Lately, the stock has not done too well - in fact it is down about 25% in the last few weeks. So I have been doing some digging to see if anything changed regarding the fundamentals.

The main trigger for the decline seems to be an analyst downgrade (2 levels below previous). Rather strangely, the main reason he gave for the downgrade was the lack of stock price appreciation in response to a positive event (more on this later). I expect a better reason from a professional analyst: if there is no fundamental deterioration and the price is lower than before then I would expect the stock to be upgraded rather than downgraded.

The positive event the analyst referred to is the recent sale of a neighboring oil field asset by Anadarko (NYSE:APC), which established a comparable market value to HNR's relatively illiquid assets. Now the APC sale established a value of proven & probable ("2P") reserves of about $6 to $8 per barrel of oil equivalent. Using comparable metrics, the enterprise value of HNR implies that their oil & gas assets are being valued at $3 per barrel of oil equivalent, implying that the stock is selling at least 50% below what just the Venezuelan assets are worth. Note that the "Chavez" discount would be shared by both APC and HNR assets since they are neighboring fields. And there are more assets outside Venezuela that are not being valued in the stock price at all.

Today the company announced its Q1 results which indicate that the recovery towards normal oil production is still intact, albeit a bit slower than I would have liked. Production is up to 13.3Kbpd which is up slightly from last quarter. While I am a bit disappointed at the slow pace of progress, most of the disruption due to the two year hiatus seems to be finally over, and normal operation seems to have resumed. During the conference call, the CEO suggested that the peak production that is possible (based on pre-disruption 2004 performance) may be in "mid 40Ks" range, as more and more production drilling takes place. And since the fixed costs are high, every extra barrel of oil produced adds disproportionately into profits.

The CEO also hinted at more stock buybacks ahead - he suggested that the stock price is irrationally cheap but that the $18M pre-approved buybacks could not be done due to constraints of quite period following internal news about the quarter. Since the total EV is only about $200M, a buyback of about $18M can be significant. The CEO also said that the analyst downgrade made no sense to him.

HNR has been adding geographical diversity to their asset base with fields in Gabon, Indonesia and (recently) two small fields in US, further reducing risk and improving the chances of positive surprises.

But the main reason to invest in HNR is the huge leverage as production recovers from the current 13kbpd (where its a bit above break even due to large fixed costs) to a possible figure near 30 to 40Kbpd over the next few quarters. This will also add to the recovery factor assumed in pricing the assets under ground which also should add to the enterprise value of HNR.

I think that HNR is even more attractive at the current price and the weakness over the past month presents a great buying opportunity.

It has $189M of net cash. I estimate its diluted Earnings/ADS share to be approximately $0.7 so PE@13/sh is about 18. Its fast growth thus implies a forward PEG less than 0.5, making it compellingly cheap at the current price.

I think its a good way to bet on alternate energy as well as China, now that the Chinese market has had a large correction.

The stable growth pattern of Brazil and good fiscal management has dramatically declined inflation and interest rates (into single digits down from 20%+) in the last few years. The fast growing middle class and the cheaper availability of home financing (no subprime!) has created a significant demand for affordable housing. In response Gafisa, which started out as a high end builder, is now focusses on the affordable segment of the market. Gafisa will also benefit from increasing leverage as external bank financing for longer term mortgages becomes available.

2007 actuals:
Operating Revenues $697M (up 77%)
EBITDA $109M (margin improved to 15.7%)
Net income $85M (up 89%)

Analysts based in Brazil expect EPS for 2008 to be around $2.5/ADR share (I computed this average of 15 analysts by converting to USD and adjusting for ADR ratio).

This translates into 2008 PE of around 15 and since I expect annual growth to exceed 30% for the next few years, it seems cheap at PEG of < 0.5.

A near term catalyst is the stock's recent inclusion in EEM & Bovespa indexes.

I think GFA is a good way to bet on Brazil.

Unfortunately, fundamental metrics seem to indicate that the housing problem still has a long way to go before it will turn. For example, using ratio of home prices to rental rates as a metric, economists are suggesting that average home prices have declined only 10% of the 25% needed to restore affordability.

A full 25% decline will cause about 20 million people to have negative equity (25% of all homes). This will result in $6 trillion or $7 trillion in total capital losses in housing and $1 trillion of that will be losses to the financial sector. So far only a fraction of that has been declared. Thus we will continue to see more declarations of losses for quite a while.

On the other hand, the inventory of newly built house has finally stopped rising and even started declining due to sharp reductions in new houses being built coupled with the drop in prices. If this process continues then eventually we will reach the point at which new houses will have to be built again and normalcy will be restored. I think we are still multiple quarters away from this point.

Since the stock market is a discounting mechanism it should recover somewhat sooner that these underlying fundamentals would suggest. Thus there is a reasonable probability that we will see the market turn this year, although not perhaps within the timeframe of this round of our competition.

The housing situation impacts the entire portfolio, but it particularly impacts two of my positions: LOOP and RATE.

Loopnet (LOOP) is the leading online "MNLS" type listing service targeting brokers of commercial real estate. They make money on subscriptions and hence are indirectly driven by real estate transactions rather than on prices. They reported in their last release that they are seeing revenue shift from buyers to sellers who pay them to list their properties. I think LOOP is still a good buy at this point so I will continue to hold it.

Bankrate.com (RATE) is the leading website that aggregates information on mortgages, credit cards, automobile loans, money market accounts, certificates of deposit, checking and ATM fees, home equity loans, and online banking fees. It makes money by supplying this information to leading newspapers (100+ papers, including WSJ, NYT & USA Today) as well as by charging for click-thru when users click on its rate table entries. Its business has held up really well through this crisis (in fact it has continued to grow!). This is because shifts in interest rates drive fresh traffic to its website as consumers shop for optimal rates. I think this will be a good stock to own right through the housing recovery.

An opacity discount is currently available on my largest holding, Harvest Natural Resources (HNR), a US company which has most of its assets located in the politically risky Venezuela.

In March 2006, Chavez forced all foreign oil companies to transfer substantial chunks of ownership to a state owned company in exchange for ownership of some new unexplored fields. The situation remained foggy until October 2007 when a new decree was signed and the new ownership terms finalized.

While some "crazy dictator" discount is justified, I think the market has overreacted in this case due to lack of visibility caused by the hiatus in releasing quarterly financial numbers from April 2006 until now.

HNR owns $97M in net cash (= $2.7/share) and has an enterprise value of $311M. It is trading below $13/share at the time of this writing.

HNR can be valued in two different ways:

Asset based Valuation:

HNR owns proven reserves of 1.3 Barrels of oil equivalent (Boe) and 2.2 Boe of proven+possible (P2) reserves. Past analysis has put a value of $8/Boe on comparable Venezuelan P2 reserves, which implies a stock price of $21/share for HNR. This ignores the third category of "possible" unexplored reserves (P3); if we include this, HNR owns 4.3 Boe/share which would imply a much higher valuation.

Cashflow based Valuation:

HNR produces 15K barrels of oil/day (down from 30K/day in Jan05 & up from 14K recently). Using a DCF analysis with 10% discount, the company estimates the net pretax value to be $1.7B. Taking out 50% in taxes leaves a DCF valuation of $27/share.

To be sure, one needs to apply a huge (50%?) "Chavez" discount to these numbers. On the other hand, there are significant upside factors that could increase the valuation significantly:

- HNR will be short receiving a one-time back-payment for oil delivered but not paid for the period Q2 2006 to Q3 2007.

- Now that the money is flowing again, HNR will ramp up production quickly. It should be able to double the current production of 15K bpd to 30K bpd, the rate before the Chavez disruption took place. Workover of old wells now should add value (one workover rig started operating Dec 07). A New rig is starting in Q108 and 1 more being selected for Q2 and another for 2009. Last time they had 2 drilling rigs they went from under 20K bopd to over 30K bopd in 6 months. This could be a 2x upside.

- The boe/share numbers assume a recovery factor of 13% which is conservative since they have demonstrated a factor of 27% in the past. Upside of 2x. The converstion of P3 into P2 and P2 into P1 will add value.

- The $8/boe figure assumed above was used when the price for Venezuelan oil was $46/b. It is now $80/b. Another 1.5x upside.

- HNR also owns fields in Indonesia and Gabon that are unexplored and hence not priced into the calculation so far. Unknown upside.

Taking into account all of these possible upsides, I think HNR is significantly underpriced, even after applying a 50% Chavez discount.

The near term catalyst for HNR will be the earnings release for Q4 and FY2007. Since the company could not post its numbers since April 2006 until the agreement was finalized, the stock price has been severely depressed due to lack of visibility (think of all the screens, indexes, and ETFs for which HNR failed to qualify). As this situation gets fixed in the next few weeks (expected release before mid-March), the stock should provide a nice return.

In the meanwhile WSJ is now reporting the first signs of weakness in commercial real estate, suggesting that the weakness is spreading:

The report is an early sign that the commercial-property sector is being dragged down by the growing reluctance of lenders to extend credit for anything related to real estate, which in turn could create a new drag on the economy and additional problems for investors. Declining commercial-property values could lead to an increase in default rates on commercial real-estate loans and on commercial mortgage-backed securities.

I own Loopnet (LOOP), which is the leading online "MNLS" type listing service targeting brokers of commercial real estate. They make money on subscriptions and hence are indirectly driven by real estate transactions rather than on prices. I think LOOP will benefit from any change in conditions which causes more transactions; hence I think it is a buying opportunity on any further weakness.

Thus I think for now I well stick with both SRS and LOOP even though at first glance they seem to be bets in the opposite directions. SRS should directly benefit from the forthcoming markdown of prices and LOOP from the resulting froth.

The problem with getting thru FDA approval for such pain killers is that patients on the placebo arm of the trial often drop out (since they don't get relief) and hence its difficult to get meaningful statistics. This problem has plagued PTIE in the past. The last quarter's earnings release, however, seems to suggest that they are close to the finish line. Remi Barbier, Pain Therapeutics' president and chief executive officer: ``In Q4 2007, we plan to release top-line results of our Phase III pivotal study for Remoxy, our abuse-deterrent opioid painkiller. For now, the Remoxy study remains blinded while the last patients' data are being gathered.''

Subtracting out $206M of cash, today's enterprise value of PTIE is $282M which seems cheap given the potential for a widely used pain killer; if the anti-abuse feature works, it may well induce doctors to switch their standard of practice for prescribing opioids fairly quickly. In order to fund their R&D, PTIE has made a distribution deal with King Pharma which provided them milestone based cash, as well as a 20% royalty on future net sales of drugs, (15% for the first $1.0 billion of net sales).

I think the chances are good that the next few months will see a string of positive news and hence established a new position in PTIE.

I closed out my position in IBN (with a nice gain) as well as took some profits in FMCN in order to raise the cash for the PTIE purchase.

My own take is that the dollar had a lot of pressure to fall due to trade and budget deficits that are long term problems and that the rate cut was the proximal trigger that catalyzed the adjustment process. See for example, international trade specialist Paul Krugman's analysis of the situation. If this is true then the situation will take a long time to resolve.

I think this implies favoring stocks of non-US companies. While many investors think of holding just US stocks as a conservative strategy, I think it that, on the contrary, it is a very risky position to be in since it is essentially equivalent to betting 100% of one's portfolio on a single currency (USD)!

In particular, I like the prospects of blue chip Indian companies ICICI Bank (see my previous post) and Sterlite. The Indian Rupee has appreciated 11% last year (one of the strongest movers against the USD) and these two companies will benefit from the heavy investment in infrastructure that is needed by a rapidly emerging economy. The relative fraction of assets allocated to India (and China) in the MSCI World Index is still a small fraction of the ratio of its GDPs to world GDP (using exchange rates and even more so when using PPP numbers) so, despite the huge gains in the Indian (and Chinese) market over the last few years, I feel that the world portfolio allocations are still underinvested in India (and China).

I also think that the housing market has a long way to fall. According to the Standard & Poor's/Case-Shiller US National Home Price Index, US home prices increased 86% in real, inflation-corrected, terms from 1996 to 2006, but have since fallen 6.5% - and the rate of decrease has been accelerating. This index was created by economist Robert Shiller who specializes in bubbles; he sees housing as a global bubble which has just started to correct with a long way to go. I have placed my bet on this unwinding by buying SRS. This represents a contrarian take on the rate cut in the sense that I think that the cut provides a transient boost to real estate related stocks which, in turn, presents a buying opportunity in SRS due to the false belief that housing has already bottomed.

Here is an excerpt from a Seeking Alpha transcript of a recent presentation ACUS sales chief made to investors that I think explains their lead product pretty well:

We've got a broad technology platform in microspheres... Our microspheres are porous and they could be customized depending on the application. [The Imagify molecule] is a synthetic shell [that is made of] the same sort of material that's used in disposable sutures. So, it has a long history of safe medical applications.

And finally, the payers. As I started this fact, there is a lot of concern about the cost of nuclear, and the overall use of such an expensive procedure. And of course, given all the things that I have just told you, you can see that ultrasound would be cheaper.

It sure seems to me that their Imagify contrast agent for ultrasound is likely to get approval from FDA since it significantly improves upon the current test in being both cheaper and much more convenient. ACUS has announced plans for filing for approval before the end of this year. And yet the stock is down a lot last year. Why? My guess is that investors are nervous about their weak cash position ($50M) and are betting that it will need to raise more money soon and hence dilute the existing shareholders. While this may happen, my bet is that they will announce some kind of partnership soon to strengthen their cash position. The news stream is therefore likely to be positive from here on out over the next few months.

I think the market is still overly optimistic in its expectation of real estate recovery. The boom in real estate over the last decade is of historic proportions, comparable to the high tech boom of the late 90s. The Yale economist Robert Shiller (the co-creator of Case-Shiller real estate indexes which underlie corresponding futures that trade on the CME) has made a careful study of real estate prices in the US over the last 100 years and found that in real terms (i.e. taking away inflation) real estate prices have basically been flat until this latest boom! See for example the graph created by Shiller to show real house prices over the past century.

In a recent survey of buyer attitudes, Shiller found a large degree of denial about the markdown of prices; in fact the buildup of inventories in an indication of this denial. Home inventories will shrink and the market will clear when sellers finally accept lower prices. See also this and this for more interesting commentary from Shiller.

And from today's WSJ, note the delinquencies trend in the graph on the right.

I feel, therefore, that there is a reasonably high probability that real estate still has a long way to fall and a fairly low probabability that prices will continue there recent boom. SRS should do well as prices fall; I will sell my position when the it seems that the market is actually clearing as people start marking their expectations to reality; it might take a few years.

Incidentally I sold a small portion of my HNSN position yesterday in order to bring the porfolio into compliance; I remain very bullish on HNSN.

I still need to adjust a couple of percentages to bring the portfolio into full compliance but I think I'll wait until the special situation with HNR plays out; this should happen once Chavez has signed the new contractual agreement.

The first three cylinder are firing and the fourth has a decent chance of succeeding. As a near term catalyst, ICICI plans to sell a stake in its insurance subsidiary near the year end, which is also market leader in the fast growing insurance market. This should add visibility to this hidden gem within ICICI and could provide a nice bump to the stock.