The volatility continues, although it is starting to feel more like a game to force the Fed to cut rates on September 18 than a real reaction to some new news. You see, the plunge on Tuesday came out of the blue, and the commentary was all about old issues, followed by “the Fed had hoped their actions so far would stabilize markets, but that hasn’t happened.” Then yesterday’s big rally was attributed to hope that the Fed will cut the ever-important Fed funds rate on September 18 “or even sooner.” These hopes were ignited when Chairman Bernanke sent a letter to Senator Chuck Schumer saying that the central bank would “act as needed” if the economy appeared to be imperiled by the troubles in the financial markets.
Note that he didn’t say that the Fed would act just because of the troubles in the financial markets. But for Wall Street mucky-mucks and hedge fund managers, those are the only troubles that matter — yearend bonuses are imperiled! So, strategists on CNBC were saying that a Fed rate cut is “imperative,” and you can bet that if tomorrow’s Bernanke speech at the annual Jackson Hole conference doesn’t say something to acknowledge these financial pressures, the market will tank again.
So, let’s assume that the Chairman is backed into a corner and cuts rates. Then what? The dollar will plunge, but it won’t affect most Americans because they don’t travel to Europe. Today’s June-quarter GDP revision up to +4.0% shows that the economy is OK so far, and Wall Street already expects growth to slow to +2.0% in the current quarter. Surveys show that both consumer and business spending will grow in the December quarter, although at a slowing rate. Earnings will be OK, in part thanks to the falling dollar. The VIX Fear & Greed Index, which dropped less than three points yesterday while the S&P 500 gained more than 30, is still high enough to power a 200-point rally. So, as you can see, we’re not at a point where we need to be panicking and throwing stocks out the window.
The breathtaking round-trip for the SPX over the past few days was just the expected test back down to the last breakout level at 1430, although it seemed like a bigger deal because we are in a much larger pattern than we’ve gotten used to over the last year. That’s good, because it keeps the possibility of a parabolic upturn intact. Tuesday’s drop and Wednesday’s rise looked very similar to the Friday drop and Monday rise back on August 3 and 6, when the S&P broke back over 1455 and ran to 1503. Here we are again.
This is a critical balance point, and we will either get one last panicky test down to 1405 before heading up, or just break out right now. It depends on how the news goes in the economy, housing, a sub-prime mortgage bailout to buy votes for the 2008 election and the Fed. But even if we get the panicky test, I think that the market is setting up for a big run. With virtually everyone looking for weakness or a possible crash in the dreaded September to October period, what better trick for the market to play than rally right through that and on into March 2008?
The August 16 bottom looked like a major low to me, and if that’s the best that the bears can do before the Fed rides to the rescue, the next easy direction is up. We should see the S&P get over 1479 and then break through 1530, 1555, 1610 and 1710. At any or all of these levels there could be quick, scary declines or periods of consolidation to build energy for the next upleg.
If the market does go down first in the traditional September to early-October weakness, it will be weaker earnings news and preannouncements that drive it. One market analyst swears that stock market crashes often start with a lunar eclipse, which we had before dawn on Tuesday, and said that the sharp Tuesday drop didn’t surprise him. I haven’t seen his comments, if any, on the offsetting Wednesday rally. Predictions like this need to be taken with several grains of salt.
Our best course of action is to stay calm, take advantage of weakness here and there to add to positions, and wait for the market to tell us if it really wants to go down substantially from here. My read is still that a big rally is coming, possibly a parabolic move up, and we need to stay fully invested. So, I have redone the Top Buy list this week to focus on the stocks that I think can move the most over the next few months in an up market.
With that said, let me just point out one thing. I know it’s hard to watch our holdings take a beating when the market is having a down day. But it’s important to remember that we are focusing on development-stage companies in emerging industries. So these companies are bit more susceptible to the market’s down days because they are riskier positions. In the long run, though, these companies have the potential to dramatically outperform the market because they are operating in areas of rapid real growth, often in MegaShifts that are happening on a worldwide basis.
Now, let’s take a look at what’s been happening in our MegaShifts this week.
Biotech MegaShift
Amgen (AMGN) scored two straight wins in their patent lawsuit against Roche, and the next big win for the company will be with the FDA on September 11. The Federal District Court in Boston ruled that Roche’s CERA drug clearly infringes on one of the five patents that Amgen alleged, and the court granted Amgen’s motion for summary judgment. This was the same composition-of-matter patent that Amgen used to beat Transkaryotic Therapies, before the same judge. The judge also ruled against Roche on a number of its other defenses. A trial starts on September 4 on the other patents, if Roche really wants to fight an endgame before settling and paying legal costs and royalties.
On September 11, the FDA’s Cardiovascular and Renal Drugs Advisory Committee and the Drug Safety and Risk Management Advisory Committee will hold a joint meeting to consider the risks and benefits of Aranesp, Epogen and Johnson & Johnson’s Procrit in kidney dialysis. The agenda will be available about 48 hours prior to the meeting. I do not expect any change to the current treatment recommendations, but these types of meetings can be unpredictable. So, I’ll keep you posted on the outcome of the meeting.
The new Medicare rules on when Aranesp and Epogen will be reimbursed when used for cancer patients have been out long enough for the medical community to come to a consensus: They are unworkable and will not save any money. Private payers, which account for 60% of cancer reimbursement, are likely to adopt an 11 grams per deciliter (g/dl) cutoff for hemoglobin before using the drugs, down from the current 12 g/dl but more practical than Medicare’s 10 g/dl limit. At some point, Medicare will be forced up to 11 g/dl due to stresses on the blood supply and poor patient outcomes, but that could take a year or two.
With the patent win, the September 11 meeting soon to be behind us and private payers about to adopt a less damaging hemoglobin policy than Medicare, Amgen’s stock should be ready to recover. Plus, the company’s cost reduction program will protect earnings, and they have a terrific pipeline of new drugs. Buy the AMGN January 2009 $70 LEAP calls (VAM AN) up to $12.50 for my $25 target — over 13X on your money from current levels.
Content on Demand
Akamai (AKAM) has several officers selling stock under distribution plans filed with the SEC, and that caused Peter to ask: “This stock seems to have a large overhang of ‘Planned Sales’ by a bunch of management. Why buy when they are saying sell?”
There are two reasons that these sales don’t mean anything. The first is that technology managements get a large percentage of their compensation in stock options, to align their interest with ours: Do well, and get the stock up. It makes no sense for them to hold every share, because they would be terribly underdiversified with most of their assets in one stock, and their job is also dependent on that one stock.
So, it is normal for all tech companies to have a steady stream of small insider selling. What used to make people angry was when the selling accelerated just before bad news came out. This led to the plaintiff’s bar suing every company that had a problem and a declining stock, alleging that the stock sales before the bad news were based on inside information. So, companies implemented Planned Sales, where a management person commits to selling a fixed number of shares every month, regardless of the price or news. Usually, the amount sold is trivial compared to the amount owned.
So to sum up the second reason and this long-winded answer to your question is: Planned Sales don’t have any information in them, because by definition the stock will be sold whether the coming news is good or bad. They aren’t saying sell — they aren’t saying anything. The company lawyers won’t let them. I am taking AKAM off the Top Buy list because it has gone over my buy limit, but I still would buy it on any dips under $30 for my $60 target.
QuickLogic (QUIK) was the subject of an article in EETimes Online that focused on the company’s change in strategy from competing with Altera and Xilinx to selling Customer-Specific Standard Products. But the reporter put a negative spin on it, saying that the company chose the wrong technology for the older PolarPro line introduced in late 2005.
The truth is that QUIK’s one-time programmable PolarPro only fits a few niches in the traditional Altera/Xilinx markets of telecom, storage and networks, but it is a natural for the consumer handheld device market. So, QUIK has introduced the ArcticPro with a controller included. They can sell the customer a low power-using, ready-to-go chip that is specific for a customer’s core platform, and the chip can be easily modified to add or subtract the features that create a full line of products. Thus, a line of music players could include one with hard disk storage, one with removable flash memory, one with a Wi-Fi connection, one with a Wi-Fi and a Bluetooth connection, and so on — all based on the same QUIK design. The chips would all have long battery lives, instant-on use and any kind of copy protection (or none). By using these chips in their products, QUIK’s clients can get to market quickly, keep introducing new variations of the product and adapt to their new customer demands.
With the holiday product building season starting directly ahead, now is the time to complete your QUIK position. I’d hoped to get the second half of our positions closer to $3, and it did trade down to $3.06 for a minute at the August 16 bottom, but otherwise this stock has been very stable between $3.25 and $3.50 during the whole decline. I am making the stock a Top Buy and raising the buy limit to $4. I want you to build a full position now. My target remains at $8.
New Energy Technology MegaShift
Energy Conversion Devices (ENER) reported a pretty good quarter and gave decent guidance, but an analyst downgrade clipped the stock. The company reported sales up 29% from last year to $36.0 million, of which United Solar Ovonic accounted for $29.5 million, up 36%. They lost 16 cents a share before restructuring and retirement charges, compared with the consensus for a 12-cent loss. Some of those retirement charges are because founder Stan Ovshinsky is retiring on Saturday, and Bob Stemple is handing over the CEO slot on Sunday, while keeping his spot as Chairman of the Board.
The company guided for $40 million to $45 million in sales for the September first quarter, higher than the consensus for $41 million. For the June 2008 fiscal year, they are looking for $220 million to $245 million, compared with an average estimate of $228.4 million. Gross profit margins will remain under pressure as they dramatically expand their solar production capacity, but the restructuring program will start to pay off, and there will be a second round of cost reductions before the end of 2007. It looks to me like they are headed in the right direction, but the Cowen & Co. analyst said that he expects profit margins to fall as the company introduces new products, and they won’t be profitable until fiscal 2009. That’s what clipped the stock.
I am still looking for them to turn profitable this fiscal year, in the March or June quarter. In addition to expanding their existing solar facility to 58 megawatts capacity, their new 120-megawatt facility is on schedule. They are moving some assembly to China and Tijuana, with the latter facility also on schedule and budget.
The new CEO, Mark Morelli, was President of the Carrier Commercial Refrigeration unit of Carrier Corporation and has a good reputation as a nuts-and-bolts manager. With Bob Stemple still in the ambassador-at-large position to the auto industry, the Cobasys joint venture with Chevron should continue to roll. ENER and Chevron are looking at “strategic alternatives,” and I expect them to take it public in the next six months if the market is as good as I expect.
I think the decline in the stock is a temporary reaction to a negative analyst, and this is a buying opportunity to get ENER well under my $35 limit for the $55 target.
FuelCell Energy (FCEL) jumped after they reported June-quarter results and announced two contracts that may finally open Wall Street’s eyes to what is really going on here. First, the numbers. Revenues hit $13.5 million, up 55% from last year and well ahead of the $11.9 million consensus estimate. That included product sales of $7.8 million, up 45%. They lost 24 cents a share, down from 37 cents last year and better than the 33-cent loss consensus estimate.
The first contract that FCEL won is with Ford Motor, which is buying a fuel cell for a Canadian plant. It will reduce paint solvent emissions from painting cars. The plant produces about 200 pounds of volatile organic compounds per hour in the painting process, and Fuel Cell Energy will feed those compounds into their fuel cell to produce electricity! It is scheduled for startup in early 2008, and if all goes well, I expect Ford and other auto makers to install many more units.
The second contract with the Turlock Irrigation District here in California will use methane from wastewater treatment to drive a 1.2 megawatt fuel cell power plant, producing electricity to run the District’s pumps. In both of these cases, an emissions problem became the feedstock for a power plant. It is not just about hydrogen any more.
FCEL’s Direct Fuel Cell stationary plants run at a 47% efficiency rate, well above conventional power plants, and a combined cycle plant where the customer can use the waste heat approaches 80% efficiency.
In Connecticut, all of FuelCell Energy’s 68 megawatts of clean energy projects were submitted by two utilities for consideration by the Connecticut Department of Utility Control, which is expected to render its decisions on which projects to fund by December. When FCEL breaks above resistance at $10, it is going to soar. There are 14.5 million shares sold short, or 31% of the float. Buy FCEL while it is under $11 for my $22 target.
Ocean Power Technologies (OPTT) drew a question from Scott: “What do you have to say about OPTT that would make me hold it rather than selling at a loss of over 20%? It is now down to 63% of your Buy Up To price and 32% of your target price. Why is it not a Top Buy? Is it going to continue heading the other way?”
I have liked the way OPTT has acted during this volatile period, as it seems to have a rock-solid bid at $12, except for the August 16 panic dip. I think that we saw the bottom that day. But the reason to hold OPTT is that they are winning new contracts and pilot installations, and wavepower is about to take its rightful place with geothermal and onshore wind as an alternative energy technology that does not need subsidies to be practical today. Chevron just filed for a wavepower farm off the Mendocino coast of California, and I am going to follow the permitting process with great interest. This is just the sort of demonstration project that could turn Governor Schwarzenegger from solar to wavepower as California’s main alternative energy source.
Ocean Power is not a Top Buy because there is no near-term event to be the catalyst for a sharp recovery in the stock. It deserves to be in the mid-$20s, and it will get there. But every stock on the new Top Buy list has a major catalyst coming before the end of the year to drive it much higher. Still, OPTT is a superb buy at current levels and, as Scott pointed out, all the way up to $20 for my $40 target.
Robotics MegaShift
iRobot (IRBT) will introduce two more types of home robots on September 27 at the Digital Life Expo in New York. Management is being coy, just saying that they are “very cool” and “very different” from the Roomba and Scooba. The CEO said: “They’re not floor-cleaning robots. They’re not lawn mowers, and they’re not butlers. But that’s all we’ve said so far. These robots are going to make you think.”
That made me think that I should try to find out exactly what they are, and I found one in an FCC filing: A gutter-cleaning robot. iRobot has to get FCC approval because there is a remote control antenna on it, and they filed the whole owner’s manual.
I don’t know where “Looj” came from, but this looks just like the toy that your Dad wanted when he was five years old. Will this be the Dad holiday gift of the year? It has two cool treads, a handle to put it in position that detaches to become a remote control (requiring FCC approval), and a very cool “distruptor/ejector/sweeper” auger assembly out front for clearing out the drains. Then a 500 RPM rotating sweeper scrubs the gutter. The manual says that it does one gutter at a time, so it has to be moved by hand at any gutter junction. It has a belt clip to make it easier to move around — how can your local Tom The Toolman hold up his head if he doesn’t have a Looj on his belt? I want one, and I have gutter covers.
I haven’t been able to find the other new product — laundry? Ironing? Walk the dog? The company released the Verro pool cleaning robot in April, so they could be going in any direction. “These robots are going to make you think.” Hmmm — will it be a chess robot? A football coach robot? We’ll see on the 27th.
Roomba is one of the most successful consumer robots ever made, with well over 2 million units sold. The new Roomba 500 series that tops out with the Roomba 570 for $400 is the first major revamp since 2004, and it is getting great reviews. It has double the suction power, lasts up to five times as long because all the components are modular and can be replaced by the owner, can automatically clean multiple rooms using a “lighthouse” guidance system, shuts off when it gets to tassels on the edge of a rug, and can get itself out of most jams. It includes a voice tutorial built in to the vacuum, which you can watch here.
iRobot managed to sell off its inventory of the last models ahead of this release, so there shouldn’t be a hit to earnings this quarter other than the usual introduction expenses.
Even as the consumer business starts to grow again, the military side looks great. PackBot robots have saved many, many soldiers’ lives in Iraq, and the Department of Defense now wants a next-generation Small Unmanned Ground Vehicle to let soldiers remotely conduct reconnaissance and get real-time intelligence while remaining out of harm’s way. For example, a soldier could toss one of these robots through a window to search a building for enemy combatants, instead of sending in troops. iRobot is working with Boeing to develop SUGV Early, and they will deliver the first prototype early next year. It will be a lighter and smaller version of the 60-pound PackBot, coming in around 30 pounds. The CEO said: “That’s going to be a huge new leg on the government and industrial side” of iRobot’s business. Market researchers believe that the market for PackBot-class robots over the next three to five years is about 2,000 to 3,000 units, but the market for SUGV-class robots is about 10,000 to 20,000. They’ll also be bought by SWAT teams and possibly commercial security firms. Incidentally, iRobot has other robotics projects underway with Lockheed Martin, Taser and Deere (the robotic organic farmer?).
The stock is above my buy limit, after the big jump earlier this month following their increased guidance. I don’t want to raise the buy limit because at this point I can’t see more than $30 for a target price, but buy IRBT on any dip under my $19 buy limit for the $30 target price.
Security MegaShift
SiRF Technology (SIRF) is getting cheaper and cheaper for absolutely no good reason, so I am making SIRF a Top Buy for the next several months. It’s trading at the same levels that it did two years ago, but earnings are 4X higher now than then. The Price/Earnings ratio is about half of its growth rate. This is a gift.
I think Wall Street is worried about SIRF’s market share and their exposure to Motorola’s (MOT) cell phone business. Competitor STM Microelectronics won a design at Garmin for a chip with an integrated processor. SiRF will use technology from their recent Centrality acquisition to introduce a similar product. But SiRF already has integrated the RF (radio frequency) functions, and STM Microelectronics has not. It will be much easier for SiRF to add an integrated processor than it will be for STM to add RF.
The point here, though, is that the market and applications for GPS technology are exploding, and both SIRF and STM are in the right place. Wall Street is focused on design wins, when they ought to be looking at overall market growth. I want you to add SIRF to your portfolio immediately, with a $22 buy limit and a $40 target.
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