I’ve just returned from the Las Vegas Money Show. I was startled by the number of investment advisers that are lukewarm or outright bearish towards the market. In one session I followed Joe Battapaglia, who gave a negative presentation for the first time I can ever remember. His litany of reasons the market is in trouble followed almost to a “T” my PowerPoint slide series that lists the bad news (falling home prices, continuing subprime write-offs, dazed consumers, high oil prices, hurricane season coming, geopolitical risks). The second slide in that series says the bears are probably right about all those factors, but they are wrong about one thing: The stock market is going up anyway.
The reasons, of course, start with the fact that all those negatives are known and in the market. If CitiCorp keeps writing off $10 billion a quarter for the next year, will you really be surprised? Then there’s the little matter of $4 trillion in cash on the sidelines, record short selling and record put buying. The ingredients are there for a massive bear trap, and it will have to be a big one to catch all the bears I heard in Las Vegas.
Although 1420 is putting up more resistance than I expected, today may be the breakthrough day. I still think the most likely path for the S&P 500 is to grind up to 1440, consolidate around there, give us one more dramatic plunge back to 1395 or maybe 1350 in a late June/early July “summer swoon” to get the bears short again and the bulls back on the sidelines, and then run up 20% in 21 trading days, just like in early 1991. The swoon might come from a big negative earnings preannouncement (Google? Apple?), or an Obama raise-the-capital-gains tax white paper, or something bad in Iran–who knows? The rally just depends on realizing that things will not get worse in the short run, as the Fed’s firehose of liquidity continues to run full blast even if they don’t cut interest rates again.
But, I am open-minded on this, and as always we will let the market tell us what to do. At the moment, it is lifting off the March 17 bottom in what is starting to look like a parabolic upturn, similar to tech stocks in 1999. But that can change, and if the S&P fails at 1440 and then breaks all the support levels down to 1270, I’ll be on the alert for a real bear market signal. It sure doesn’t look like that’s happening today, though.
We’ve had a few more companies reporting earnings, and I have a couple of changes I’d like to make to my recommendations, as well as some “get readies.”
Biotech MegaShift
Amgen (AMGN) spoke at a Robert Baird Health Care Conference. Discussions with the FDA are ongoing over exactly what the new Aranesp label will say. It sounded like we’ll have an answer in six to nine weeks. Denosumab data for osteoporosis in post-menopausal women will come in the September quarter, and based on the clinical results so far, that may be the event that lights up this stock.
They are now calling 2008 a “reset” year in which they will earn $4 to $4.30 a share, and then resume their double-digit growth from that new base. So why is this stock still selling for only 10X earnings? I have no idea. It is grossly mispriced, and will be one of the prime targets when that $4 trillion starts coming off the sidelines. Hold the Amgen January 2009 $70 LEAP call (VAMAN). Buy the Amgen January 2010 $40 LEAP (WAMAH) under $10 with a $20 target.
A Note on Leaps
Thanks to the subscriber at the Las Vegas Money Show who reminded me to remind you that when the exchange introduces the January 2011 LEAP contracts, the 2010 contracts probably will take a hit–the former “furthest out” contracts always do. LEAPs trade in three cycles, and the Cycle One contracts will be listed on Tuesday, May 27 (May 26 is Memorial Day). Cycle Two lists on Monday, June 30 and Cycle Three on Monday, July 28. In next week’s issue, I will give you a specific strategy to sell the 2010 and then buy them back while minimizing the time you are out of a market moving up. Of course, if the S&P runs right up to 1440 and then starts to fall back, we may be able to accomplish this very gracefully. In that case, you’ll read my advice here or in a Flash Bulletin.
CombinatoRx (CRXX) reported last week. They booked a net loss of $16.7 million or 48 cents a share, but that included $1.7 million of stock-based compensation, so the pro forma loss was closer to 43 cents. They used $13.6 million in cash in the quarter and have $99.0 million left, enough for seven more quarters of similar losses. But with the good news from their Phase 2a clinical trial of CRx-191 in plaque psoriasis, they are looking for a development partner that would bring a cash infusion. In addition, they have a lot of trial results coming this year:
- CRx-102 Phase 2b knee osteoarthritis clinical trial data in the second half of 2008, with Phase 2b rheumatoid arthritis data following in early 2009
- CRx-197 Phase 2a topical dermatology clinical trials for plaque psoriasis and atopic dermatitis, with data in the second half of 2008
- CRx-401 in Type-2 diabetes data expected in the second half of 2008
Good data on any of these will mean more partnering discussions and more cash in the door. R&D expenses hit $17.0 million in the quarter, up from $12.8 million last year, with the increase due mostly to the CRrx-102 and CRx- 401 trials. There will be an R&D Day on July 23 to go through the entire product pipeline in detail.
Management reconfirmed their guidance to do $15 million to $20 million in revenues this year with a pro forma loss of $49 million to $55 million, leaving them with $58 million to $64 million of cash. CRXX is a very cheap stock with a $7 buy limit and a $16 target price.
Crucell (CRXL) posted good results, with revenues up 36%, the gross profit margin up sharply from 23% to 40%, and their net operating loss cut in half. About half of the loss was from currency changes: The weak dollar and the strong Swiss franc. They reiterated full-year guidance for 20% growth in sales and positive cash flow. They are trying to reduce expenses (excluding R&D) by 15% by the end of 2009.
The travel vaccine business is good, and the real growth can be seen in their 5-in-1 childhood vaccine. As I’ve said before, I am not comfortable with this product as I think it is a terrible idea to give even single vaccines to babies under the age of six months, but the medical establishment disagrees with me so far. Crucell picked up another $150 million in government orders for 2008 and 2009 to go with the $230 million they announced last December, and I’m sure there’s a lot more coming.
The company’s rabies vaccine is on a fast development track in the Philippines, and we’ll get Phase II results for their pandemic flu vaccine this quarter. They were able to find an antibody that seems to be capable of neutralizing not just H5N1 avian flu, but all pandemic strains so far known to man, including the Spanish Flu. In animal trials, even when the vaccine was given when the animals were sick and ready to die, this antibody saved their lives. They have a number of other vaccines in trials, either with partners or on their own nickel, and one of the attractions of this stock is the very broad pipeline based on their human cell line production technology for vaccines. The stock moved up a couple of dollars after the report and went over my buy limit, so buy CRXL only on dips under $17 for my $35 target.
Content on Demand
Telkonet (TKO) reported March quarter revenue of $5.0 million, tripling last year’s results. The company has a record backlog, including contracts with more than 2,400 customers that will generate about $3.6 million in annual recurring support and Internet advertising revenue. They also have purchase orders under a major utilities energy management initiative. One contract is for $600,000 now, with committed future sales of $4.5 million for products and services through March 2010. They recently partnered with another energy efficiency program in Wisconsin that will grow to 5,000 rooms. Yet another $3.8 million contract with a national hotel chain covers energy management devices in 16,000 rooms. The current order backlog for this contract alone will generate $2.5 million in revenue in the June and September quarters.
On the conference call, management said market researchers peg the energy management market alone at $25 billion by 2011, thanks to high energy prices. There are increasing federal and state pressures on utilities to provide rebates and incentives to customers installing energy-efficient products. Telkonet’s new CEO has refocused the company on this opportunity and the sales force is meeting with utilities to help them develop programs for their service areas. Telkonet also works with large commercial customers and franchisers to set up corporate programs directly with utilities.
The company continues to do well in the hospitality industry and government, and has some recent wins providing broadband over power-line systems to schools. TKO is back on track, and expects to be cash flow positive this year. Even though the stock is selling for less than 50 cents a share and about a $32 million market capitalization, I still think their opportunity is gigantic. I am maintaining my $5 buy limit and $15 target price in the expectation this will be a billion dollar market capitalization company at some point in the next few years.
New Energy Technology MegaShift
Eugene, a subscriber, asked a timely question regarding solar power stocks.
Q. “How do you rate solar stocks such as (STP) and SunPower (SPWR)?”
Below about $100 a barrel for oil, solar economics don’t make sense unless someone is messing with the free market and subsidizing solar systems. That’s a shame, because all the way down at $40 oil, some alternatives make sense: onshore windpower, wavepower and geothermal. At $50 to $60 oil, Canadian tar sands, Rocky Mountain shale oil and coal to oil make sense. But solar has a great lobby, both here and in Europe, and has captured most of the alternative energy subsidy dollars.
One factor people rarely discuss is the quality and longevity of the solar panel. The gold standards are Kyocera, Sharp and BP panels; they’ve been in the business for years. Solar installers tell me those panels might go for 25 years, while some of the newer entrants might only last 10 years. A builder wanting to advertise solar homes might go for the cheaper panels–they don’t care what happens in 10 years, and the customers don’t know the difference. I’ve heard solar installers justify using the cheaper panels because in 10 years panels will be so much better that they ought to be replaced. Well, maybe.
I am actively looking for another solar investment to back up Energy Conversion Devices (ENER), which not only jumped 40% in one day last week, but has gone on to hit my $55 target price. I think we can squeeze a little more out of ENER, so I recommend holding for another $5 or $10. I hope to have another solid solar recommendation shortly to switch into.
Connacher Oil & Gas (CLL.TO) reported knockout results. The great news is that the steam-assisted gravity drainage (SAGD) technology we bought this company for is working better than expected. In only two months, with 14 of the 15 well pairs fully converted to SAGD, daily production is running 7,000 to 8,500 barrels a day, on its way to better than the 10,000 barrels a day design target.
Steam is made by burning natural gas, and the company produces more gas than it needs from its own wells. The bitumen is then sent to the refinery they own in Montana, which they bought from Holly Corp. (HOC). Every refinery’s business has been squeezed by the rapidly increasing price of crude oil, so Connacher is delaying some capital spending on the refinery until margins improve. I still expect that to happen during the summer driving season–that’s why I recently recommended buying Holly. Connacher is increasing their overall capital spending budget, in part to drill more conventional gas wells and in part to buy long-lead-time items for Pod Two.
Management said if their March cash flow was annualized, it would exceed $125 million, and they expect cash flow to grow with production. They now plan to be profitable for 2008. Although the stock went up some in response to the news, it is still very undervalued as the low-cost, environmentally-preferred producer of bitumen from Canadian tar sands. Their integrated approach to the business, burning their own natural gas to run the SAGD process and then refining their own bitumen, was costly to establish, but is starting to pay off big time. The stock is right on the edge of my $4.50 buy limit, and the $9 target looks more and more realistic.
Energy Focus (EFOI) reported $4.8 million in sales for the first quarter, a drop of 3% from last year’s $5 million. However, this was a good quarter because the declining swimming pool product sales (related to the housing crunch) were almost completely offset by a $1 million increase in EFO sales. (EFO is their new high-efficiency LED/optical fiber product, with immediate applications in cold storage and freezer displays.) The year-over-year revenue decline in the December quarter was 24% due to swimming pool products, so this was a good showing. They lost 28 cents a share compared to 23 cents last year, and have $14.8 million in cash, including a $9.4 million financing in March. They have committed to burn less than $5 million of that in 2008.
The new CEO from Johnson Controls, who came from sales and marketing, said they still expect to double EFO sales in 2008 to $14 million, and get those products up to 50% of total revenues this year. Traditional products will continue to decline at a 15% rate this year. My model has them showing year-over-year revenue growth beginning in the September quarter for sure, and possibly a bit ahead in the current June quarter. Their backlog of orders is double what it was last year.
They have a test installation of the EFO-ICE products in a freezer case at a U.S. Commissary facility, and the government is a natural market for them for the next several years.
Larry, another loyal subscriber, asked:
Q. “Why is EFOI not enjoying a rally along with other “solar/energy efficient” stocks? Is it time to ‘turn off’ this company’s lights?”
Companies are just waking up to how much their utility bills are rising, and I think by the end of the year most of us will be shocked at the office and at home by electric bills that are 50% higher than today. Although it took them a while to pay attention, cutting utility bills by using EFOI LED products or Telkonet energy management system gives such a fast return of investment that business should be great for years to come. EFOI is quite small and I wouldn’t expect it to be one of the first movers, but ultimately I think it will be one of the biggest movers in the energy efficiency group. EFOI is a Top Buy up to $6 for my $15 target as they turn a technology-based company into a marketing-driven company.
Infinity Energy Resources (IFNY) reported March quarter sales of $1.2 million, down from $2.1 million last year due to the sale of assets to Forest Oil. The operating loss was $796,000, much better than last year’s $2.2 million loss (that included some unusual items). They are in a second forbearance period with Amegy Bank that has a May 31 deadline to pay off $7.1 million of the bank line. Amegy will probably grant an extension, but they could require IFNY to sell their Texas properties.
Forest Oil has started drilling under the joint venture agreement, and Infinity can cut costs and muddle along for a long time with oil prices this high. But that’s no reason to own the stock. The reason to own the stock is that they have a total market capitalization of less than $8 million, yet they have a 1.6 million acre leasehold concession in the Caribbean Sea off the coast of Nicaragua that probably contains one to five billion barrel oil fields. On the conference call, they said a neighboring leasehold has jumped through all the hoops and is about to start drilling, so Infinity is ever more comfortable that they will get permission to push ahead.
If Amegy Bank wants to play hardball, they can bankrupt Infinity at anytime. But I don’t think they will, and as they get paid off (earning gluttonous fees along the way) Infinity will review the seismic data on their leasehold and look for partners to exploit it. The people now running the company are level-headed and well connected, and I would buy IFNY all the way up to $2 for a $7 first target based on the ultimate value of their Nicaragua concession.
Rentech (RTK) reported $28.5 million in sales for their March second quarter, up 68.6% from last year thanks to continued strong demand for fertilizer to grow corn for ethanol. Still, their loss grew to $22.8 million or 14 cents a share as they increased selling, general and administrative expenses by 50% and doubled R&D, where they are expensing the costs of building their pilot plant in Commerce City, Colorado. That project remains on schedule, and their first commercial production facility near Natchez just qualified for a $175 million tax-exempt project-financed bond issue.
They have $31.2 million in cash left and are quietly downsizing the company to take corporate spending to a level that can be supported by the free cash flow from their REMC fertilizer plant. As it turns out, buying this plant to convert to coal-to-liquids was a mistake, because they never could figure out what to do with the carbon dioxide the Fischer-Tropf process produces. But they lucked out as fertilizer prices boomed thanks to the ethanol scam, and they might be able to sell the plant for what they have invested in. I would tell them to do it, rather than count on these high fertilizer prices to last for many years. On the other hand, reducing costs is always a good idea as long as they don’t cut muscle, and what they need to do now is get the pilot plant going and then partner and build as many production plants as possible.
Yesterday, they said the pilot plant is mechanically complete and will be producing synthetic petroleum liquids–jet fuel, ultra-clean diesel and chemicals–by the end of June. It eventually will produce 420 gallons of liquids a day, at first from natural gas and later, when their gasification equipment is turned on, from coal, biomass and a variety of feedstocks.
On the conference call, management said that rather than sell stock at these low levels, they will borrow the money to complete the Colorado pilot plant and buy the land for the Natchez operation. That land is over 400 acres, and it has lots of buildings and other infrastructure that they can use or sell.
An announcement around the end of June that they are producing liquids from the only synthetic petroleum facility in the country should move the stock. It also will let RTK sign a series of contracts to evaluate and test the liquids in various applications, and they’ll announce all of those. It’s been a longer wait than I thought, with a major misstep at the fertilizer facility where good luck has counted for more than good planning, but we are finally on the edge of cashing in. Buy RTK all the way up to $4 for my $8 target as they move towards commercial production in Natchez.
Nanotechnology & Materials MegaShift
Subscriber Robert from Fremont had a great question about IPG Photonics.
Q. “In December of last year IPG Photonics (IPGP) released some interesting news on their newest products and claimed ‘Heavy industry applications, such as shipbuilding, pipelines, gas tanks, aerospace, and construction, can now weld thick metals outdoors or very large pieces at the highest power levels with the flexible beam delivery of IPG’s lasers.’ Is IPGP the type of company that will outperform for the New World Investor?”
The quick answer is yes. I’ve been working on a package recommendation of IPGP and Rofin-Sinar Technologies (RSTI). IPGP is the dominant company in second-generation fiber lasers, while RSTI is the leading producer of traditional lasers. But the slowdown in business capital spending, a lagging indicator that will probably be soft for a whole year, is creating a headwind for these industrial companies. RSTI is at 19X earnings and their business probably will be hit harder than IPG’s, but IPGP is at 28X earnings. So I decided to wait for what seems like an inevitable earnings miss, and then just recommend IPGP at lower levels and a lower valuation.
New World Economy MegaShift
I sent you the following earlier today in a Flash Alert:
Cnet Networks (CNET) will be acquired by CBS for $1.75 billion, or $11.50 a share. That’s well below my $17 target price, which I expected to see after Cnet showed better monetization of their traffic, and it’s a great deal for CBS. As I say on the website: “This could turn into a multi-year hold, or it could be bought out at any time.” Even though we are booking a 8.6% profit in eight months during a tough overall market, I am sorry to see the company sold so cheaply. But this is a done deal, unless Jana Partners, the dissident shareholders that led a proxy fight, won’t go along and look for a higher bid. Hold CNET for now until we see if there is another bidder. We’ll sell the stock in a few weeks if the CBS is the buyer and $11.50 is the price.
Security MegaShift
American Science & Engineering (ASEI) missed their revenue target due to a 62% drop in sales of Z Backscatter vans. They also announced a $9.2 million order for these vans from a Latin American country, an order they could not book in time for the March results. So they did $42 million in sales, down 8.5% year-over-year, while Wall Street was looking for $46.4 million. In addition to the shortfall and product mix impact on profit margins, they had sharply higher R&D expenses that hurt the bottom line. Earnings dropped 52% from last year to 42 cents a share before a 12 cent bad debt write-off. The consensus was looking for 65 cents.
ASEI always has unpredictable quarterly results, which is why they don’t give quarterly guidance. Their orders are huge and lumpy, but it is still a great, dominant business in the security area. The stock fell on this news, and ASEI is a Top Buy at these levels and all the way up to my $59 buy limit for an unchanged target price of $93.
WiMAX MegaShift
Airspan (AIRN) reported earlier, and I reviewed the numbers last week. My conclusion was to keep buying the stock up to $3 for an $8 target after they turn profitable. AIRN makes very high quality hardware, especially for mobile WiMAX, and it always tests out right near the top in competitive analyses. But I learned something new this week: Their software is pretty bad, to the point that it is hard for their own engineers to make the hardware work well in a system application. This seems to be the real reason the company doesn’t convert as many trials to orders as they should.
Software problems can be fixed, but it takes a while and this small company simply may not have the talent to do an adequate, let alone superior, rewrite of their software system. From these prices, I am willing to give them more time to get things straightened out, in part because there are a number of companies that would buy them just to get the hardware designs.
As I said last week, they have enough cash to survive, and the stock is selling for about four months’ revenues, or around $25 million for the whole product portfolio after you adjust for the cash. That still doesn’t make any sense. But bad software will cap the stock at a lower target price than I’ve been thinking, so I am moving AIRN to a hold for a reduced $5 target in a buyout or after they turn profitable.
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