Technology is changing rapidly, and so is the way people use it. Ask anyone under 20 this question: “If you had to give up one of these, which would it be: Email, text messaging or Internet Messaging?” Virtually every one will say: “Email.” Does that surprise you? It shouldn’t. People want to communicate with one another in the fastest and most efficient manner.
Luckily for us, as Alan Kay, an Apple Fellow, once said: “If computing was a baseball game, we would be in the first inning.”
Companies are throwing money right and left at projects to develop new technologies to make our work, home and play easier. This year, Microsoft will spend over $6.5 billion on Research & Development (R&D), mostly for developing software. IBM spends over $5.8 billion on R&D for semiconductors, semiconductor production equipment, software and communications gear. Cisco will spend over $4.3 billion this year on advanced communications products. Applied Materials spends about $1.2 billion on R&D for new ways to make semiconductors. And Intel spends about $5.6 billion a year on R&D of new semiconductors. That’s a total of over $23.4 billion this year just from these five companies to keep pushing the technology envelope, cutting costs, improving products and integrating technology into our lives. People always seem surprised at the rate of change technology is causing in our lives, but with this kind of push, what do they expect? Heck, even Google will spend over $1.2 billion a year on R&D this year, and they weren’t even a factor in the first 40 years of commercial computing.
An example of how all this R&D spending will increase the rate of change, look no farther than supercomputers. Ten years ago, a teraflop supercomputer at Sandia National Labs took up 2,000 square feet of floor space, used 10,000 Pentium processors and ate 500 kilowatts of electricity.
Now fast forward to present day. If you recall, a couple of weeks ago, I talked about the Intel and IBM process breakthroughs that will let us build ever-smaller semiconductors in line with Moore’s Law for the next 15 years. Now Intel has a supercomputer processor in their research labs that has not dual cores (two processors) or quad cores (four processors), but 80 cores. The numbers are staggering. It can do a trillion calculations a second (one teraflop) on a chip the size of your fingernail, running at a reasonable 3.16 gigahertz clock rate, using only as much electricity as a 60-watt light bulb. Intel is stacking the memory in three dimensions on top of the chip to transfer an incredible 80 billion bytes a second.
That’s 2,000 square feet to a fingernail in 10 years.
Intel is targeting market introduction in 2011, as it will take five years to make it work in a real system, learn how to make the chip and get the necessary software written. But it is coming, and it will drive many new MegaShifts that we can only guess at today. A supercomputer on every desktop…and no let up in the rate of change as far as the eye can see.
While Intel’s and IBM’s breakthroughs will create incredible opportunities to invest in the upcoming years, right now with the market taking off due to the weakening dollar, I’m seeing some real opportunities in lagging or recently-hit stocks. I sent you a Flash Alert on Monday on Silicon Image (SIMG) and a new buy on Energy Conversion Devices (ENER). Today, I’d like to tell you about another opportunity to invest that should give you a double over the next two years at most — and probably by the end of 2007 — in one of the biggest and best biotech companies.
LEAP Into Amgen
Amgen (AMGN) is one of the largest biotech companies, with a well-established portfolio of drugs. Its original Epogen drug, which was licensed to Johnson & Johnson for use in cancer in Europe, supports people on kidney dialysis or chemotherapy by stimulating the production of red blood cells to treat or prevent anemia. Aranesp is the new version of Epogen, and Amgen has the worldwide rights in both dialysis and cancer.
Neupogen, their second drug, stimulates the production of neutrophils to fight infections. It, too, has a second generation version named Neulasta.
Enbrel, the primary drug that the company received when they acquired Immunex in 2002, inhibits tumor necrosis factor (TNF), and has applications anywhere there is an excessive response to inflammation or immune threats, such as psoriasis and rheumatoid arthritis.
Amgen’s major collaborations are with Alcon on treatments for eye diseases, with Predix for oral autoimmune drugs, with NPS Pharmaceuticals for hyperparathyroidism, and with Cytokinetics for oral drugs to treat heart failure. The company used to be very secretive about its pipeline of drugs, but a couple of years ago they decided to lift the curtain and really dazzle Wall Street with the breadth and depth of their research programs.
The stock dropped from $87 in September 2005 to $65 last July, and then recovered only partly to $75 in January this year, before sliding back under $70 to $68.28 today. Wall Street is worried about the usual issues: Reimbursement rates, because Medicare and SSI pay most of the dialysis bills, and competition from new drugs. But Amgen has been very skillful at protecting their reimbursement in the past, and the competitive issues are no different from any other major biotech company.
The key to this recommendation is their broad product pipeline coming through trials, their proven ability to get drugs approved and on the market in a big way, and their demonstrated lobbying skills in protecting their reimbursement rates. With the Democrats in control of Congress, there is sure to be continual pressure on all drug prices — but that has been priced into the stock for months.
Although some analysts are using 12-month target prices of $110 to $114, I am only looking for $95 over the next two years. Like my recent Intel recommendation, this is a situation we want to participate in, but not by owning the stock. There isn’t anything wrong with making 37% on your money over the next two years, but we can squeeze a double out of the same move by buying the January 2009 $70 LEAP call contract (VAMAN). I know some of you have not bought options in the past, but these LEAPs run for nearly two years and are as easy to buy as the stock. You do need to get your account qualified with your broker to buy options, but that usually takes less than a day and you only have to do it once. LEAPs are OK for retirement accounts, too. So, I want you to buy VAMAN under $12.50, which is roughly equivalent to a $70 price on AMGN stock. At my $95 target price for AMGN stock, these LEAPs will sell for $25 and you will double your money. If the more enthusiastic $110 projection comes true, you’ll have better than a triple.
More on Energy Conversion Devices
Energy Conversion Devices (ENER) reported earnings last Thursday and dropped $5.85 on Friday, closing under $30 a share. I sent a Flash Alert on Monday morning urging you to buy back into the stock with a $32 limit. If you recall, we sold ENER in January 2006 at $50.63 for a 119% gain in six months, and I have been watching it ever since for another buying opportunity.
If you read my original July 14, 2005 recommendation on ENER, you know that one of the big reasons why I like the company is that Bob Stemple, the former CEO of General Motors, is running it. He has entrĂ©e all over the world to the automobile companies that are making or planning hybrid cars, and ENER’s Cobasys joint venture with Chevron to make nickel-metal hydride batteries for hybrid vehicles is a major contributor to revenues right now. Since my first recommendation, ENER has announced NiMH wins for the Ford Escape and Mercury Mariner, Honda Accord and Toyota Camry. They already had the Toyota Prius and the Honda Civic. Plus, they have at least another dozen trials and negotiations underway, and have been chosen by Hyundai for that company’s forthcoming hybrid.
Also since my first writeup, ENER has doubled production capacity for the United Ovonic Solar thin-film photovoltaic roofing material, just in time for the worldwide solar boom funded by government subsidies. They will be increasing capacity by 10 times over the next four years. The cheapest way to go solar is to install an Ovonic roof at the time a house or commercial building is built or re-roofed, because the owner has to pay for the labor anyway.
Finally, Ovonic Memory Systems has signed additional technology licenses with Intel, Elpida Memory, STMicroelectronics and Nanochip since my first recommendation. This product line will have a longer-term payoff as it moves from research to production over the next three years or so.
As I said in the Flash Alert, ENER stock was hit because management pushed out their profitability forecast by about six months, from the June quarter to the December quarter. Big deal. With dominating products in two of the biggest Green Tech areas — hybrid cars and solar power — and a potentially major kicker from Ovonic Memory technology replacing flash memory, making money in this stock is primarily an issue of buying it right. The last time we bought it, I didn’t plan to sell it so quickly, as I think of it as a three- to five-year holding. Of course, if it shoots back up to unsustainable levels, like it did last time, we will take profits rather than fall off the surfboard and drown. But I am hopeful that we will see a classic “steadily up and to the right” chart for the next few years. I want you to buy ENER under $32 for a $55 near-term target. If you are nervous abut the market or the stock, at least buy half a position, and then buy the other half at $25 or $35, whichever comes first.
Avian Flu MegaShift
Crucell (CRXL) reported $99.9 million in sales (76 million euros) and a small profit before one-time charges in the December quarter. After three acquisitions, including Berna Biotech, the company looks very different from last year. The new 5-in-1 childhood vaccine is selling well since the October introduction, and seasonal flu vaccine sales were noticeably strong. They did $185.2 million in sales for the full year, and expect to increase at least 42% this year to $263 million. They also said that they will be operational cash breakeven in 2007.
Working jointly with one of their licensees on the human cell line vaccine production technology, Crucell announced a yield breakthrough. They can produce monoclonal antibodies with fermentation yields of more than 10 grams per liter, a target they set just one year ago. That is 10 times the current standard, and Crucell thinks that they will be at 20 grams per liter this year. That allows smaller bioreactors and lower production costs, bringing this technology closer and closer to the day it completely replaces chicken eggs in vaccine production.
The stock sold off about a dollar a share due to the size of the one-time charges, but, hey, that’s why they call them ONE time charges. We won’t see them again this year. Crucell remains an excellent buy under $28 for my $50 target.
Biotech MegaShift
Affymetrix (AFFX) reported earnings late last week, and the news was pretty good. The conference call was even better. The company did $104.2 million in sales, below last year’s $111.5 million, and reported earnings of 13 cents a share, well below last year’s 43 cents. But the results were good because AFFX returned to profitability after the September quarter’s 21-cent loss, placed their new 500K array chips in the market in December, and clobbered the Street estimate of four cents a share. They also got their gross profit margin back to the 60% area, and said that it will stay there in 2007.
I believe that for three reasons. First, the higher-margin 500K chip just started shipping and will become a larger and larger percentage of sales this year. Second, AFFX will introduce a one million array chip midyear. Third, they are pushing hard to get diagnostic chips and systems into the market — many with partners — so they can reduce their dependence on selling to research labs, where budgets and timing can be fickle.
The company said that they have about 20 clinical diagnostic programs in development, mostly collaborating with partners. Affymetrix will open a clinical services laboratory later in 2007 to make it easier for doctors and clinics to transition to the new systems. The FDA recently issued draft guidelines for In-Vitro Diagnostic Multivaiate Index Arrays, which is the long way to say Affymetrix diagnostic chip systems. The FDA also just approved the first of these tests, an Agendia system named MammaPrint. It measures the expression level of 70 genes associated with recurrent breast cancer and calculates the probability of the cancer spreading. That should help doctors design more personalized treatment programs.
Affymetrix is the best-positioned company to take advantage of the enormous amount of data coming from human gene sequencing, both in providing much of the equipment to do the sequencing and also in using the information to create diagnostic products. The stock moved up about a dollar on this news and then another 76 cents today, but we had plenty of time to buy it under $26. AFFX can be bought on any market-related dip under $26 for my $40 target. If it doesn’t come down soon, I will probably raise the buy limit, to make sure that everyone has the opportunity to get onboard.
Biogen-Idec (BIIB) reported good results this morning, but missed Wall Street’s estimates and the stock slid $2.49 today. December-quarter revenues increased 11.9% to $708.3 million, driven by sales of Avonex for multiple sclerosis and Rituxan for rheumatoid arthritis. But that was also a bit short of the $714 million analysts were looking for. Tysabri contributed only $30 million in sales in the quarter, but has now been prescribed to over 10,000 MS patients. The company gave a very positive outlook for Tysabri in 2007, saying that they have trained enough doctors and clinics to let Tysabri become a significant contributor to sales and earnings.
After adjusting for special items, BIIB reported 53 cents a share. Analysts were looking for 54 cents. The company guided for 2007 revenue growth in the mid-teens and $2.50 to $2.65 pro forma. That was in-line with consensus expectations for 15.6% growth and $2.57 a share. So, the hit to the stock was based on a $5.7 million revenue shortfall and a one cent per share shortfall.
Our LEAP calls were hit for $1.50 today, closing at $7.80. Our January 2008 $45 contract (YZUAI) remains a strong buy under $12 for my $23 target, or higher.
Content on Demand MegaShift
Silicon Image (SIMG) reported last Thursday and the stock was killed on Friday, causing me to put out a Flash Alert that you should have received Monday morning. As I said in the Flash Alert, the December quarter was good, although by the time I adjusted the numbers for one-time events, SIMG was three cents per share short of the consensus. And their guidance for the March quarter was a little light. The March period is not important for consumer electronics, and certainly not important enough to knock the stock down $2.93 on Friday. The company guided up for the full year, looking for $340 million to $360 million in sales, well above the consensus for $343 million. Yet the stock has not recovered from Friday’s drop and is still selling for only 12.3X my 75-cent earnings estimate for this year. That’s very cheap for 25% to 30% growth. So, I’m adding SIMG to the Top Buys, and I recommend that you buy a full position or even a little more in SIMG at these prices. The buy limit remains at $13 and target price at $20.
New Economy MegaShift
Omniture (OMTR) will acquire Touch Clarity, a London-based provider of automated behavioral targeting software and services. Omniture is paying up to $60 million and can now offer automated analytics to their existing data collection software service. This is an incremental revenue opportunity, and it is already fully integrated because Touch Clarity was an Omniture development partner. The deal will close by the end of March and will add to sales but dilute earnings for 2007. The new pro forma revenue range is $134 million to $136 million, up from $128 million to $130 million. The new earnings range is three cents to five cents a share, down from seven to 10 cents a share. The stock was knocked from the high $14s to the low $14s due to the lower earnings forecast. I recently raised the buy limit and target price on OMTR to be sure you own this dominant provider of web analytics, and I want you to buy OMTR now under $15 for my $22 target.
New Energy Technology MegaShift
Barclays Capital published a report arguing that global warming will provide as much opportunity for some growth companies as it will harm others, and the net result will boost the global economy for the next 25 years, rather than have a devastating impact on economic growth. They pointed out that every energy source evolution, from dung to wood to coal to whale oil to oil, was stimulating for the economy. Every major technological change was accompanied or followed by faster economic growth.
I agree broadly with these conclusions, recognizing that many of the changes will be disruptive to our food supply, the way established companies do business, and even real estate values. Many areas of the economy will have to restructure to cope. However, change and risk equal opportunity for our New Energy Technology companies, which have a chance to displace older energy companies — or sell out to them. We need to increase world energy capacity by 50% by 2035, while at the same time reducing dependence on hydrocarbons generally, and in-ground oil specifically. Our companies will lead this energy revolution, and I am working on a couple of more ideas for this MegaShift. But for now, let’s take a look at two of our holdings that reported earnings recently.
Holly Corp (HOC) reported a good quarter, with sales up 15.5% to $938.1 million, net profits up 19.5% to $47.7 million, and earnings per share up 29.2% to 84 cents share. That was a penny above expectations. Refinery margins slipped a bit to $12.08 per barrel from $13.71 in the fourth quarter of 2005, which is not surprising since that quarter followed Hurricane Katrina.
For the year, sales of refined products rose sharply to $4.02 billion, up 32.1%, while earnings per share jumped 72.8% to $4.58. That was the third straight record year, thanks in part to their 4.5 million share buyback. The company raised the quarterly dividend 25% to 10 cents a share.
In 2007, the Street consensus is for $2.77 billion in sales and $3.55 earnings per share. That assumes oil prices stay around $60, which may be right for the first half of the year, but I expect it will be low for the second half. I am looking for $4 billion in sales, essentially flat with 2006, and $4 per share, reflecting some additional squeeze on refining margins. However, HOC is not just an oil price story. The company specializes in refining sour crude, and since their July 2006 plant conversion, they can now produce ultra low sulfur diesel at their two refineries in New Mexico and Utah. In California, that’s the only kind of diesel you can buy, and all 2007 diesels can only run ultra low sulfur fuel. In Europe, 40% of the new cars are diesel, designed to burn ultra low sulfur.
I expect U.S. sales of diesel passenger cars and light trucks to accelerate dramatically over the next few years, because they are very economical compared to their gasoline brethren and no longer pollute. My Ford Excursion diesel gets about 18 mpg on the highway, or 14 mpg towing, while the V-8 and V-10 gasoline versions get eight mpg to 12 mpg, if they’re lucky. And I don’t have to get a California smog certificate, because the engine burns clean.
Holly’s focus on handling sour crude gives them a technology edge, which qualifies them for this MegaShift. At a price/earnings ratio of 15.1X the consensus estimate or 14.5X my estimate, the stock is still cheap. In 2005, Forbes ranked Holly’s five-year annualized total return of 80.7% as the best in the oil and gas industry. In 2006, Forbes ranked HOC’s five-year average growth in earnings per share of 52.3% as #1 in the oil and gas industry. This is a well-managed company, and HOC remains a buy under $46 on any oil-price related panic, and otherwise a strong hold for my $60 target.
Rentech (RTK) reported sales of $35.4 million in the December quarter versus essentially nothing last year, when they did not own the East Dubuque, Illinois, fertilizer plant. They lost six cents a share, compared to five cents last year. The revenues are funding a big increase in R&D, where the company spent $8.4 million, compared to $1.3 million last year.
Most of this spending is going for equipment and construction of their Product Development Unit, a fully integrated Fischer-Tropsch, coal-to-liquids demonstration facility in Commerce City, Colorado (near Denver). The plant will demonstrate the process by producing fuels and naphtha from various hard and soft domestic coals, petroleum coke and even biomass and municipal solid waste feedstocks. The fuels will be provided as test quantities for potential customers, such as the Department of Defense, and also to companies that want to investigate using the Rentech Process. This plant should be physically complete in the September quarter and come online around the end of this year.
Another chunk of R&D is going to convert the East Dubuque plant to an integrated clean fuels and ammonia production facility. That should come online in late 2009 or 2010, and will be the first commercial scale application of Fischer-Tropsch technology in the United States.
Their two projects with Peabody coal are also advancing, with the scoping phase expected to take the rest of the year. Deals with Williams Coal and Arch Coal seem to be coming along slower. The Natchez project with the German energy company DKRW is moving forward with a six- to 12-month feasibility study. DKRW is also working on their 11,000-barrel day project in Medicine Bow, Wyoming, where they have contracted to sell clean diesel to Sinclair Oil.
Senators Obama and Bunning introduced the Coal to Liquid Fuel Promotion Act of 2007, a bipartisan bill to provide meaningful incentives to accelerate CTL production of clean fuels. The bill includes valuable tax credits for the equipment to handle carbon dioxide. Another piece of legislation under consideration is to make CTL fuels part of the Strategic Petroleum Reserve.
Rentech ended the quarter with $53.8 million in cash, so at their current $8.7 million burn rate, they have enough cash to last six or seven quarters. I expect them to sign more deals and increase sales from the fertilizer plant to stretch out their cash. The price of the nitrogen fertilizer that they produce has soared due to the demand for more corn for ethanol, while the price of their natural gas feedstock has been pretty stable, leading to improved profit margins.
RTK is a Top Buy under $5 for my $11 target, and it is more and more obvious that this will turn into a multiyear holding for much higher prices.
Robotics MegaShift
iRobot (IRBT) fell $2.79 on 1.2 million shares after they reported an unexpected loss for the fourth quarter and guided down for 2007. Sales rose 31.5% in the quarter to $61.1 million and they lost eight cents a share, even though the gross profit margins improved a couple of points to 37.5%. Consensus expectations for a six-cent loss were a little higher, but the real disappointment was management’s forecast for 2007 of $225 million to $235 million in sales (19% to 24% growth) and eight cents to 15 cents per share. Estimates had previously ranged around $250 million and 30 cents.
The company sold 725,000 Roomba vacuum and Scooba floor washing robots, plus another 385,000 units to the military and industrial markets. Management said that they will enter a third category of robotics in the second half of the year, and they expect that to be another growth accelerator.
So, this is still a fast-growing company, with improving margins and new products coming. I think IRBT is weaker in marketing than I originally thought, but I still believe the robot hobbyist/inventor/science fair kit for $149 that they introduced at the Consumer Electronics Show is going to pay huge dividends.
Just to be cautious, I am lowering the buy limit $1 to $18 and the target price $8 to $30, but I still think you should buy IRBT on this drop.
Market Outlook
I discovered at last week’s Orlando Money Show that many advisers were waiting for a 3% pullback in the S&P 500, from about 1450 to under 1407, to buy stocks. My analysis said that was unlikely to happen, as the S&P cleared major resistance in the 1435 to 1440 area. Sure enough, after a quick test back down to 1435 on Friday, Monday and Tuesday, the market took off. The next stop up is 1510. While there could always be a test back down to the 1450 breakout level, we are more likely to find a temporary resistance/support level on the way to 1510 that will be tested, followed by a slingshot up to the old highs at 1552.
I think we will break through to new highs this year, although it could be postponed to 2008. It depends on how fast the dollar gets weaker under the Bernanke “money from helicopters” regime. When it does break into new high territory, watch out — we could easily hit 1800 before this party is over. I recommend that you get fully invested right now, if you aren’t already. The Intel and Amgen LEAPS are a good place to start.