from the secular trend towards people spending a lot of money on their pets, though clearly the weak economy has put a dent in that theme.  With that in mind, I wanted to share some investment highlights of the universe of 7 publicly-traded stocks that derive a great portion of their sales from companion animal spending. 

A few observations before some detail:

• Generally, the group is cheap on a PE basis relative to the past several years
• Despite the recession, 5-year growth rates are pretty high for most of these companies
• The companies all generate good ROIC
• Margins are expanding at the smaller companies

I have looked at all of these companies at some point over the last few years.  The only one that I have owned of late is Abaxis (ABAX,) from which I was spooked right after I had just bought the stock before they reported  after I heard the CEO on the Q1 earnings call.  When describing some steps they were taking to improve their human testing business, he said something to the effect that they were going to start running it like a "real business".  Not the kind of thing I like to hear, but I should have realized that he is somewhat of a loose cannon.  I missed a quick double, though one of my clients stayed in the name.  It was one of my worst moves in 2009 (after selling out ISRG at a 50% gain in the 140s).

Looking at them in order, Patterson (PDCO) is a long-time distributor in the market, but it is not a big part of their business at 18% of sales and an even smaller percentage of profits.  The rest of their business is primarily dental and then rehab equipment.  This company is a case study on what happens to companies when they trash the balance sheet to do acquisitions in order to support an inflated valuation.  I would title it "Turning Your Stock Into a Dog", but I digress.

Everyone knows Petsmart (PETM), the retailer.  I don't follow them that closely.  The stock peaked in 2004 with a PE of 25X and has delivered 10% top-line growth (not bad) but just 9% growth in earnings (EPS boosted by share repurchases to 15%). 

Idexx Labs (IDXX) was pounded recently amidst seemingly minor FTC issues.  This company makes instruments and consumables primarily for vets, but also has water testing and food production animal health lines.  The GM is among the highest, signalling the lack of competition.  The company is in an upgrade cycle as well.  It's expensive, but it always is.  The current valuation is median for the past decade.

VCA Antech (WOOF) wins the best ticker award.  It owns vet clinics (a neat roll-up business), offers testing and also has a technology division (digital x-rays and ultrasound).  This one seems likely to snap back when the economy eventually recovers, but it suffers from a potential lack of acquisitions ahead due to its balance sheet being less-than-pristine.  It has been allowing its ample free cashflow to boost its balance sheet (deleveraging) over the past year.

Abaxis (ABAX) is one of the most interesting to me.  Notwithstanding CEO Severerson's "talk first, think later" behavior when discussing a major strategic change, this company, which is focused on diagnostics for animals and humans, seems to have a better mousetrap.  What really captured my attention was the higher gross margins and better balance sheet than IDXX. I have continued to follow this one from my watchlist.

MWI Veterinary Supply (MWIV) is the one I know the least, though it seems to be working the best (approaching an all-time high).  The valuation is lower than it has been traditionally and is certainly in line with its projected earnings growth rate.  The company just announced a highly accretive acquisition in the UK.

The smallest of the bunch, PetMed Express (PETS), is one that I have looked at recently.  I am a former client, and I really like what they do (direct-to-consumer) and appreciate the challenges that they face in terms of getting the vets to cede business to them by giving customers the prescriptions.  The stock is cheap (still), and the chart looks excellent.  I have been nervous about this one, though, as their prices are much higher than at Amazon.com (AMZN).  I am not sure if AMZN will crush them or buy them, so I stay on the sidelines.

I think that some of these names are investable now, though a protracted weak domestic economy (kind of what I expect) could keep the lid on returns for a while.  I believe that they do have somewhat defensive characteristics. 

Disclosure:  No positions

33 Mid-Caps: High ROC + Low Debt = Take-out?

This weekend's Barron's had an interview with Roger Vogel of Silvercrest Asset Management, who likes the idea of investing with the potential for consolidation ahead.  I tend to agree with his statement that "we firmly believe there is going to be a very big merger-and-acquisition cycle, mostly focused on small-cap companies."  He elaborates that those with strong balance sheets are likely to fare the best in a continued environment of tight credit. 

I have noticed lots of deals lately, though most of them tend to be strategic rather than financial.  While I never invest solely with the expectation of an acquisition, it is something that I increasingly incorporate into my views. 

Inspired by Vogel's hypothesis, I decided to run a screen to try to identify stocks that might look attractive to potential suitors.  I took the Russell 3000 and narrowed it to companies with strong balance sheets, high historical returns on capital  and low capital intensity.  My screen ended up with 171 companies, but most of them were very small.  For the purpose of this article, I limited it to names above $1 billion in market cap.  Note that one of them received an acquisition offer just this week (Zenith) (ZNT).  The 33 names below met the following criteria:

• ROC:  5yr Average > 10%
• Net Debt to Capital:  < 10%
• Total Liabilities/Current Assets:  <67%
• CapEx/Revenues:  <5%

Here is the group that made the cut:

7 of the 10 economic sectors are represented.  I highlighted expected PE ratios that are below 12 as well as Price to Tangible Book ratios below 2.  I also highlighted the name if it is a stock in my watchlist and the symbol if I own it or it is in one of my Model Portfolios. I can't comment on all of these, but I do believe that Lufkin (LUFK), Clarcor (CLC), Wolverine World Wide (WWW), Fossil (FOSL), Timberland (TBL), Columbia Sportswear (COLM), Wellcare (WCG), Immucor (BLUD), Dionex (DNEX), Quality Systems (QSII), HMS Holdings (HMSY), Microstrategy (MSTR) and maybe Plantronics (PLT) could fit strategically for larger acquirers.  I don't believe that Buckle (BKE), Men's Wearhouse (MW) or Plexus (PLXS) are potential targets, but they are all very cheap in my view.

If you find this interesting, you should really check out the complete list.  Many of the companies have little or no analyst coverage.  I have highlighted the names I either own or that are in one of the model portfolios - there are a total of 9.  Considering the combined total number of names in the model portfolios or the foundation is just 27, you can tell that this theme is important to me.  I will be perusing the complete list further. If you would like to check it out too, just click the link below:

Download Cheap R3000 Stocks - Full

Disclosure:  Long BKE and TBL in a portfolio I manage or in at least one model portfolio.

Natural Gas Producers: Profitless Prosperity Ahead?

It's that time of the quarter again, when I review the transcripts of the quarterly conference calls of the natural gas producers to try to gain some insight into what's going on.  Unfortunately, they haven't all reported yet, as it is year-end, but I feel compelled to address the issue now.  This is my third installment, as I first addressed the topic in September (Natural Gas:  Extreme Contango Suggests Caution) and then in November (Time to Bail on Shale).  These posts have been very "well" received, with many clearly appreciating the argument I have been trying to convey. The stocks of the companies I have mentioned have been mixed.  I would characterize them as generally higher in price and in line with the overall market, but, in some cases, better.  There have been some major transactions, including the XOM purchase announcement of XTO as well as Devon's new focus on resource plays.  I should point out that the price of gas has soared since that first article, with spot doubling and the one-year forward price rallying over 30%, mainly in response to what has been a pretty cold winter. 

Today I want to try to make the analogy to the semiconductor industry, which is one I have followed more closely over the years.  Semiconductors have proliferated in recent years, with very strong unit growth in all segments. On top of very robust demand, the supply has gone up as well, and Moore's Law has continued to rule.  While it may surprise you, worldwide semiconductor billings are very near their all-time high, which is well above the bubble high from 2000.  If you look at the earnings, though, in the industry, it is clear that only a handful of companies have been able to prosper.  Most have endured what many have called as "profitless prosperity", where everyone is busy working but not making money.  Here's a picture of what it looks like:

It's not pretty, is it?  The global market has grown 5.8% over the past 15 years, and this commodity manufacturer of DRAM has grown slightly faster, yet over the time-period, it has seen earnings per share fall and average pretty close to zero.  Even a company in a much better position in terms of competition, like Intel (INTC) has struggled over the long haul.  I'll spare the chart, but here are the 15-year tallies:  Sales up 7.3% and EPS up 7.5%.  Looking at the 2000 peak, their sales today are higher, but their EPS are lower. 

I know that most of you reading this probably don't care about the semiconductor industry, but I think it illustrates a great point:  Just because demand for something is strong, it doesn't mean the suppliers can make money.  Micron is the better example, as natural gas is about as much a commodity as one can imagine.  So, yes, while I concur with the experts that the demand outlook is fantastic, we need to focus on supply.  There, the game has changed recently, and rather dramatically.  We now have these massive "resource plays", and their numbers just keep growing.  Just recently, we learned of a massive discovery in the Gulf, the Davy Jones.  If you are unfamiliar, you can read about it here.  In any event, the landscape has changed, and with technological advances in both discovery and in production, we can expect sources like Haynesville, Granite Wash, Barnett , Bakken, Eagle Ford, Marcellus, etc. to transform gas availability to the equivalent of water.

Investors can quit looking at things the way they have historically.  Traditionally, following the rig count gave a nice read into the future price, especially when it was depressed.  After all, if producers cut supply, low prices will lift.  Such is life for a commodity.  Now, there are two dynamics that are driving very high supply despite "less drilling": 

• Higher production from wells in the resource plays 
• The availability of high forward prices

For now, the prices of the stocks aren't really reflecting the new reality of supply in my view due to artifically high forward prices that enable the companies to lock in very favorable pricing by hedging.  I have hypothesized that the other side, stodgy utilities that aren't really paid to optimize their purchase price, is to blame.  They keep buying expensive gas out in the future to smooth their costs.  How long will they keep paying such a high premium?  

The future I envision is one in which the price of gas is extremely low.  I expect that the forward prices will weaken, but producers will keep producing.  They have debt to service and capital investments to monetize.  Before I share the highlights from the big gas producers, I wanted to highlight the forward and spot prices again.  To strip out seasonality, I include the year-over-year change:

 
Several observations:

• The contango, though less extreme than at Labor Day, persists
• Gas bull market ended with a double top
• Gas, which has appreciated since the end of the last major recession by 9% annualized, has outperformed the CRB index (1.3%)
• The long-term "average" is close to $3
• The rally in gas from depressed prices has been anemic relative to other commodities (CRB up 26% y-o-y)
• This is interesting, as typically gas is MORE volatile than other commodities
• The forward price of gas (panel 2) seems to have hit a wall (the lows of 2006-2007)

OK, now to what the guys who know a lot more than me are saying, with the caveat that Chesapeake (CHK), which is ALWAYS bullish, hasn't reported.  Late last year, they explained why they aren't hedging at all.  Smart or just lucky?  Southwestern(SWN), Devon (DVN) and XTO (XTO) haven't reported either.  Devon is scheduled to report 2/17, and SWN will report 2/25.  Here are some big players and others who have already reported:

Petrohawk (HK) had an operational update on 2/1.  Here is the transcript.  Chairman and CEO Floyd Wilson eloquently stated what the company is all about:

"Petrohawk and a handful of other independent producers are sitting on a lot of homegrown natural gas. Our plan and commitment to drill and hold these valuable leases and assets, particularly, in the Haynesville Shale has proven to be sound.

We hedge, we contract for certain materials and services, we make financing available and we drill to grow. Perhaps at a higher rate than some would choose in today’s natural gas price environment assuming that others would have hedged as much as we had, and of course, you have to own these types of assets to provide this kind of choice as the growth rate."

Recently promoted COO Stoneburner summarized the just stunning growth from last year and the plans for this year:

For all of 2009 we drilled a total of 626 wells, all of which were successful. 564 of those wells or 90% were drilled in the three Shale Plays. 135 of those wells were operated with all but three being located in the three Shale Plays.

The main driver for the Company during 2009 once again was the Haynesville Shale. During 2009, total of 64 wells were placed on production. With the exception of those wells that were purposefully had produced at restricted rates the average initial production rate was 17.8 million a day.

These wells were able to increase production almost 450% for the year, growing gross production from approximately 110 million a day at the beginning of the year to approximately 480 million a day at the end of the year. This growth was accomplished with a relatively modest drilling program that average slightly less than 11 rigs on average during 2009. During 2010 the Company intends to operate 17 rigs and drill between 110 and 120 operated wells."

On February 9th, Comstock Resources (CRK), which is also focused on the Haynesville, reported.  I recently added this stock to my watchlist and really like the CEO, Jay Allison, and his team.  Here is the transcript, and some key comments:

"...in the fourth quarter of 2008, we were producing less than 2 million cubic feet of gas per day from the Haynesville.  By the end of the fourth quarter in 2009, we were producing 84 million cubic feet of gas from the Haynesville. And we did that without buying anything. We did that through the drilling program."

"We expect to have 18% to 25% production growth this year driven by our Haynesville Shale program. Based on results we had in 2009, we think our Haynesville Shale program could add 400 Bcfe to 500 Bcfe proved reserves in 2010."

Big Dog in the Marcellus, EQT (EQT), reported on January 27th.  Here is a link to the transcript, and here is what retiring CEO Gerber had to say:

"..the headline statistic of course was of the nearly 20% growth in produced natural gas sales and as Phil mentioned at a lower capital costs with projecting sales of another 20% in 2010 at as he described lower cost this was all driven by aggressive horizontal air drilling in our Huron, Berea plant all with the drill bit. Significant progress in the development of the Marcellus also all with the drill bit is our sixth consecutive quarter of double digit natural gas sales growth..."

On to EOG Resources (EOG), which reported on February 10th.  Here is a link to the transcript, and here is what CEO Papa had to say:

"...we're bullish on oil and believe North American gas prices will be weak for the first half of this year and strengthen in the second half. Accordingly on a quarterly basis, our natural gas production profile is expected to increase sequentially this year. A majority of our gas growth will come from the Haynesville, Horn River and Marcellus plays while the liquids growth will emanate primarily from the Bakken, Barnett Combo and Westgate areas...

Now I switch to our natural gas play, starting with the Haynesville. The big news here is that our initial test in the Bossier was successful. The Bossier is a shale in about 200 feet above the Haynesville with similar rock properties. The Sustainable Forest 5 - No. 2 Alt well and DeSoto Parish blow tested at a 13 million cubic feet a day flow rate with 7625 PSI flowing cubic pressure.

Up surface frac and pressure analysis indicates this Bossier zone is separate from the underlying Haynesville zone. This means we have two valuable prorogates over a portion of a 160,000 total net acres were both zone in present. We plan to drill 70 grow Haynesville and Bossier wells this year and this area will be the largest single driver if our 2% year-over-year North American gas growth....

We have only a small amount of gas hedged through June and are un-hedged thereafter. Our overview continues to be that the 2010-12 NYMEX is reasonably reflective of future prices."

I hope that these comments give you a flavor of what's going on in gas production.  It is clear to me that production will be soaring.  While I know that some folks question the decline rates in these new wells, I would counter with declining costs, improving technology, new finds, and companies want to produce whether to grow EPS or cover interest expense.  So, I envision profitless prosperity in the years ahead.  If you agree with me, you might want to avoid investing in companies without shale or other resource play assets, as they will be buried.  Even the shale guys will probably have problems with their stocks, as many investors value the companies on the value of their reserves, which is based upon what I view as an inflated price (acknowledging that the new SEC rule made it less inflated).  Finally, there are lots of companies that could benefit from lower gas prices, including restaurants and certainly energy-intensive industrial companies. 

Disclosure:  No positions in any stocks mentioned.

2010: A Year to Seek Alpha

Five weeks into the year, I am sticking to my guns:  The economy isn't good, but stocks aren't so bad.  For those of you pressed for time, let me summarize concisely what follows:  Turn of CNBC and read some SEC filings and listen to conference calls.

Ok.  For the rest of you have some time to follow my thought process, I always think that the market is ripe for picking stocks.  I admit my bias!  With that said, though, 2008 and 2009 were years to avoid or seek Beta rather than to chase Alpha. 2010 will most likely not see the directional moves we have experienced over the past two years.  The action just this past few weeks could serve as a model for what might ensue over the balance of the year.

So far, while the market is indeed down, it's important to keep things in perspective:  The Bear Rally lives, at least to this point.  We have seen ferocious rotation out of sectors and asset classes that performed exceptionally well last year, but, from my perspective, it's just profit-taking.  The S&P 500 in aggregate is down 4.25% YTD after rallying 6% last quarter.  The two best areas last year, Tech and Materials, are clearly pulling the market down.  Emerging markets soared last year as did commodities, but now they are back into the ranges from the summer.  These things get lots of attention in the media, but do they really signal anything at this point? 

I think that there are a lot of very interesting things going on that don't seem to get media attention:  M&A is back (ok that gets some attention, but not as much as what's going on in Greece!), dividend hikes and share repurchases are cranking up, investors seem to snap up large-cap names that gap down on earnings misses (now that's a good sign).  Yes, they are also selling overextended names that report good numbers, but they aren't pulling out of the market, just redeploying.

So, rather than assume that this rotation is indicative of a return to the days of early 09 or late 08, I suggest that investors keep in tune with the bigger picture.  The key risk factor isn't the dollar, it's our interest rates.  If we see rates rise despite the economy being weak, it's probably game over.  That will be the sign that the deleveraging is kicking in again.  For now, though, the game goes on (and it's definitely a game).  I suggest spending time focused on special situations or turnarounds or seeking exceptional management (last year all companies needed was someone who could hand out pink slips).  Valuation matters.  The tide isn't rising, nor is it receding yet.  Take a look at this chart - is this scary?

Will the market go up or down this year?  Yes, but not much, at least not initially.  Perhaps Beta begins to trump Alpha later this year, but I suspect a narrow range ahead.  My Top 20 Model Portfolio is all about Alpha, as it is by design always fully invested.  The model performed exceptionally well last year, and it is doing well so far this year.  While it was up in January, it pulled back last week to about unchanged, which is well ahead of the market.  I have recently described rather extensively the  strategies I am pursuing there, though I would note that we have already sold two names and replaced them with a technology company and another industrial. 

I think that this market will reward hard work in the trenches.  It's probably best to focus in areas where others don't, so that probably means smaller names and more of a value orientation or GARP rather than aggressive growth.  As the global economy remains challenged, we should continue to focus on companies with better balance sheets.  My guess is that the kind of market I envision will require us to be more opportunistic than normal, taking profits when they arise and jumping into herd selling situations.  I certainly don't have a crystal ball about whether or not the market rally from the lows last March continues all year, but I am confident that there are plenty of opportunities for those willing to do the work.

Disclosure:  No stocks mentioned