GEO Investing

Our current increased focus on U.S. growth stocks has proven to be a fruitful decision while we strengthen our on the ground due diligence and investigate companies in the ChinaHybrid space. Does this mean we are done investing in the China space on the long side? That is absolutely not our intention. But the GeoTeam has decided to act on the side of caution and learn as much as we can about a wide variety of issues surrounding Chinese companies before implementing a significant long investment strategy in them.

The good news is that identifying promising U.S. micro cap companies has always been the staple of our investment success, even before the ChinaHybrid opportunity surfaced.

Below you will find a brief earnings recap of select GeoSpecial, GeoBargain and open short-term positions, as well as an update regarding our due diligence in the China space.

So far the GeoTeam has been very satisfied with the majority of earnings releases from our GeoSpecials, GeoBargains, and GeoTrades.

GeoInvesting mock portfolio selections ABG, SMCI, WWWW, IEC, RES, CVU, CMT, LXU, MERC came through with strong quarterly results, as did GeoBargain ENDP and GeoSpecials IDSA, AEIS. LXU, MERC, CVU and CMT shares have responded positively.  Only two mock portfolio selections, PDFS and TORM, reported results below our expectations.  The trend of our GB/GS stocks to underperform after the release of positive earnings has been a common theme of late– a scenario that Renn’s OBOSS had recently predicted.  Although investor reaction to positive financial results has been tepid, we are hopeful that once market sentiment improves so too will share price momentum in these names.

Earnings Score Card:  12 positive and 2 negative.

Recent GeoBargain,GeoSpecial, and GeoTrade Earnings:

*Prices as of May 16th, 2011

LSB Industries (LXU) $43.93 GeoTrade: Reported 2011 first quarter results on 5/05/2011.  LXU reported a “record quarter” in certain aspects, while boasting that the 2011 QI was the most profitable quarter in the company’s recent history.  Both its climate control and chemical product categories experienced increased sales growth from QI 2010 to QI 2011. The largest contribution of the growth came from production of UAN (solution of urea and ammonium nitrate in water used as a fertilizer) at the company’s PRYOR Oklahoma chemical facility which contributed to over half of the overall earnings improvement.  QI 2011 fully diluted EPS came it at $0.90 compared to $0.07 in QI 2010, blowing away analyst estimates of $0.62.  Net Sales for QI 2011 were $177.5 million compared to $130.4 million Of QI 2010.

Other impressive figures from the conference are listed below:

  • Operating Income increased 16% to $34 million compared to $4.4 million for QI 2010.
  • EBITDA was up significantly to $32.6 million from $4.9 million in QI 2010.
  • Total Debt has been reduced from $95.4 million from QI 2010 to $81.7 million ending QI 2011.

Challenges facing LXU:

  • New residential construction was lower than anticipated.
  • Gross margins decreased as a result of material cost increases and product mix
  • Unpredictable weather patterns.

Positive signs for LXU:

  • Raw materials costs (copper and steel) are showing signs of potential decline that could boost margins.
  • Green building niche will continue to support long term Residential Construction growth (lagging segment of LXU).
  • PRYOR plant still not at full production, however, it is still beating ETA targets in both UAN and Ammonia.
  • All indicators point to a strong Agricultural industry outlook.

We have been scaling out of our LXU trade, which has yielded a return of over 80%, thus far.  We are banking that the stock will approach $50.00

Mercer International (MERC) $12.23 GeoSpecial: MERC easily beat analyst 2011 second quarter EPS estimates of about $0.37 when it reported adjusted EPS of $0.46. These results compare to a net loss in last year’s first quarter. MERC’s solid EPS growth trend is encouraging.

Conference Call Notes

  • MERC operates in a cyclical business but is currently in a sweet spot for at least 2011 if the economy holds up;
  • The company’s plants temporarily close every year for maintenance.  This year they are spreading out this task by closing one plant in QII, one in QIII, one in QIIII.  This could help smooth out  quarterly EPS results;
  • Demand remains strong;
  • Price increases to take effect in April;
  • China is a big growth driver with Europe and U.S. business also showing promise;
  • 2011 QII will receive orders that were originally slated for the QI, so QII could be sequentially stronger;
  • Input costs are trending down to flat for wood fiber;
  • Management said 2011 will be a strong year as long as the economy holds up and if no unforeseen problems surface.

Core Molding Technologies (CMT) $9.30 GeoSpecial: As expected, CMT, one of our newest additions to the GS list came through with a home run 2011 first quarter. The Company posted solid diluted EPS of $0.31 vs. a loss of $0.02 in the same quarter last year. Comments were bullish, indicating that further EPS gains may be on the way. Recall from our mock portfolio update that this stock is benefitting from robust growth from its two largest customers NAV and PCAR.

We are increasing our internal near-term price target from $12.00 to $17.00

CPI Aerostructures (CVU) $15.38 GeoBargain: CVU continues to post solid gains.  For 2011 QI, it reported diluted EPS of $0.19 vs. $0.14 in its 2010 QI. Revenues increased 45% year-over-year, while gross margins remained flat at around 24%.

The Company reaffirmed guidance for the 2011 year:

“We are once again confirming our 2011 guidance which calls for revenue to be in the range of $78 million to $81 million, a 77% to 84% increase over 2010, primarily due to increased work on our three major long-term programs: A-10, E-2D and G650. Net income for 2011 is expected to be in the range of $9.2 million to $9.5 million. Our gross margin for the year should be in the range of 25% to 27%. In addition, we continue to expect that for 2012, revenue should be in the range of $88 million to $91 million, with resulting net income of between $11 million and $12 million.”On its conference call, the company mentioned that both the 2011 second and third quarters should be higher than first quarter numbers.

CVU remains one of our favorite selections

Advanced Energy Industries (AEIS) $14.37 GeoSpecial: AEIS shows us that Wall Street is more concerned with companies crushing estimates than with EPS growth. The company posted 2011 first quarter EPS of $0.43 vs. a $0.35 estimate. While this is positive, EPS declined from $0.45 in last year’s comparable quarter. For the next quarter, AEIS guided for EPS of $0.36 to $0.44 EPS, compared with analyst estimates of $0.41. Going forward, consistent quarterly EPS growth may be a challenge for the Company.

We only view AEIS as a market performer.

Industrial Services of America (IDSA) $10.39 GeoSpecial: The Company posted 2011 first quarter EPS of $0.31 vs. last year’s $0.27, showing steady growth. The quarter was another record for the Company, with revenues up 45%. IDSA’s recent share weakness is likely due to management’s comment on its conference call that investors should focus more on yearly first, and then quarterly results since volatile commodity prices impact margins. However, management did say that they will focus on improving margins to drive further EPS growth. It seems that there has also been an inability for analysts at Taglich Brothers to get a grip on the IDSA financial model. The 2011 first quarter mean EPS estimate for IDSA at the time of the GeoSpecial coding was $0.11. Two months prior, estimates were at $0.32–the drop is most likely attributable to Taglich, despite commentary in the 2010 fourth quarter call that suggested a great 2011 first quarter–which soon thereafter became a reality, proving that Taglich was off base with its estimates.

More Conference Call Notes:

  • Volume increases have been able to keep pace with increases in commodity prices.
  • The Company made comments indicating a need to tap financial markets for capital at some point to fund its growth.

IEC Electronics Corporation (IEC) $7.55: What is probably most promising about the IEC 2011 QI release was the sequential increase in operating income as a percentage of sales (9.5% vs. 7.0%). Organic sales saw a boost of about 20% for the quarter while EPS grew 55% to $0.17 vs. $0.11 last year.

For IEC, we believe that investors may have expected an EPS number closer to $0.20, expecting stronger margins. Still, the company exceeded analyst estimates and increased revenue guidance. Management did not provide net income guidance, which may have played a factor in the weak response of shares to stellar financial results. But they did, however, provide operating margin guidance of about 9.7% for the remainder of their fiscal year, which is good enough for us.

As in the past, during the 2011 QII conference call, management told investors not to look at IEC on a quarter to quarter basis (which of course leaves the door for a disappointing quarter), but the company did a great job managing expectations, which we believe positions IEC to under promise and over deliver. Upside EPS surprises may be in the cards, as IEC plans to pay down about $7 million debt from strong cash flow generation and their guidance did not include potential accretive acquisitions. Using the midpoint of operating income guidance of 9.7% and applying a conservative no debt repayment assumption, IEC is in a position to report an EPS of $0.46 for the remainder of the year vs. analyst estimates of $0.36. The Company did mention that it experienced limited component disruptions from Japan. Comments and guidance are still strong enough to maintain IEC’s inclusion in our mock portfolio

We are holding our internal near-term price target at $12.00

Web.com (WWWW) $11.00 GeoSpecial: Revenues for the 2011 QI came in at $45.1 million, just over the high end of guidance. However, we are extremely perplexed by the weakness in WWWW shares. EPS results ($0.21, a 91% increase over last year) were in line with estimates, as was full year 2011 guidance of around $1.00. We believe that investors were hoping the company would beat estimates. In any case, the conference call was very bullish, we may add shares if the stock retreats

Endo Pharmaceuticals (ENDP) $41.83:  The stock’s initial reaction to superb 2011 QI financial results was not impressive, but has been slowly trending up over the last couple weeks. The Company exhibited strong year-over-year growth during its 2011 first quarter. Revenues increased 54% from the previous year to $560 million, while adjusted diluted EPS grew 35% to $1.00. ENDP has a GPR of 4.

Company management was optimistic in their comments:

“Endo had a terrific first quarter, with strong performance across every segment of our business,” said Dave Holveck, president and CEO of Endo. “We continue our focus on creating sustainable long-term growth and look forward to delivering a strong performance in 2011.”

Investors are also excited about a recently announced pending acquisition. We are expecting the stock to react positively once the deal closes. We will continue to code ENDP as a GeoBargain and are considering adding it to the U.S. mock portfolio.  Our internal near-term price target is $65.00.

Tor Minerals (TORM) $16.48 GeoSpecial: TORM exhibited strong 2011 first quarter year-over-year revenue growth of 40% compared to the 2010 first quarter. TORM’s revenue growth was not, however, enough to raise EPS, which saw a $0.04 decline to $0.22 compared to the same period last year. This was due to a 50% increase in shares outstanding resulting from a recent financing transaction. Recall that in our mock portfolio update we were concerned about this issue. The Company believes that pricing for its products will adjust upwards as the year progresses, resulting in earnings growing faster than sales. A $2 million investment in a Netherlands plant coupled with increased utilization of their Malaysian plant should allow TORM to expand its production capabilities and capture greater market share.  We expect the next two quarters to show a resumption of healthy EPS growth.

For the near term, TORM will remain coded as a GeoSpecial.

RPC (RES) $22.90: GeoSpecial RES had one of the most promising earnings releases thus far. 2011 QI revenues grew by an impressive 79.1% with EPS growth 5 times that of the first quarter last year. Management claims results would have been even more impressive had the harsh winter season not impacted results by an estimated 1% to 2% range for the quarter.  Growth was seen as a product of a major expansion in the company’s fleet of pressure pumping service equipment as well as increased utilization and efficiency rates. A reassuring note: management purchased over 800,000 shares in a stock buyback, increasing our faith in the company’s vision and goals.

RES share price has pulled back sharply with commodity prices, but easily maintains its designation as a GeoSpecial as we still feel that further capital appreciation can be attained. Our internal near-term price target is $30.00

Tal International Group (TAL) $33.42 GeoSpecial: Another GeoSpecial with a strong 2011 QI, TAL experienced a whopping 160% growth in diluted EPS to $1.37, compared to the same prior year period. The company is using the proceeds from a recently completed a 5,500,000 share offering to invest heavily in new equipment to expand business operations in the near future. Management is optimistic about the future, stating:

“In general, we expect our market to remain highly favorable. The supply / demand balance for containers remains tight, new container prices remain historically high, and we expect most of our customers to remain cautious about placing large orders for new containers this year. As a result, we expect our key operating metrics such as utilization, market lease rates and used container sale prices to remain strong throughout 2011…”

With an undeniably stellar quarter and solid growth, TAL will remain a GeoSpecial in the near term.

Asbury Automotive (ABG) $16.41 GeoSpecial: In line with its fellow GeoSpecials, ABG reported solid 2011 QII results, with revenue growth of 18% and sales topping $1 billion. Diluted EPS saw a 30% increase over the prior year to $0.35. ABG officially exited the heavy truck space, focusing its attention on light-vehicles. On a more somber note, inventory is being affected by the Japan tragedy, though management did not indicate this would be a severe detriment to the Company.  ABG will focus on increasing margins and placing emphasis on the used vehicle program to combat the decreased Japanese-maker inventory.

ABG will remain in the GeoSpecial portfolio.

Super Micro Computer (SMCI) $16.34 GeoSpecial: 2011 QI revenues increased 24%, with EPS exhibiting a slightly higher 30% increase ($0.28 vs. $0.21 EPS) over last year’s numbers. While this should please investors, SMCI shares have fallen despite price target upgrades by several analysts pre and post earnings. As we stated in an earlier email to premium members, we will view pullbacks as buying opportunities. The stock has since rebounded to its current price of $16.88, after hitting a low of $15.75 on May 4, 2011.

The conference call was very positive:

  • The March quarter is traditionally the weakest quarter, so the strong performance bodes well for the rest of the year.
  • The Company experienced a shortage of some components as well as reduced demand out of Japan. However, the “negative Japan” impact should not be material.
  • Asia and Europe are driving growth.
  • 2011 QII guidance is in line with street estimates.

PDF Solutions (PDFS) $6.24 GeoSpecial: PDFS was one of the more disappointing releases of this round of earnings. Both revenues and earnings saw a decrease from the same period a year ago with non-GAAP EPS falling to $0.02 from $0.08 last year.

We had mentioned that we were considering removing PDFS from the GeoInvesting mock portfolio. However:

  • Analysts still have 2011 non-GAAP EPS growing near 70% to $0.50
  • GPR remains strong at 7
  • Conference call commentary remained bullish.

Conference Call Notes

Negative factors reflecting QI:

  • Decrease of 3 clients and 2 engagements compared to QIIII 2010.
  • Expected 3 nanometer contracts to be signed during QI.  One was signed during the quarter; another was signed at the beginning of QII while the 3rd is still expected to close this year.
  • Delay in customer orders.
  • Lower business from one of their clients.

Comments indicating favorable growth:

  • “Bookings for QI 2011 were on pace with bookings pre 2008 downturn.”
  • Business activity and bookings remain strong, leading management to believe that 2011 goals will be attained.
  • “Anticipates earnings growth to be greater than revenue growth on percentage basis for 2011.”
  • In line with previous guidance,  “First quarter booking results lead executives to believe annual revenue will grow greater than expected for the overall chip industry.”

Additional notes:

  • Revenue breakdown: Asia 51% total revenue, Europe 20% total revenue, US 29% total revenue. (* Japan business unaffected by Earthquake and Tsunami disaster)
  • 10 clients represented 86% of revenue for the quarter.
  • The number of clients contributing more than 10% of revenue was 4.
  • Company stressed that investor should not measure progress on a quarterly basis.

In other news, we added SOA to the GeoSpecial portfolio at $25.66 based on a strong Geo Power Ranking of 6. UCTT and CCIX were selected as GeoSpecial due to solid EPS growth during their 2011 first quarter.

In early trading, on May 6, 2011, we alerted investors that we were taking a short-term trading position in shares of NATR at $9.59.

“It appears that Natures Sunshine Products (NASDAQ:NATR) crushed earnings estimates of $0.09 with a $0.43 EPS for the quarter. The GeoTeam took a small short term trading position at $9.59 while we are looking to see if there were any one-time events during the quarter.”

Since the press release did not contain much commentary and no conference call was held, we needed a little extra time to look into the NATR story.  Through further due diligence, we were able to confirm that the reported 2011 first quarter EPS of $0.43 was fairly clean, prompting us to code NATR as a GeoSpecial later during the trading session at $10.39.  It appears that NATR operations carry a good deal of leverage meaning that once revenues reach a certain point, profits margins accelerate. Another major positive trend was the substantial decrease in SG&A expense as a percentage of revenues (from 41.2 percent in the prior year to 34.9 percent). It looks like the company expects this trend to continue.

“We continue to implement cost reduction measures within all of our operating segments.”

There are, however, caveats to this story as potential legal problems may limit P/E expansion.

  • The company is battling with the IRS over past due tax obligations
  • See the other issue here.

It appears that the company has already established adequate reserves pertaining to the IRS issue, but we will have to speak to management to gain clarity on other outstanding legal issues.

We have set our initial internal short-term price target at about $15.00.

Trading Recap:

  • Tuesday, April 27th, the GeoTeam took a position in SYNL based on strong earnings for the quarter. We bought at $15.00
  • As mentioned above, we increased our GeoSpecial SMCI position on the recent pullback, which we viewed as an opportunity for a cheap buy in.
  • Our short-term tradeSPWRA experienced a nice boost after a company took a 60% stake in the Company. SPWRA could join a growing list of GeoTeam holdings that have been acquired at healthy premiums, including GTEC, MRM, HX, PPCO, LB, VM and HSR.
  • We closed out our KUTV trade week at $7.25. Our initial position was acquired at $4.45–a very satisfactory short-term return.
  • Also, we closed our put/call option positions in MOBI, which luckily provided us with positive returns.

On the China Front

We will continue to tread carefully in this space as we carry out our thorough due diligence on many more companies.

  • We initiated a short position in WKBT around the low $1.00 area based on SAIC filing issues.
  • Here is a recent article describing how Yahoo has become involved with a controversial ownership issue relating to its investment interests in Alibaba Group, located in China.
  • The biggest development over the past few weeks in the ChinaHybrid space was our on the ground due diligence findings regarding SCEI. You can read our full report here. In addition the GeoTeam released supplements to the investigation in response to management’s rebuttal.

**Note that our SCEI research is the latest in a string of our investigations that includes CGPI, PUDA, LTUS, NEWN and SBAY. **

Also of interest last week was our further findings on CGPI, including the following:

“A GeoTeam investigator also called Civil Affairs Bureau of Changshou District in the morning of April 25, 2011.  The officer confirmed that CGPI did not have the required cemetery business license for the land issue.   The GeoTeam believes that CGPI has an obligation to address this issue, which we have brought up on several occasions, even if it is in the process of being resolved.”

Risk Analysis Update

We are in the midst of adding companies to our already extensive Risk Analysis page. We urge readers to refer to this page for an easy read regarding crucial information regarding Chinese companies.

We have been monitoring the internal controls updates for many ChinaHybrids. Please see our latest message board post pertaining to this subject.  We will soon track upgrades/downgrades of risk parameters in the premium risk analysis section of GeoInvesting.

Due Diligence Update: The GeoTeam has a few due diligence reports in the pipeline and slated for release, such as OINK, CCCL, and OSN. Stay tuned.

Our loyal readers should realize by now that developments in the China space arise quickly and can change constantly. We urge our readers to check frequently on GeoInvesting research pages, GeoInvesting message boards and the GeoInvesting blog for the most up to date information regarding Chinese and U.S. companies.

Make sure to also follow our U.S. mock portfolio updates and performance tracker.

For the timely receipt of crucial information intrinsic to our research and interaction, members should subscribe to the following GeoInvesting boards:

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