Tom A's Stock Picks

An alternative to LDK

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I did a lot of work on LDK: I analyzed the company in depth and from there I went on to review the entire solar industry. After completing my review, rather than make the call one way or the other on LDK, I would strongly recommend a smaller, but potentially more rapidly growing competitor: China Solar Titan (CST).

CST has a unique, patented method of converting Metallurgical Grade Silicon to the higher purity solar grade. To give you an idea of the importance of this process, please consider the following: Metallurgical Grade Silicon (98.5% pure) costs $1 per kg, while solar grade (6N, meaning six nines - 99.9999 pure) costs $200 per kg. CST's process is unique in that it does not rely on Trichlorosilane (TCS) and as such does not produce the pollutant silicon tetrachloride (STC). CST estimates their cost will be in the range of $1.19 to 1.91 per kg. There has been much environmental concern on these issues, as China is developing a reputation as a highly polluted country. The PRC is subsidizing CST because of the importance of their new, high and clean technology. Indeed, the academic work leading up to their process was performed at government expense.

The only drawback to the process is that it utilizes large amounts of electricity, approximately twice as much as the conventional methods. However, CST has a 40 year fixed price contract for low cost hydroelectric energy, reaffirming the government's commitment to make the process competitive. As an additional source of energy, they plan to set up a solar farm in the Ghobi Desert, which will supply their power requirements by tapping the area's abundant solar potential.

CST recently announced that they have pre-sold 400 gigawatts of solar wafers under a 20 year, fixed price contract to a large and as yet unidentified South Korean firm. This represents 85% of their projected production for the period. Also, a source close to the matter has stated that they also are in the final stages of negotiations with a consortium of Mideastern investors who are developing alternatives to petroleum energy exports. Their pilot plant has been producing for three months and has only recently achieved the required degree of purity, producing 2,000 metric tons per month. Total Construction Services (TCSI) is supervising the construction of their plant, in a modern suburb of Shanghai, P.R. China.

A person familiar with the investment thinking of Warren Buffett has intimated that the Oracle of Omaha will be involved, estimating that his stake will be similar to what he took in China Natural Gas (CHNG). The source quoted Buffett as saying he liked the Kaching from CHNG and figured he'd play double or nothing. I haven't talked to Warren for a while, but I gave him a buzz to ask his opinion. He said "Tommy, this stock is hot! Go for it!"

Watch for the IPO

Tom

PS April Fools

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Building Materials Holding Corp (BLG) - After the Big Bath

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BLG is a combination of building materials supply and construction services, and finished 2007 with a massive write off of goodwill and customer relationships. The stock has tanked accordingly, and at today's close of 4.91 it is trading at a discount to its tangible book value, which stands at 5.94. It's attractive as a play on the eventual housing recovery, and offers a margin of security due to trading under tangible book. I added it to my SLOport at 4.07 on 3/14, when the market was at its recent low point.

I got the idea from Krishna Gullapalli, a value investor who did very well in SLO1. I followed it for several months and when it got down around 4.00 I emailed Mr. Gullapalli who agreed it was probably a good time to stick my toe in the water. Initial results have been surprisingly good, consisting of a 20% return in a matter of weeks. I had it in my personal portfolio also but elected to take the quick profit and hold the cash for other opportunities.

Visibility for the next few quarters is not good, and when taking the writeoff, BLG got a very limited tax benefit because they can't realistically project enough earnings to use the losses against. That has been happening a fair amount lately - a number of homebuilders have written off tax benefits for the same reason. Some Financials are in the same boat.

There was an article in the WSJ on Thursday, about a new piece of legislation which would increase the time period to carry back losses from 2 years to 4 years. This would be a big benefit to homebuilders and also to BLG, since it would enable them to recover their taxes, typiclly 35%, on some of the high earnings years of the housing bubble. I hope that is not the only reason this stock is rallying, because I don't like my results to depend on the whim of our legislators. Apparently the PACs of the NAHB (National Association of Homebuilders) stopped donating until some legislation was passed - no tickee, no washee. That's America, the free enterprise system at its best.

Anyway, back in 2002 and 2003, BLG was able to earn .71 and .74 per share. Using that as normalized earnings a P/E of 12 would get you up over 8.00. a doubler, more or less. Earnings were much higher in 2005 and 2006 but I don't think recovery to that level is in the cards for a couple of years. They have some debt but they have amended their terms and have an unused revolver good until November 2011, by which time hopefully things will be moving again.

They plan to do some reorganizing but as of the last earnings report they had not completed their plan. I will look at this again when they announce their plan. In the meantime, if it gets up around its 5.94 tangible book, that might be a good time to take profits.

Tom

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Cobra (COBR) - Name Brand Merchandise - Cheap

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Cobra is the number one brand in the domestic radar detection market. Other products include CB radio, power inverters, marine products, and mobile navigation. They were unable to compete successfully with the likes of Garmin (GRMN) in mobile navigation and wrote off a lot of their investment in the area at the end of 2007. They will continue to compete in certain niche areas. It closed Friday at 3.12, a substantial discount to its tangible book value of 5.69. At a price to sales ratio of .13, and projecting a return to profitability in 2008, the stock is attractive as a value play, given the brand recognition factor. Most years it trades above tangible book at some point, so it could double from its present price.

Longterm Debt/Equity stands at .3, with a price to cash flow of 3.5. Noting the quick ratio of 2.2 and current ratio of 3.8, I see a small and sturdy company with brand name recognition on their primary product.

I originally started to follow it because I was interested in mobile navigation and figured if they were able to penetrate the market growth would be spectacular. It never got low enough for me to buy it, and then they had to admit defeat and take the write-off. However, the radar detection business is not going to go away. They sell mostly to retailers, and their sales are seasonal, heaviest in the fourth quarter. This company is small - 132 employees.

It traded 4,800 shares on Friday. I placed a market order for 4,000 shares, which under the Marketocracy system filled only 160 shares at 3.10. I am planning a small position here, which could take a while to fill. In my personal portfolio, I also plan to build a position, using limit orders. I like the Marketocracy system on a case like this because otherwise you could go crazy trying to buy much of it without driving the price up.

This is part of a strategy change, going back to what worked for me in the past. Over the years, I have had some success on smaller companies where nobody pays too much attention, particularly when I could get margin of security based on tangible book value. In this case, after abandoning the attempt to get into mobile navigation, the remaining product lines should be profitable and the radar detection is supported by name brand recognition. COBR would make a nice acquisition target at any time, but the payout from owning it would most likely come late this year or early next, if and when it become apparent that the remaining businesses are profitable.

Tom

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TSO - are margins sustainable?

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As others have pointed out, the value of TSO's stock depends on margins - the crack spread in the parlance of the industry. That would depend on supply and demand of refinery capacity. Searching "refinery capacity" in Yahoo, I wound up at the EIA (Energy Information Administration) website where they had more information on the topic than I could easily digest. Doing a few calculations, it looks like refinery capacity has been increasing 2% per year for the past 5 years. That doesn't sound like much, but once supply exceeds demand margins can shrink rapidly. The price and availability of crude oil is not really the issue - it's the amount of competing refinery capacity. It doesn't matter what the oil costs, it's how much can TSO get paid for refining it.

Checking TSO's net income as a percent of revenue for the past 8 quarters, comparing year over year due to the seasonality of demand, it is apparent that in the second half of 2007 margins declined precipitously. Reading their 10-K, they give a variety of reasons, and go on to add that they expect 2008 margins to return to the 5 year historical average, which would still generate a nice profit. If you accept that assertion, I get an EPS of 3.90 for 2008; using a P/E of 8 (this is a "single digit" stock), the 4/16 price of 25.98 looks attractive.

My experience with refiners as an investment is limited to Frontier Oil (FTO). I bought it as a value stock somewhere in 2002-2003 and eventually gave up on it because they couldn't sustain decent margins. Sadly, I gave up too soon and missed an extremely large profit as the stock doubled, redoubled, and split. I shorted it at intervals on the ground they couldn't sustain margins, and made small profits. However, the stock always went up over my last cover price, so I was definitely playing with fire. What I think I learned is that once the supply/demand equation tilts one way or the other on these capital intensive, slow moving businesses, it can take quite a while to restore equilibrium.

TSO operates on the West Coast, which has housing problems that should depress the economy and demand for fuel. The company has done some recent acquisitions and has an ambitious 5 year capital budget, to include capital expansion. If the decline in margins for the 2nd half of 2007 represented the tipping point, the acquisitions and expansion will prove to be ill-timed. For the long haul, TSO appears to be well run and has compiled an impressive growth record over the past 5 years.

Looking at options implied volatility, this stock is poised to go either up or down a fair amount. My best guess is that margins will contract but not to the pitiful levels seen in 2001-2002, because long-term there are difficulties to expanding refinery capacity, NIMBY, etc. I would be buying it as a value stock at 20 and selling at 35, due to concerns about the sustainablility of margins. I would not short the stock because my experience with the somewhat similar FTO suggests that would be hazardous.

Tom

PS on 4/17 - the WSJ has an article today on refinery utilization, which was very low for the most recent week. The EIA website has a weekly history for the statistic that goes back for years. After looking at that, and watching TSO, VLO and FTO rally today, with utilization in the low 80's, well below the same time for any past year, I am mystified. I thought the lower refinery utilization would depress refinery stocks but apparently not so. There is something here that I just don't get...

My thinking was that if utilization was below 90% then refineries would be expected to have poor margins and the stocks would decline accordingly.

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WaMu - Mighty no more

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I'm glad WM came up as the QOTW - I held it in my personal portfolio until January 07, making respectable returns, and with the stock trading at less than 25% of what I last sold it for I have been interested in looking at it as a value investment. The sell high, buy low strategy.

The history - from 2000 to 2004 WaMu was a success story, riding the wave of the housing bubble. In 2004 problems surfaced in the mortgage operation, hedges that went awry, as I recall. From there on in it was rumors, at intervals, WM would be acquired by this or that larger competitor. Or it was the sum of the parts argument, that their retail banking and commercial banking were worth more than the stock traded for, so that you got the mortgage operation for free. Or the expense reduction, that they would bring their expense ratio in line with the industry, creating shareholder value. None of this materialized and it traded in a range of 2 to 3 x tangible book value. I became concerned that the mortgage business was problematical and management just didn't seem to be cleaning up the mess and made what proved to be a very timely exit.

After the horrendous 1Q 2008 quarter, and the more or less simultaneous recapitalization by TPG and others, I recomputed the tangible book value per share, making an allowance for the dilution, and came up with 12. The reason to use tangible book is that their assets include a lot of goodwill from acquisitions. If WM, which recently traded at 11.66, were to get to the lower end of its historical price to tangible book ratio, it would be a doubler. If it got to the high end, it would be a tripler. That is the attraction of this situation.

The "what ifs" are numerous, but I will only offer one. WaMu's 1Q 2008 financial info as available on their website shows that they have a total of 71.378 Billion of ARMs in the portfolio, of which 55.846 are Option ARMs. Unfortunately, the unpaid principal balances are larger than the original principal amounts, and the difference has been growing every quarter. These mortgages are not reducing principal. WaMu does a lot of business in California, so the market value of the houses involved is probably decreasing. This is not a situation that can continue indefinitely. To place the size of the issue in perspective, the tangible book value is 19 billion after the recapitalization. The bookkeeping here is, after the customer pays an amount that does not reduce principal, or even cover interest, you add interest to the balance of the mortgage, which is an asset on the books.

TPG and other investors got a good deal on the recapitalization. They effectively bought the shares at 8.75 while the stock traded at 10.95 and now stands at 11.66. Too bad the ordinary shareholder can't participate in these deals. Actually he does, as the victim. This brings to mind the troubles and hardships I recently experienced and endured when MBI and ABK did equity offerings. Shares of both companies have traded at less than the share price of the additional shares sold to raise capital, ie, less than the smart money paid. As a big for instance, Warburg Pincus, which I thought was smart money, got involved with MBI at 31.00. The stock subsequently traded as low as 6.75.

So, my suggestion here is, if you can get past the what ifs, that you buy where the smart money bought, which would be 8.75. I personally would not get involved, why should I buy a company that started messing up in the mortgage business in 2004, when it was a cakewalk, and never really cleaned up the situation? Particularly when you get the same management that created the problem.

Also, there are a lot of banks out there - you could start with Wells Fargo (WFC): Russ recommends it. How about Regional Banks, some of which are well run and don't have trouble like WM, NCC, C, or BSC et al? I normally prefer to pick my own stocks, but in my personal portfolio I have been accumulating a small position in a mutual fund - John Hancock Bank/Thrift Opportunity (BTO). My thinking is, banks should be attractive as recovery commences, but diversification would be a must. The expense ratio for BTO (1.43%) might be money well spent, particularly when it trades a discount to NAV.

Tom

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Jabil Circuit (JBL) CEO is buying

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Jabil Circuit (JBL), at today's closing price of 10.78, is attractive at a price/sales ratio of .18. Jabil is in the Electronic Manufacturing Service business. EMS is extremely competitive and cyclical, and in recent years JBL and various of its competitors have been involved in restructuring. For JBL, that seems to be an ongoing process, moving work to lower cost areas, with regular charges. EPS is low as a percentage of Cash Flow, so the price history looks quite high compared to earnings. Margins have been thin for years, especially recently. The attraction here is if they can get back to their 5 year average net income as a percent of revenues, EPS will increase substantially, moving the stock from its current 10.xx to somewhere between 17 and 27. You get a dividend, 2.62% at today's price, while you wait.

I have had very mixed results with low Price/Sales ratio situations as value candidates. It is tempting to look at a final margin of .5% (for example) and figure if it could be increased to 2%, which seems easy enough, then EPS would quadruple. All too often margins are thin because of intense competition and it seems there is hardly enough profit to cover the risk of credit loss, slowdowns, etc. But Jabil has traded at price to sales ratios of 1 X frequently over the past 5 years and if it ever returns to that area, it will be a definite winner.

Using a service like Jabil, as compared to building product in house, is attractive for a number of reasons. First, Jabil has plants in low cost areas, so U.S. or other high cost manufacturing operations can be offshored without the delay and expense of setting up a new plant. Also, customers who have cyclical variations in volume can avoid the cost of temporarily idled manufacturing facilities. Finally, Jabil has considerable expertise and may be able to do a better job than their customers can do in house. During economic slowdowns, outsourcing is attractive as a cost-cutting measure. EMS is a good business and should grow steadily as world consumption increases. Jabil has grown 20% per year over the past 5 years, partly by acquisition, with a slowdown this year. I think long term they can to 7% or better per year.

Using 7% growth and 5 year average margins, JBL should be able to earn 1.00 to 1.10 per share, at a P/E of 17 that would be 17 or 18 per share. The stock has often traded higher than that when growth prospects look good, so possibly the upside could be greater.

CEO Tim Main recently bought 50,000 shares at 9.00-9.25. My timing is not as good as his, so for my SLOport my average cost is 11.67, although I did buy some at 9.14, getting the "smart money" price on part of my position. Any wonderful things that may happen will be later this year or early next, so there is time to enlarge the position if it backtracks - the idea would be to buy more at 9.00 to 9.25, do like the CEO, buy near the bottom. It doesn't always work, but I have had some success stories buying at prices where management bought substantial amounts.

Tom

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King Pharmaceuticals (KG) - lean, focused, well-funded

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King Pharmaceutical is a high flyer that has come down to earth, and attracts my attention primarily because of a strong sales force and balance sheet, together with proactive management. The stock is trading in the vicinity of 52 week lows, 9.xx today, based on the fact that most of the company's key products will lose patent protection in the near future. Following the loss of a patent case, the company has reorganized, slimmed down, and focused its priorities on areas where it is most competitive. The R&D pipeline has some promising candidates, and management has done well by in-licensing in the past. Based on what I regard as a well thought out strategy, implemented vigorously, and the possession of ample resources, I think the situation warrants a small position due to the potential for resumed growth in revenue and leverage on the reduced expenses.

From the 2007 10-K: Accelerated Strategic Shift - Following the Circuit Court's decision in September 2007 invalidating our Altace® patent, we conducted an extensive examination of our company and developed a restructuring initiative designed to accelerate a previously planned strategic shift emphasizing our focus on specialty-driven markets where we have core capabilities and assets, specifically the neuroscience, hospital and acute care markets. This initiative included a reduction in personnel, staff leverage, expense reductions and additional controls over spending, reorganization of sales teams and a realignment of research and development priorities. Pursuant to this initiative, we terminated approximately 20% of our workforce, primarily through a reduction in our sales force. We have incurred total costs of approximately $65.0 million associated with this initiative. We estimate that the 2008 selling, general and administrative expense savings from these actions will range from $75.0 million to $90.0 million.

I visted their web-site and located a nice writeup of the R&D strategy, which they call virtual R&D. That means a kind of outsourcing and partnership approach whereby they utilize the strengths of outside organizations rather than attempt to maintain inside capabilities. This may permit them to focus their R&D on areas that they think will be productive, rather than on what their in-house people are skilled at. It also should reduce expenses in that money is not spent on research people who are between projects, etc.

I don't put much emphasis on trying to second-guess pipeline reults, there are plenty of people better informed than me and I'm not sure they do real well either. That having been said, I think the company's focus on pain management and specifically abuse resistant opiods is well thought out - the argument from demographics, an aging population afflicted with chronic pain, the growing awareness of the amount of prescription meds that gets out on the street, etc.

While the future is uncertain here, the price affords some margin of security in that it is a little below book value and there is a lot of cash. If management succeeds in their strategy, I don't think 16 or 17, (from today's 9.xx) is unrealistic. I am accumulating a small position and monitoring the news.

Tom

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