AB Analytical Services

"Sell DECK and Buy TRLG"

I started My Own Analyst two years ago to help individual investors who invest on their own.  One of the features that has gained in popularity is what I call "Ask Alan" - there's a button to push on the website that launches an email to me.  I respond on the website.  Here is one that I received two months ago:

03/11/2012

Question on DECK

Tim asks:  

Are you familiar with Deckers (DECK) or do you have an opinion on the stock? I think the company is very well run with a strong balance sheet. The recent earnings haircut due to rising material costs looks to be factored into the current price.

I don't follow DECK closely at all.  I have always felt that it was too much a fad (Uggs), though that has proved incorrect.  The margins are quite high - so high they scare me a bit.  It's easy to get lulled into a feeling of "cheapness" when the PE is low (especially considering the $6 per share of cash) when the margins are inflated.  Over longer periods of times, those margins inherently come under pressure.  I have liked CHS because its margins were low and rising.  When I look at SKX, it too had historically high margins (though not nearly as high as DECK) and reliance on a single product's trendiness before it crashed when the trend changed.  CROX is a better example perhaps.  Outside of shoes, there are lots of examples.  This is a long way of saying that I would be careful with DECK.  With that said, from a trading perspective, it seems a bit overdone, but I don't see support anywhere near here.  When a stock goes from 12.40 to 119 in two years, there are lots of big LT gains embedded.  The stock could pull back 62% of that move and still be in a LT uptrend.  This would be 53 or so.  When I look at the 2-year weekly chart, I see 53-55 as support.  Fundamentally, it's easy to blame weather and to dismiss potential negative longer-term trends.  I hope that is not what is going on here.  If I had a bullet to shoot at a fallen angel in the retail sector, it would be TRLG.

At the time, DECK was 68.31, while TRLG was at 26.22.  Subsequently, DECK reported earnings and plunged, closing this evening at 52.50 after trading as low as 50.18 on 4/30.  Meanwhile TRLG suprised the market with a big initial dividend along with a small share repurchase authorization and closed in the after-hours at 30.50 (and traded as high as 32).

Subscribers to My Own Analyst get this type of advice every single day.  It doesn't always play out this well, but often it does.  For example, another feature is what I call "Short-term Trades", where I set a target and stop price with a two-week limit.  This morning, I went out with a buy on CRK just after the open, with a buy price of 15.84, a stop of 15.25 and a target of 18.  The trade was closed out within a couple of hours - that's almost 14%.  Of course, many of these trades, which are set up typically as 3.5 to 1 up/down, don't work out - they become small losses, but the wins really add up and have produced large gains overall.

If you could use a professional input into your own investment process, why don't you check out this service?  If you can avoid one or two mistakes a year, the service more than pays for itself.  Click here for the brochure.  If you like what you see, email me and I will let you take a look for the next week.

Paired Trade: Buy Dorman Products, Sell O'Reilly Automotive

This is the 9th in a series of ideas where I contrast a cheap security with an expensive one that otherwise shares some characteristics. So far, I am 6 for 8:

		BUY	SELL
		MPR	NLC
13-Mar		7.30	11.99
28-Aug		9.78	17.52
		34.0%	46.1%	-6.1%
		JNJ	AGN
17-Apr		53.05	49.49
28-Aug		60.29	55.10
		13.6%	11.3%	1.2%
		COLM	UA
1-May		30.36	24.00
28-Aug		39.94	24.30
		31.6%	1.3%	15.2%
		BCR	ISRG
8-May		73.52	158.77
28-Aug		80.31	224.90
		9.2%	41.7%	-16.2%
		EZPW	AAN
5-Jun		13.09	32.85
28-Aug		13.46	26.64
		2.8%	-18.9%	10.9%
		SCVL	PSS
19-Jun		12.04	14.38
28-Aug		16.21	15.84
		34.6%	10.2%	12.2%
		HRL	DIN
9-Jul		34.09	31.80
28-Aug		36.89	21.91
		8.2%	-31.1%	19.7%
		AKAM	NTAP
14-Aug		18.01	23.59
28-Aug		18.11	23.32
		0.6%	-1.1%	0.8%
			Average:	4.7%

For reference:

• 3/14: Buy Met-Pro (MPR), Sell Nalco Holding (NLC)
• 4/18: Buy Johnson & Johnson (JNJ), Sell Allergan (AGN)
• 5/3: Buy Columbia Sportswear (COLM), Sell UnderArmour (UA)
• 5/10: Buy C.R. Bard (BCR), Sell Intuitive Surgical (ISRG)
• 6/6: Buy EZCORP (EZPW), Sell Aaron's Rents (RNT)
• 6/20: Buy Shoe Carnival (SCVL), Sell Collective Brands (PSS)
• 7/9: Buy Hormel (HRL), Sell DineEquity (DIN)
• 8/15:  Buy Akamai (AKAM), Sell NetApp (NTAP)

Today's trade idea involves two companies that are both in my watchlist.  I wrote positively about O'Reilly (ORLY) last year, but it has almost doubled since then as the thesis has played out.  I wrote about Dorman Products (DORM), a major supplier to ORLY and other auto parts retailers, in February and then again in May.  It had a huge run, and I sold the position.  I added it back very recently in my Top 20 Model Portfolio and continue to like it here.  Let's go to the tape:

 

I probably shouldn't pick too much on ORLY, as I believe it was hit along with peers on the Cash for Clunkers program that took a small amount of potential customers off the road.  I had been concerned that DORM was getting squeezed by its customers, but the last two reports tell me that pressure is abating.  If ORLY works, DORM should work a lot better.  DORM has a similar growth profile, a superior financial structure and a much lower valuation.  My analysis doesn't include the off-balance sheet lease exposure of ORLY either.

Disclosure:  Long DORM in a portfolio I manage

Paired Trade: Sell NTAP and Buy AKAM

This is the 8th in a series of ideas where I contrast a cheap security with an expensive one that otherwise shares some characteristics. So far, I am 5 for 7:

		BUY	SELL
		MPR	NLC
13-Mar		7.30	11.99
14-Aug		10.43	17.51
		42.9%	46.0%	-1.6%
		JNJ	AGN
17-Apr		53.05	49.49
14-Aug		60.08	54.38
		13.3%	9.9%	1.7%
		COLM	UA
1-May		30.36	24.00
14-Aug		36.96	23.99
		21.7%	0.0%	10.9%
		BCR	ISRG
8-May		73.52	158.77
14-Aug		73.62	223.80
		0.1%	41.0%	-20.4%
		EZPW	AAN
5-Jun		13.09	32.85
14-Aug		12.25	27.32
		-6.4%	-16.8%	5.2%
		SCVL	PSS
19-Jun		12.04	14.38
14-Aug		12.44	14.45
		3.3%	0.5%	1.4%
		HRL	DIN
9-Jul		34.09	31.80
14-Aug		37.39	23.85
		9.7%	-25.0%	17.3%
			Average:	2.1%

For reference:

• 3/14: Buy Met-Pro (MPR), Sell Nalco Holding (NLC)
• 4/18: Buy Johnson & Johnson (JNJ), Sell Allergan (AGN)
• 5/3: Buy Columbia Sportswear (COLM), Sell UnderArmour (UA)
• 5/10: Buy C.R. Bard (BCR), Sell Intuitive Surgical (ISRG)
• 6/6: Buy EZCORP (EZPW), Sell Aaron's Rents (RNT)
• 6/20: Buy Shoe Carnival (SCVL), Sell Collective Brands (PSS)
• 7/9:  Buy Hormel (HRL), Sell DineEquity (DIN)

While I am not particularly excited about either the meager 2% average return or the mistake on ISRG, I will point out that each one of these paired trades was designed to be conservative.  I aimed for the better balance sheet, the lower growth, the more diversification and/or the lower valuation in all cases. 

Today's trade shouldn't draw some of the criticisms that past recommendations have elicited.  While Akamai (AKAM) and NetApp (NTAP) certainly aren't competitors, they are both leveraged to the exploding data growth theme.  Further, they are both Mid-Caps.

NetApp reports this week (8/19), while AKAM just reported.  Both these stocks are on my watchlist, and I am long AKAM in a portfolio I manage as well as in my Top 20 Model Portfolio. 

AKAM disappointed with its disclosure of a more aggressive pricing environment for its content delivery services.  I would note that the company has long been reducing operating expenses and passing along savings to its customers (lower GM).  I had never invested in AKAM until very recently and find it to have a valuation that should attract value investors.   NTAP has been struggling too in a more competitive environment for its storage solutions.  Here's the tape:

	AKAM	NTAP
Price 8/14/09	18.01	23.59
Market Cap (mm)	3112	7838
Enterprise Value	2695	6499
2009 YTD Price Return	19.4	68.9
2008 Price Return	-56.4	-44.0
Income Statement
Sales (ttm)	825	3406
Sales growth ttm	14%	3%
Sales growth mrq	5%	-6%
EBITDA (ttm)	350	296
EBITDA Margin ttm	42.4%	8.7%
Pre-tax Margin 2008	30	3
Avg Pre-tax Margin 2005-2007	25.0	14.0
FCF (ttm)	225	160
Balance Sheet
Equity	1681	1662
Tangible Equity	1155	935
Cash	617	2604
Cash/Equity	36.7%	156.7%
Total Liabilities	308	3810
ST Debt	0	0
LT Debt	200	1265
Net Debt/Cap	-22.2%	-45.7%
Liabilities/Current Assets	0.4	1.1
Liabilities/EBITDA	0.9	12.9
Liabilities/FCF	1.4	23.8
Valuation
PE F12M	11.3	18.6
EV/EBITDA	7.7	22.0
EV/Sales	3.3	1.9
(EV/Sales)/Pre-tax Margin	13.1	13.6
P/B	1.9	4.7
P/TB	2.7	8.4
FCF/Market Cap	9.0%	3.1%
Dividend Yield	0.00%	0.00%

 

While NTAP's margins are depressed, it seems that the market is betting AKAM's margins will come down a lot while NTAP's will rise.  NTAP has a lot of cash, but it also has a ton of deferred revenue on the other side.  This shows up in the three highlighted ratios regarding total liabilites.  AKAM is a much safer play in a weak economy, while both companies should prosper in an improving economy.  NTAP is a little overbought these days, but that's not so unusual in this market.  Both of these companies could be acquisition candidates.  My bottom-line is that AKAM is very cheap relative to NTAP.

Disclosure:  Long AKAM

Paired Trade: Buy Hormel, Sell DineEquity

This is the 7th in a series of ideas where I contrast a cheap security with an expensive one that otherwise shares some characteristics.  So far, I am 5 for 6:

		BUY	SELL
		MPR	NLC
13-Mar		7.30	11.99
8-Jul		10.17	15.45
		39.3%	28.9%	5.2%
		JNJ	AGN
17-Apr		53.05	49.49
8-Jul		57.08	46.10
		7.6%	-6.8%	7.2%
		COLM	UA
1-May		30.36	24.00
8-Jul		30.30	20.89
		-0.2%	-13.0%	6.4%
		BCR	ISRG
8-May		73.52	158.77
8-Jul		74.76	145.18
		1.7%	-8.6%	5.1%
		EZPW	AAN
5-Jun		13.09	32.85
8-Jul		10.19	28.68
		-22.2%	-12.7%	-4.7%
		SCVL	PSS
19-Jun		12.04	14.38
8-Jul		12.55	13.31
		4.2%	-7.4%	5.8%

For reference:

3/14: Buy Met-Pro (MPR), Sell Nalco Holding (NLC)

4/18: Buy Johnson & Johnson (JNJ), Sell Allergan (AGN)

5/3: Buy Columbia Sportswear (COLM), Sell UnderArmour (UA)

5/10:  Buy C.R. Bard (BCR), Sell Intuitive Surgical (ISRG)

6/6: Buy EZCORP (EZPW), Sell Aaron's Rents (RNT)

6/20: Buy Shoe Carnival (SCVL), Sell Collective Brands (PSS)

Similar to each of the trades above, my idea today is one that allows the investor to go "up in quality".  I have liked Hormel (HRL) since Thanksgiving - check out my views back then.  The stock is in my own portfolio and has been a "staple" in both my model portfolios, the Top 20 (up over 29% YTD) and Conservative Growth/Balanced (up almost 11% YTD).  The bullish thesis is that the company is extremely well managed, has a good balance sheet (great for the industry) and has strong prospects for EPS growth despite the weak economy as input costs fade.  The other side, DineEquity (DIN), is the operator of Applebee's and IHOP.  I don't know the story that well, but clearly the company is extremely leveraged.  I recall not liking either of the companies before and don't see how the combination makes for a better company.  This trade benefits from the shift from restaurants to home-prepared meals.  Check out the tape:

	HRL	DIN
Price 7/9/09	34.09	31.86
Market Cap (mm)	4578	560
Enterprise Value	4716	2715
2009 YTD Price Return	10.0	175.6
2008 Price Return	-23.2	-68.4
Income Statement
Sales (ttm)	6824	1545
Sales growth ttm	7%	85% (post-merge)
Sales growth mrq	0%	-15%
EBITDA (2008)	612	259
EBITDA Margin 2008	9.0%	16.8%
Pre-tax Margin 2008	7	3.4
Avg Pre-tax Margin 2005-2007	7.5	21.0
FCF (2008)	286	166
Balance Sheet
Equity	2105	266
Tangible Equity	1340	-1384
Cash	312	98
Cash/Equity	14.8%	36.8%
Total Liabilities	1528	3008
ST Debt	100	18
LT Debt	350	2235
Net Debt/Cap	5.4%	85.5%
Liabilities/Current Assets	1.0	8.8
Liabilities/EBITDA	2.5	11.6
Liabilities/FCF	5.3	18.1
Valuation
PE F12M	14.1	15.0
EV/EBITDA	7.7	10.5
EV/Sales	0.7	1.8
(EV/Sales)/Pre-tax Margin	9.2	8.4
P/B	2.2	2.1
P/TB	3.4	-0.4
FCF/Market Cap	6.7%	35.9%
Dividend Yield	2.22%	0.00%

DIN could work out great if they can grow their way out of their debt, while HRL seems very reasonable without any requirements of much growth (though I expect it to grow).

Disclosure:  Long HRL

Paired Trade: Buy Shoe Carnival, Sell Collective Brands

This is the 6th in a series of articles that attempt to identify relative value discrepancies between two closely related securities. So far, the first five (but not the most recent one - ouch!) have been modestly successful in aggregate, though it's a little early to be drawing conclusions:

		BUY	SELL
		MPR	NLC
13-Mar		7.30	11.99
22-Jun		10.21	16.00
		39.9%	33.4%	3.2%
		JNJ	AGN
17-Apr		53.05	49.49
22-Jun		56.09	46.48
		5.7%	-6.1%	5.9%
		COLM	UA
1-May		30.36	24.00
22-Jun		32.17	22.05
		6.0%	-8.1%	7.0%
		BCR	ISRG
8-May		73.52	158.77
22-Jun		74.35	161.15
		1.1%	1.5%	-0.2%
		EZPW	AAN
5-Jun		13.09	32.85
22-Jun		10.88	30.99
		-16.9%	-5.7%	-5.6%

For reference:

3/14: Buy Met-Pro (MPR), Sell Nalco Holding (NLC)

4/18: Buy Johnson & Johnson (JNJ), Sell Allergan (AGN)

5/3: Buy Columbia Sportswear (COLM), Sell UnderArmour (UA)

5/10:  Buy C.R. Bard (BCR), Sell Intuitive Surgical (ISRG)

6/6: Buy EZCORP (EZPW), Sell Aaron's Rents (RNT)

Today's idea is driven primarily by the sell, Collective Brands (PSS), which I find to be very expensive relative to a host of competitors.  I have written about Shoe Carnival (SCVL) in the past on several occasions, including late 2007, August 2008 and as part of a review of the first year of my Top 20 Model Portfolio (of which it is still a member).  I follow the shoe and shoe-related companies fairly closely and could select any number of other companies against PSS.  As you can see in the table below, it has one of the worst balance sheets but a fairly high valuation:

While I highlighted TBL and DSW as well, I chose SCVL as the other side as it remains so inexpensive. In addition to a pristine balance sheet and high inside ownership, this retailer had a great report recently, reducing absolute inventory and per-store again. The company isn't too exciting - focused singularly on selling shoes to women, men and children in low-income markets in the Southeast. Here's the comparison:

Don't be fooled by the low PE - PSS has a lot of debt and EV/EBITDA is a more appropriate metric.  Historically, the vertically integrated PSS (which admittedly has more moving parts) hasn't really had better margins than SCVL, but note that the EV/Sales ratio is more than double that of SCVL.  PSS is scaling back, while SCVL, with its strong balance sheet, is taking advantage of great real estate conditions to grow selectively.  With the economic headwinds likely to be protracted, it makes little sense to pay up to own PSS when SCVL and so many other similar companies are as cheap if not cheaper with less financial risk.

Disclosure:  Long SCVL

Paired Trade: Sell Aaron's Rents and Buy EZCORP

This is the 5th in a series of articles that attempt to identify relative value discrepancies between two closely related securities. So far, the first four have been modestly successful in aggregate, though it's a little early to be drawing conclusions:

• 3/14: Buy Met-Pro (MPR), Sell Nalco Holding (NLC)
• 4/18: Buy Johnson & Johnson (JNJ), Sell Allergan (AGN)
• 5/3: Buy Columbia Sportswear (COLM), Sell UnderArmour (UA)
• 5/10:  Buy C.R. Bard (BCR), Sell Intuitive Surgical (ISRG)

In this trade, I am looking at two companies that deal with credit-impaired or low-income consumers generally.  In the case of Aaron's (AAN), which just changed its ticker from RNT, the company "leases" appliances, televisions, computers, etc. to anyone without doing a credit check.  Not surprisingly, its sales have been strong lately.  My thesis is that it's easy to sell to someone with bad credit, but harder to collect when the economy is struggling.  It's not a bad business in a strong economy, but it's very risky in a weak one.

EZCORP (EZPW), on the other hand, is a pawn shop and payday lender, though it is moving into other areas such as auto titles.  When it sells used merchandise, it is a final sale, unlike AAN, which may have to repossess if the "buyer" doesn't keep up his payments.  While the payday lending is at risk, the low valuation of EZPW tells me that investors are paying very little for that business.  According to management (twice publicly to me on their conference call), the exit costs are minimal should the business become uneconomic.  Here's the tape:

EZPW is much cheaper on a PE basis, and it has a very strong balance sheet. AAN has a high EBITDA margin, but its D&A is huge.  AAN has also been boosting its sales by buying in franchises.  I don't know management at AAN as well, but I can say that EZPW management is very strong.  I believe that EZPW will trade towards 18 this year as the strength of its pawn business supports earnings growth, while AAN is likely to pull back towards 24.

Disclosure:  Long EZPW

Paired Trade: Buy Bard, Sell Intuitive Surgical

This is the 4th in a series of articles that attempt to identify relative value discrepancies between two closely related securities.  So far, the first three have been modestly successful in aggregate, though it's a little early to be drawing conclusions:

• 3/14: Buy Met-Pro (MPR), Sell Nalco Holding (NLC)
• 4/18: Buy Johnson & Johnson (JNJ), Sell Allergan (AGN)
• 5/3:  Buy Columbia Sportswear (COLM), Sell UnderArmour (UA)

I will eventually do a review of each of these, but the first one is slightly negative now (after a great start) while the other two are equally positive.

As many of you are aware, I love Intuitive Surgical (ISRG) as a company.  But as I warned when I was very bullish on the name back in March, "I have always believed that one shouldn't fall in love with stocks."  I reported back after their disappointing Q1 results that the stock still had room to run, highlighting 175 by year-end as a potential target in an optimistic case.  Well, 8% upside over the next 8 months doesn't seem worth the risk.  I actually sold the last piece in my Top 20 Model Portfolio last week to buy C.R. Bard (BCR).  We have been very fortunate in the model, with a return in 2009 so far of almost 28%, and I want to protect those returns!

Big picture, both of these companies are excellent Healthcare companies with similar market caps.  The whole idea here is to move out of the high PE (high expected growth) story into a more conservative and safer stock.  This rationale is quite similar to the JNJ/AGN trade.  Here is how it looks:

 

Again, ISRG has a great balance sheet (as does BCR).  The key metrics here are the ones I boxed:  The PE is very high for ISRG relative to BCR, and the FCF yield doesn't give any room for disappointment.  In contrasting the two, it is important to consider that BCR derives essentially all of its sales from consumables, while ISRG relies upon $1.4mm (or higher now with the new product) capital equipment sales for about 1/2 of its revenue.  If you share my view that the economy will remain weak for quite some time, this isn't the time to be aggressive in growth assumptions.  I want to own ISRG again, but not at this price.

Disclosure:  Long BCR

Paired Trade: Buy Columbia Sportswear, Sell Under Armour

This is the third in a series of recommendations (MPR vs. NLC, AGN vs. JNJ), and I actually addressed these two companies last year.  While Under Armour (UA) cratered relative to Columbia Sportswear (COLM), it has surged back to about the same relative price level since the two companies recently reported.  When I looked at UA a year ago, I saw a very expensive stock and used COLM as an example of a much cheaper albeit less "exciting" company.  Now, my relative interest in the two is that I see COLM as dirt cheap.  I recently added it to my Top 20 Model Portfolio and increased the position in the Conservative Growth/Balanced Model Portfolio  after it reported Q1 EPS and added it late this week to my own holdings.  Here are the numbers:

One number that I don't include but is important is the short-interest.  COLM has large insider ownership, so the ratio is high relative to the daily trading volume or the "float", but UA is just sky high at 13% of all shares outstanding and may account for the recent doubling of the stock since March.The basic story is clear:  UA is growth, while COLM is value.  If, like me, you are expecting economic growth to remain weak for quite some time, you would prefer to invest in a company with very modest growth expectation like COLM and not expose yourself to the chance of another collapse in performance (like Q4, when UA sales growth plunged) or expectations.  As I said a year ago, UA has high growth, but high inventory and margins as well.  In a recessionary environment, expect the company to continue to lower its margins if it wants to grow.

I believe that it will be hard for COLM to hit my target of 44 over the next year, but that would represent about 2X "tangible book less cash" plus the cash added back in.  In that environment, UA would probably rise, but not as much, unless it can grow its top-line well in excess of 20% throughout 2009.  In a more pessimistic environment, COLM downside should be limited, while UA could retrace much of its recent ascent as it struggles with falling margins and reduces its still high inventories (despite some improvement).

Disclosure:  Long COLM

Paired Trade: Buy JNJ, Sell AGN

This is the second in a series of paired trade ideas that I intend to share over time.  As I stated in the original article, these articles will be hopefully quite succint, with the goal of sharing the overall thesis.  By the way, that first trade recommendation, which was 5 weeks ago, has been marginally profitable thus far, with the buy up 34% and the sell up 26%.

I have followed AGN more closely than JNJ but currently own JNJ in a portfolio I manage for my family as well as in both of my model portfolios, Conservative Growth/Balanced and Top 20.  I typically prefer AGN, as it has a better growth profile over the long-term, but these aren't typical times.  AGN has run up lately on acquisition rumors that may or may not pan out, while no one will be acquiring JNJ!  Here is the "score sheet":

 

I believe that AGN is properly labeled as a mini-JNJ, as both are in pharmaceuticals, devices and consumer products.  In the device area, both have extensive facial and breast franchises. They actually compete in the eye area too. In any event, it is clear that AGN has more growth, which is primarily a function of its size. Note that the balance sheet metrics are extremely similar. The only glaring differences are in valuation.

 

The longer-term relationship has regressed towards the mean after a spike last year that left AGN quite cheap on a relative basis.  The recent acquisition rumors along with Botox not falling off as much as feared has propelled AGN to a level that is quite overextended in the short-term, while JNJ is somewhat oversold still.  This trade is a conservative trade, taking advantage of the recent spike in AGN to get a "median" type of valuation swap at a time when one might suggest that the better diversified company (JNJ) would command a premium.  AGN has more exposure to a weakening economy in my opinion, and it makes sense in this environment to take the higher dividend and lower absolute valuation.  Coming out of the economic downturn should prove to be a better time to pay up for AGN.

Disclosure:  Long JNJ

Paired Trade: Short NLC and Buy MPR

I have been posting to Seeking Alpha for over two years now.  My articles tend to be focused on individual companies (negative or positive, but always with a conclusion), ideas that come from screening, thematic ideas, economic data interpretation, or investment strategy/outlook.  My contributions rarely suffer from tersity!  Today I am introducing a new category of articles:  Paired Trades.  I intend to publish these types of ideas on a regular basis.  Like today's discussion, future contributions will be quite brief but hopefully highlight my underlying rationale.

A paired trade in its truest form allows an investor to simultaneously short a security that is expensive and go long one that is cheap without taking market risk.  Here in Texas, we have an altogether different definition that allows you to double your risk (i.e short gold and short bonds).  Kidding aside, the key element is to try to take out all sorts of risk by choosing appropriate candidates.  They need to be in the same or similar industry and with somewhat similar market caps.  Even in these cases, the securities can continue to diverge greatly from "value" due to other factors. 

In the case of my paired trades, I am not necessarily saying to short one and buy the other, but instead suggesting to perhaps buy the cheaper one instead of the other if one is looking to invest in the industry, to sell the expensive one if one has a position in both, or to swap for the cheaper one if one owns the richer one.  The point is to try to reconcile valuation differences.  Doing one leg of a trade can result in a "Pyrrhic victory", where the one you buy goes down less than the other one, but you lose nonetheless, so caveat emptor.

So, with the background behind us, both Met-Pro (MPR) and Nalco Holding (NLC) are Industrials with exposure to water treatment and filtration, pollution control and other industries.  They compete head-to-head very marginally from what I can gather:  Water treatment.  Even there, NLC focuses on larger customers.  Here are some key metrics:

In a normal economy, I wouldn't be paying attention to the table above, as NLC, despite being extremely leveraged, would cruise along just fine as it rolled over its debt and used its FCF to pay dividends, repurchase stock, do acquisitions, etc.  These are not, however, normal times.  The company has debt maturities of almost $1 billion each in 2010 and 2011, and the CEO doesn't seem to be too worried. 

Here's what has been going on that may explain why the stock has performed well:

• Large initial purchases by Buffet and Dell in Q4
• Operational improvements in terms of EBITDA margin expansion

Here's what I think the market is missing:

• Focus should be on pre-tax rather than operating margin, and it will be pressured from higher interest-rates and weaker margins as business contracts
• covenant ratios aren't that close to being violated, but watch out with more chops to Goodwill or a deterioration in EBITDA.

MPR reports to have about 40% recurring revenue.  I believe that due to its smaller scale and some mix differences, it's level of profitability is lower than that of NLC and would normally suggest a discount on EV/Sales.  MPR definitely got hit hard in Q4 in its capital equipment focused on pollution control.  My interview with management suggests to me that the company is the leader in a bunch of small attractive niches with plenty of drivers to help them combat the economic headwinds the company faces.  The extremely strong balance sheet and the relatively low valuation offers a lot more support to the stock price than NLC.  After a strong year in 2008, the stock has "caught up" to the market after the recent disappointment, while NLC has gone the other way on folks noticing the Oracle of Omaha.  I certainly don't want to "dis" Mr. Buffet, but like all humans, his timing has been off at times.  In this case, he owns about $100mm of NLC, which pales in comparison to the debt they need to roll.  I have an end-of-year target of 12 on MPR and 5 on NLC.

Bottom-line:  MPR is a gem of a company with a superb balance sheet that few follow and that just got its stock price chopped in half (allowing me to buy and to add to my model portfolio), while lots of folks have their eyes on NLC but are looking at the wrong thing (Buffet's interest rather than the weak balance sheet).

Disclosure:  Long MPR