Owner-Oriented Investment Research and Commentary - Have a private comment or question? Email us at commonstocksense@gmail.com

Monday, May 31, 2010

Food For Thought: 2009-2050 GDP Forecast by Country - Watch Them Go!

We came across the following chart a few weeks back on BusinessInsider.com in a post titled Beautiful Chart On The End Of The Age Of Europe. We found the display worthwhile and thought provoking. The BusinessInsider.com post makes the following points:
  • "Europe is embroiled in a sovereign debt crisis, but it is just the start of a downward trend for the continent, if this GDP chart is to be believed.
  • This beautiful chart from Spanish economics blog Venturatis, makes it clear that European nations are falling behind in the GDP competition, and sure to fall behind more over the next 40 years if they can't stick together and make the European Union a growth titan.
  • Notably, the United States remains a massive growth market throughout the next 40 years."
Clicking through to the Spanish blog, we see that the analysis is based on "information from Wikipedia (based on the CIA, Goldman Sachs and the International Monetary Fund)" as well as a handful of estimates by the author. AND, here's the chart (click to enlarge):

As noted in our prior posts, we believe forecasts and "experts" are often innaccurate, yet at least a few valid reasons exist to support a long-term economic shift toward emerging markets:
  • ongoing deregulation/liberalization,
  • more stable governments,
  • increased free trade and resulting stronger trading relationships,
  • increased capital mobility, and
  • globalization of corporations
Of course, all of this is occurring in regions with large, growing populations.

The United States, as a major global trading partner, should benefit by providing goods and services to the emerging giants (hence, the forecast of a still prominent USA in 2014 and 2050). We think Europe will remain in the picture, too, and -- as the Spanish author notes:
  • "los cambios son siempre una fuente de oportunidades"
Changes are always a fountain of opportunities. Perhaps current struggles will serve as a wake-up call and Europe will surprise us. Time will tell.

Happy investing,

Jeffrey Walkenhorst

Disclosure: n/a.

© 2010 Jeffrey Walkenhorst
Please see important Risk Factors & Disclaimer

Thursday, May 27, 2010

Market Back in Love with Starbucks -- What's Next? SSW, FLWS, BIDZ?

Last September, we wrote that "the Market" was again embracing Yahoo! (YHOO), evidenced by a higher share price and Wall Street brokerage upgrades to "Buy" from "Hold" (*although mixed views remain - WSJ's Heard on the Street column today: Yahoo's Chase to the Bottom). Since last fall, the same thing has happened with a number of companies, including Starbucks (SBUX).

In April, the coffee chain received more attention on the back of improved results -- upgrades and/or higher estimates and "target prices" -- from TheStreet.com:
  • Starbucks (SBUX) upgraded at Jesup & Lamont from Hold to Buy. $32 price target. Company is seeing better sales across the globe.
  • Starbucks (SBUX) target, estimates higher at Barclays. SBUX price target jumped to $28 from $21 as 2Q10 upside was impressive. 2010 and 2011 EPS estimates raised to $1.28 and $1.50, respectively.
  • Starbucks (SBUX) estimates, target boosted at Goldman. SBUX estimates were raised through $28. Estimates were increased, given better same-store sales and costs. Neutral rating.
Of course, the stock's already had a fantastic run over the past year - two year chart from Yahoo! Finance:

Hindsight is 20/20, but the time to buy was in late 2008 or early 2009. We personally can't claim too much credit as we didn't purchase the stock -- our funds were tied up and/or allocated elsewhere, including other totally discarded names. However, we did advise family to purchase shares in the company in the low teens and below with the following summary thesis:
  • We know plenty of loyal Starbucks patrons and continue to see long lines at the ubiquitous franchise everywhere. Looking beyond the current economic downturn, odds seems fairly certain that Starbucks will remain “brand-addictive” and generate significant free cash flow for years to come, especially as the company dials back capital expenditures. We expect share buybacks will continue and see potential for a dividend.
Although we still like the franchise and would love to own a piece of Starbucks, we'll take a pass, even with the recently announced dividend (1.6% current yield). At 19-times consensus fiscal 2011 EPS and with modest forward growth expectations, shares are likely in a fair value range.

The Market has come around to the idea that (1) competition from McDonald's (MCD) and Dunken Donuts won't kill a resilient Starbucks, and (2) even a fairly mature franchise can return significant capital to shareholders over time. On the latter point, think of Berkshire Hathaway's (BRK-A, BRK-B) Dairy Queen. DQ is likely a slow growth business that faces constant competition from Friendly's, Sonic (SONC), Cold Stone Creamery, and all the rest, yet the company no doubt generates gobs of free cash flow that Berkshire can invest as it pleases.

What companies will the Market embrace next? Hard to know for sure. We mentioned the other week that the Market is coming around to our shipping companies, including Seaspan (SSW). Despite economic jitters resurfacing almost daily -- with headlines such as "Market Down on Renewed Europe Concerns" followed by "Stocks Jump After China Shows Confidence" -- our view is that conditions are on the mend. This view is supported by hard data and various economic indicators -- give a look at this, from the Conference Board today for Europe:
Of course, tomorrow or Monday, headlines may read "Stocks Down on New Risks in Europe [or elsewhere]".

Ignoring volatile, macro-related headlines to focus on corporate fundamentals and intrinsic values, we continue to believe that 1-800-Flowers.com (FLWS) and even totally discarded Bidz.com (BIDZ) remain at meaningful discounts to reasonable estimates of fair value. In each case -- while acknowledging that a weak consumer environment is an ongoing risk -- we see stabilizing results for established, well-positioned e-commerce franchises. Both have healthy balance sheets and potential for a return to Y/Y growth later this year, which might garner more Market attention. We've been wrong on Bidz.com over the past year, but we remain patient and are aware that illiquid micro-cap companies may swing widely and/or remain out of favor for extended periods of time. Lastly, although some insiders continue to quietly sell through "automatic" plans -- which we don't like, even if only slightly reducing their approximate >60% ownership position -- many other overhangs on the Bidz story are now gone and, as noted, fundamentals are poised for improvement.

Happy investing,

Jeffrey Walkenhorst

Disclosure: long YHOO, BRK-B, SSW, FLWS, BIDZ.

© 2010 Jeffrey Walkenhorst
Please see important Risk Factors & Disclaimer

Monday, May 24, 2010

Polaris Can't Keep up with Demand - And the Sky is Falling? It Simply Doesn't Add Up as People Want Their ATV!

We commented last week about market pundits emerging from the woodwork calling for DOW 5,000. We even saw someone calling for DOW 3,800 by December -- we've not had time to listen to this person's reasoning, but -- on it's surface -- "the call" is probably more a publicity stunt than anything (to sell books) and, for this reason, we don't share the link here (a quick Internet search should uncover, if you're interested).

Anything is possible, yet remember that share prices and market indices are driven by corporate earnings power and the earnings outlook remains much better than one year ago, even if muted. Thus, we strive to ignore the noise and focus on the signal. Our research focuses on bottom-up company specific fundamentals.

We're not entirely jumping up and down. We know things are still tough and creative destruction may well keep unemployment elevated until new jobs are created through plain old innovation. Yet, we look around and, for the most part, see signs that run counter to the double dip mentality. Recall that, in late March, we mentioned the cruise business and Carnival Cruise Lines (CCL) showing a recovery in pricing power and bookings.

Now today, an article in the WSJ, After Slashing Inventory, Polaris Now Struggles to Meet Demand highlights how consumer oriented companies that dramatically slashed inventories still plan to run lean but can't keep up with better-than-expected demand. In this case, the company is Palaris (PII), which makes recreational vehicles such as ATVs and snow mobiles. From the article:
  • Polaris cut its U.S. and Canadian dealer inventories by nearly a quarter last year and expects an additional 15% drop this year, taking them to their lowest level since 1997. But sales so far this year "are better than we expected for all products," says Polaris President Bennett Morgan.
  • To cope, the company has recruited almost 200 more people for its production work force—an increase of roughly 10%—and will likely boost employment significantly again during the second half, Mr. Morgan says. The company is also pushing dealers to switch from an old program of taking big deliveries twice a year to ordering less product more frequently, which would theoretically match customer demand.
The company raised guidance in its March quarter earnings report and, like so many other companies, Polaris' share price saw a tremendous recovery over the past year. Two-year chart from Yahoo! Finance (YHOO):

Despite the run, shares trade at 14 times consensus 2011E earnings and offer a 2.8% yield.

Our capital is focused elsewhere, yet we share the Polaris story as another example that things appear to be significantly better than some indicate. Apparently, some people are taking cruises and buying ATVs.

Now, please tell us about DOW 5,000 again?

Happy investing,

Jeffrey Walkenhorst

Disclosure: long YHOO.
© 2010 Jeffrey Walkenhorst
Please see important Risk Factors & Disclaimer

Thursday, May 20, 2010

Fear Back in Vogue, Social Unrest, Credit Risk, and Even Volcanoes - YET, Consider Fundamentals and Remember that Mr. Market is Schizophrenic

As we expected (noted in our 5/8 post with a brief warning to watch for DOW 5000 prognosticators), the doomsday crowd is back and fear/panic is taking control of the Market. For evidence, please see this Forbes article from Wednesday The Crash Camp Takes Over - OR - one of today's Yahoo! Finance (YHOO) headlines: Dow Slumps 3.6%: "We Are On Schedule for a Very, Very Long Bear Market," Prechter Says. We mentioned Mr. Prechter in a post last November and acknowledge that he has a seasoned perspective with well argued points.

In this regard, we're not naive or ignorant of mixed macroeconomic conditions and current events:
  • unsettling ecological disaster thanks to a horrific accident (lack of safety controls or oversight? mistakes? freak event drilling so deep? modern dependence on "black gold"?);
  • social unrest (Greece/Europe/Thailand/elsewhere?) underpinned by class warfare and/or necessary reductions in government expenditures (could be good thing over time if private enterprise can pick up slack);
  • high debt levels and seemingly irreversible deficit spending by most developed countries;
  • likely unsustainable entitlement programs (aging demographics might make earlier promises untenable though politically difficult to change);
  • higher taxes in many countries that may squeeze both consumption and investment, the latter of which is critical for economic growth and new job creation;
  • more jobs lost through corporate streamlining, mergers/acquisitions, or creative destruction (e.g. old media struggles);
  • and, even volcanic eruptions and earthquakes.
  • [fill in the blank on our non-exclusive list - you can probably think of other things].
Aside on volcano - this is well worth a listen for those interested in geological perspective on the Icelandic eruption: The Heat is on - Volcanic Activity in Iceland by Andy Hooper We pulled this directly from the WSJ site this evening and even left in a few negative headlines toward the bottom. Most are positive.

Volatility is a fact of the markets and psychology is a significant influence on market direction. Our hope is that positive fundamentals in many areas check the current trading bias toward negative psychology, stabilize market sentiment and provide confidence to businesses and consumers alike that the sky is not falling, as some might lead us to believe. Many things in the world are on track.

We don't know what the Market will do near-term, but continue to hang our hat on fundamentals of specific companies trading at sensible (or even inexpensive) valuations, including eBay (EBAY), PetMed Express (PETS), Seaspan (SSW), and Weight Watchers (WTW). All the while, we never forget Ben Graham's guiding parable that Mr. Market is invariably schizophrenic and subject to wild swings.

Happy investing,

Jeffrey Walkenhorst

Disclosure: long YHOO, SOFO, EBAY, PETS, SSW, WTW.
© 2010 Jeffrey Walkenhorst
Please see important Risk Factors & Disclaimer

Monday, May 17, 2010

Churchill Downs - Youbet.com Deal Gets Closer to Finish?

Readers know that we've been tracking the proposed acquisition of Youbet.com (UBET) by Churchill Downs (CHDN). We previously posited that certain catalysts might close to bring the share price of Youbet.com closer to that of the implied cash/stock offer -- recall, from our post last November:
In the middle of last week, Churchill Downs and Youbet.com announced the following:
  • "the outside date for termination of their merger agreement providing for the acquisition of Youbet by CDI has been automatically extended, in accordance with the terms of the merger agreement, from May 11, 2010 to February 11, 2011, in order to grant the parties additional time to satisfy the mutual condition to closing, relating to the expiration or termination of any applicable waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended (the “HSR Act”)."
However, as with recent earnings reports of Churchill and Youbet, the companies again stated that a June quarter 2010 close was expected:
  • "Although no assurances can be given as to the timing for the closing of the merger, both companies continue to expect the merger to close in the second quarter of 2010."
We believe the extended deadline could simply be a formality while also providing ample time and reducing incremental paperwork (e.g. requesting another extension) on the chance that the transaction falls into the second half of the year.

Then, on Friday, we had more news from Churchill:
  • "Churchill Downs Incorporated and MI Developments Inc. today announced that the joint venture TrackNet Media Group (“TrackNet Media”), originally formed between CDI and Magna Entertainment Corp. (“MEC”), will be dissolved. CDI and MID’s wholly owned subsidiary MI Developments Investments Inc. will remain partners in HorseRacing TV™ (HRTV)."
We don't know for sure, but we surmise this move might have been a DoJ requirement to get the Youbet.com deal through. That is, controlling a large amount of industry racing content through TrackNet that feeds into Churchill's various distribution channels -- with the inclusion of the Youbet.com business -- might have been perceived as anti-competitive and potentially harmful to customers. Hence, the DoJ might have strongly recommended the latest move.

Now, we may just be one step closer to DoJ approval and subsequent fruition. Let's see.

Happy investing,

Jeffrey Walkenhorst

Disclosure: long UBET.
© 2010 Jeffrey Walkenhorst
Please see important Risk Factors & Disclaimer

Wednesday, May 12, 2010

SSW/GSL: Container Shippers Showcase Stable Models; "Market" Coming Around

Per our mention of good news the other day, we expected our container shipping companies Seaspan (SSW) and Global Ship Lease (GSL) to bring no surprises with earnings reports this week. We are pleased to report that there were no material surprises for these predictable businesses with long duration assets. We don't have time to share nuances, but relay a handful of slides below from management earnings presentations.

For Global Ship Lease (GSL results/slides found here), revenue growth coupled with healthy growth in operating and cash earnings (both resulting from fleet expansion over the past year):

And, a similar story for Seaspan (SSW results/slides found here):

Seaspan's expected forward revenue growth assuming all goes to plan and modest additional financing is received (estimated at $140 million in 2Q11-2Q12):

Expected top-line growth translates into significant bottom-line improvement:

While company specific and macro risks remain, we continue to sleep well owning both businesses and see incremental upside for patient investors. We expect to win two ways over time: (1) potential multiple expansion as a slow global recovery continues and (2) potential dividend increases in 2011 or 2012 (reinstatement for GSL). We continue to believe it is unlikely that Seaspan's equity will remain at an implied 3-4 times 2012E distributable cash flow (on fully diluted basis). Certain brokerage houses -- part of the "Market" we refer to in our posts -- are coming around to this conclusion - from Google Finance today:

Happy investing,

Jeffrey Walkenhorst

Disclosure: long SSW, GSL.

© 2010 Jeffrey Walkenhorst
Please see important Risk Factors & Disclaimer

Saturday, May 8, 2010

Don't Fret - Plenty of Good News Out There; Again, We Look at the Transportation Sector (Which Drives/Supports the Global Economy)

The past week illustrates how topsy-turvy the market can be on the turn of a dime, all made possible by a "Market" increasingly driven by short-term traders and quantitative momentum/technical models. We don't dismiss real challenges here and abroad (all well publicized), yet economic indicators and corporate earnings results appear to be moving in the right direction. Our view is that fundamentals ultimately drive the market and the Market. Please note that we use the "Market" to describe the living, psychological body of investors/traders that participate in the market. Our hope is that better fundamentals will conquer current concerns, although we acknowledge that (1) psychology is typically fickle and (2) many forces actually want the market to trade lower. Watch out for pundits emerging from the woodwork again calling for DOW 5,000 and armageddon.

As noted in our 4/15 post, we still need to update our "How's the Economy Doing" series. But, for now, we'll try to share various data points or news items that tell the story. Some headlines from The Journal of Commerce yesterday (note: easy Y/Y comps helping):

Asia-Europe Container Volume Surges 20 Percent
Container shipments from Asia to Europe surged 20 percent in the first quarter from a year ago as the rebound in traffic that started in the final three months of 2009 continued into 2010, according to latest industry figures.

Textainer Profit, Productivity Surge
Container lessor Textainer Group Holdings Ltd. reported net income of $24.2 million, an increase of 16 percent compared to the first quarter of 2009, with fleet utilization for the quarter exceeding 90 percent.

MISC Pre-Tax Profit Rose 49.3 Percent
Malaysian carrier MISC Berhad on Friday reported its profit before tax in the fourth quarter ended March 31 rose 49.3 percent to $85.2 million mainly due to higher profits in LNG and offshore oil support businesses.

Trucking Leads April Gains in Transport Jobs
The U.S. trucking industry added nearly 10,000 jobs in April and has added about 16,000 since February, as part of a broader recovery in freight sector employment showing up in payroll surveys by the Labor Department.

FreightCar Orders Jump Despite 1Q Loss
FreightCar America saw first-quarter orders for future railcars surge to 3,656 units from just 339 a year earlier and 185 in the final 2009 period, which pointed to an improving outlook for the company despite a $3.3 million loss.

Shipments Up 83 Percent at Echo Global Logistics
The economic recovery has wheels at Echo Global Logistics. Higher volumes from existing and new customers drove first quarter revenue up 81.5 percent from a year ago to $89.1 million at the non-asset based truck freight broker and logistics provider.

FedEx Adds 777 Freighter Orders
FedEx Express, seeking to take advantage of surging demand, will add six 777 freighters to its order of all-cargo planes from Boeing, the carrier said Friday.

AND, the above is merely a sampling. We've seen similar news headlines for weeks now.

Finally, we mentioned positive container shipping commentary from TAL International Group, Inc. (TAL) in late February. Well, here's the latest commentary from last week's earnings report (5/4):

"In the first quarter of 2010, the recovery in our operating and financial performance started to accelerate," commented Brian M. Sondey, President and CEO of TAL International. "During the first quarter, the combination of recovering containerized trade volumes and decreased global container capacity led to a global shortage of containers, strong leasing demand and increasing utilization for TAL. Our core utilization, excluding idle factory units, increased 3.1% during the quarter to reach 93.4% as of March 31, 2010...


Mr. Sondey continued "Market conditions have remained strong into the second quarter, and in general, we expect the favorable market conditions to continue. While TAL has been aggressive in placing new container orders, overall new production of containers has been fairly limited so far this year due to production constraints at the container manufacturers and reduced direct buying by our shipping line customers. As a result, we expect available container capacity to remain tight for the next several quarters. Our core utilization reached 94.5% at the end of April."

"We expect our utilization to climb further throughout the second quarter as booked containers go on-hire to our customers, and we expect our average lease rates to increase throughout the year as some customer incentives expire and as containers go on-hire at rates higher than our current average level. We also expect disposal prices to increase for the next several quarters as inventories of older containers available for sale shrink, though the overall size of our disposal gains and third-party trading margins may start to be constrained by reduced selling volumes if drop-off volumes remain at the current very low level. Our leasing revenue should start to benefit in the second quarter from our aggressive new container production, though this will result in increased interest and depreciation expense as well. Overall, we expect our second quarter adjusted pretax income to increase 10%-20% from the first quarter level, and we estimate that our full year adjusted pretax income in 2010 will be 25%-35% higher than our adjusted pretax income last year."

In addition, TAL raised it's quarterly dividend to $0.30 from $0.25 (after increasing it to $0.25 from $0.01 last quarter):
"We are pleased to increase TAL's second quarter dividend to $0.30 per share. The increase in the dividend reflects our improving profitability and the expectation that our market environment will remain favorable for at least the next several quarters. We will continue to evaluate the size of the dividend based on changes in our performance and expectations."
We remain positive on our container shipping companies Seaspan (SSW) and Global Ship Lease (GSL), as well as our aircraft leasing business, Babcock and Brown Air Limited (FLY), all of which we believe remain undervalued relative to reasonable fair values. Backcock reported results last week and Seaspan and Global Ship Lease are on deck this week. With long-term charters in place, these are very predictable businesses that minimize surprises (positive or negative).

Happy investing,

Jeffrey Walkenhorst

Disclosure: long SSW, GSL, FLY.

© 2010 Jeffrey Walkenhorst
Please see important Risk Factors & Disclaimer

Wednesday, May 5, 2010

Churchill Downs Results and Headlines - The Folly of Forecasting and Related Flow of Information

We briefly wanted to share an example of inaccurate forecasting and related information in the Market. Churchill Downs (CHDN) reported 1Q10 results this afternoon and headlines are reporting a large miss -from "In-Play":
  • 4:33PM Churchill Downs misses by $0.13, misses on revs (CHDN) 37.88 -0.45 : Reports Q1 (Mar) loss of $0.65 per share, $0.13 worse than the Thomson Reuters consensus of ($0.52); revenues rose 1.9% year/year to $75.1 mln vs the $79.2 mln consensus.
Yet, from Churchill's release today (emphasis added):
  • Net revenues from continuing operations for the first quarter of 2010 totaled a record $75.1 million, an increase of 2 percent over net revenues from continuing operations of $73.7 million recorded during the first quarter of 2009. Net revenues from continuing operations for the quarter were positively affected by revenue from the newly opened Calder Casino and revenue growth at TwinSpires.com, offset by the non-recurrence of $4.3 million in source market fee revenue that had been received by Arlington Park in the first quarter of 2009.
To confirm the positive boost in 1Q09 - from Churchill's release one year ago:
  • Net revenues from continuing operations for the first quarter of 2009 totaled $73.7 million, an increase of 12 percent over net revenues from continuing operations of $65.7 million recorded during the first quarter of 2008. Net revenues from continuing operations for the quarter were positively affected by the continued strong first quarter performance of the Company’s gaming operations in Louisiana, which opened its permanent facility in November 2008, as well as the continued growth of its on-line businesses, including TwinSpires.com. Additionally, we benefited from the receipt of $4.3 million in one-time source market fees paid to Arlington Park, previously held in escrow by the National Thoroughbred Racing Association (“NTRA”), during the first quarter of 2009.
Sure enough, the one-time boost should not have been included in the consensus estimate. Okay, maybe it wasn't. Perhaps the estimate truly expected revenue from continuing operations to increase 7% Y/Y, especially with the launch of the Calder Casino. Yet, we know the core business -- the majority of Churchill's revenue -- remains under pressure. Handle data from Bloodhorse.com (reported in early April):
  • Wagering on United States races was down 10.35% for the first three months of 2010 when compared with the same period a year ago, but handle in March rebounded considerably from a month earlier. According to the Thoroughbred Racing Economic Indicators released April 5 by Equibase, handle in March totaled $998,775,323, down 6.21% from $1,064,949,906 in March 2009. February 2010 handle was $869,807,865, down 13% from the same month in 2009, in part because of a reduction in race days.
Thus, with industry handle down 10% in 1Q10, achieving 7% Y/Y growth would have been a highly unlikely miracle. Delivering +2% Y/Y isn't bad, in our view. We suspect the consensus estimate may simply have been based on the year ago figure including the one-time benefit (*if we back out the $4.3 million from the $79.2 million estimate, we have $74.9, just below the $75.1 million reported today) . Of course, Churchill has a number of moving pieces and it's hard to know what was included in the consensus number.

Forecasting is difficult and "experts" are often wrong (please see slide 11 at this link -- we'll come back to this theme in coming months). But, wait: there's one other problem with the consensus estimate: per Yahoo Finance, it includes only one analyst estimate and, therefore, is by no means a "consensus" estimate. Nonetheless, more than a handful of investors, traders, and media sources may well base their analysis, decisions, and reporting on this number. Scary, right? Yes, but this is how the Market works -- or does not work -- often creating opportunities for diligent analysts.

In other news - also from today's release:
  • [CEO] Evans continued, "CDI's Online Business revenues grew 8 percent in the quarter, primarily due to an 8 percent increase in handle recorded by TwinSpires.com. The Company's pending acquisition of Youbet.com, Inc. continues to proceed through the U.S. Department of Justice's review process, with a second quarter 2010 closing of the transaction still anticipated."
We continue to wait for the official stamp of approval as our shares of Youbet.com (UBET) remain at a wide discount to the implied purchase value if the deal were to close tomorrow.

Happy investing,

Jeffrey Walkenhorst

Disclosure: long UBET.
© 2010 Jeffrey Walkenhorst
Please see important Risk Factors & Disclaimer

Monday, May 3, 2010

One of the Most Amazing Share Price Runs We've Seen, Ever - From a Rental Car Company?

The last 14 months delivered incredible "runs" (3x, 4x, 5x, and better share price recoveries) for countless companies, literally across all sectors as persons realized the world wasn't ending. Perhaps one of the best we've seen -- Dollar Thrifty Automotive Group Inc. (DTG):

Wow - from under $1 when balance sheet worries in late 2008 pressed shares to now $50 amidst a Hertz (HTZ) /Avis (CAR) bidding war for the company.

We're not involved in any of these companies and never seriously considered the space during the downturn, but wanted to point out how quickly circumstances can change. Pretty amazing.

Structural changes over the past decade in the car rental industry would make for an interesting case study -- from what we can surmise (*without in-depth research): M&A shifted the environment from one of intense competition to a seemingly cooperative oligopoly where supply is carefully matched to demand simultaneously by all vendors to manage pricing and margins. We personally had difficulty renting cars over the past year and prices were routinely higher than we expected when we did rent cars. Sound familiar?

Happy investing,

Jeffrey Walkenhorst

Disclosure: n/a.
© 2010 Jeffrey Walkenhorst
Please see important Risk Factors & Disclaimer

Sunday, May 2, 2010

Now Enough Hazardous Waste? Maybe. Over Long-Term, Certainly.

We continue to track hazardous waste companies such as Clean Harbors (CLH) and US Ecology (ECOL - formerly "American Ecology"). We also previously mentioned Casella Waste Systems (CWST - solid waste services, not hazardous) and that we acquired shares last November. Also, in February, we shared our presentation on Alternative Energy from last September.

In our view, all of these companies own/operate near-impossible-to-replicate franchises. In fact, with a long-term investment horizon, we suspect investments at current levels would yield reasonable total returns over time -- similar to Berkshire Hathaway (BRK.A, BRK.B) paying a seemingly high multiple for Burlington Northern (BNI) (*acknowledge debate around this move, articulated here by First Eagle's Bruce Greenwald). Still, we've shied away away from the hazardous waste companies primarily because of our concern that negative fundamentals would compound negative operating leverage in the downturn and pressure shares downward.

Yet, timing entry points is extremely difficult and, while maintaining price discipline, we can't get "too cute" once we decide we like the business and the business is already trading at a discount to our estimate of normalized intrinsic value.

Example: shares of Clean Harbors leaped higher to the mid-$60s from the mid-$50s over the past week on speculation that the company might benefit from the unfortunate gulf oil catastrophe (Clean Harbors offers oil spill containment and clean-up services). Even in the $60s, we believe normalized earnings power and replacement cost analysis support much higher fair values for the company, providing reason to purchase shares despite questionable fundamentals. Further, as we've previously noted, we generally prefer to own services companies over pure commodity companies (e.g. own clean-up/remediation versus natural gas/oil companies).

Clean Harbors reports results this Wednesday, so we'll have an update on utilization levels, pricing, and overall demand. US Ecology reported March quarter results last week, including this management commentary (emphasis added):
  • "Our overall business was similar to what we saw in the fourth quarter of 2009, although we experienced declines when compared to the first quarter last year," commented Chief Financial Officer, Jeff Feeler. "As expected, our Event Business was impacted as a result of the completed Honeywell Jersey City project. We estimate that the Honeywell Jersey City project contributed approximately $0.06 per share of earnings in the first quarter of 2009 that was not replaced in 2010. Our non-Honeywell Event business revenue was up almost 18% as compared with the same quarter last year. However, our Base business, while relatively flat with the fourth quarter, was lower than the same period last year consistent with the lag in our business to industrial production levels," Feeler concluded.
The up-tick in event business (ex-Honeywell) is encouraging, although the "base" business was still down Y/Y. Additional color from the US Ecology's 1Q10 slide deck:

And, the business outlook:

Common sense implies that a stabilized and now growing economy, even if slowly, is positive news for both US Ecology and Clean Harbors. While pricing may remain competitive, the tide may be turning.

Happy investing,

Jeffrey Walkenhorst

Disclosure: long CWST, BRK.B.

© 2010 Jeffrey Walkenhorst
Please see important Risk Factors & Disclaimer

Saturday, May 1, 2010

Sonic Foundry: Déjà Vu as Pot of Gold Remains Around Corner?

Sonic Foundry (SOFO, $7.30) posted F2Q10 results and held its Webcast on Thursday. At first blush, we were disappointed:
  • 9% Y/Y revenue decline for the March quarter and essentially break-even profitability - based on our Mediasite franchise thesis, we fully expected to see better revenue and billings performance even without the larger KAUST deal this year. As awareness increases, our thesis was that seasonality would diminish and Y/Y growth in all quarters would accelerate, but we're not seeing this trend (as yet).
  • Accordingly, reasonable questions came to mind - are risk factors such as pricing pressure, competition, and execution negatively impacting the story? Perhaps some investors are right in questioning why we've not seen large deal announcements? Is this a "bad" business that can't scale and generate steady cash flows for shareholders? Will the "big deals" always be just around the corner?
  • Note that many "tech" companies are delivering consistent Y/Y growth, albeit with different business models (enabling more "linear" growth) -- examples: Blackboard Inc. (BBBB), Progress Software Corp. (PRGS), and market-darling-at-54x-2011E-earnings Salesforce.com (CRM).
Yet, we then focused on the fact that management previously guided for "mid-2010" to be the "turning point" for the company. Plus, we should acknowledge that some seasonality may always exist given typical purchasing/budget cycles and installation periods for the education sector (summer months), which represents approximately 2/3 of Sonic Foundry's business.

Other data points: service revenue increased 11% Y/Y, unearned revenue increased 4% Y/Y, gross margins remained stable at 75%, and operating expenses/cash burn are under control. Also, Sonic Foundry continues to innovate and plans to enable playback on Apple's (AAPL) new iPad as well as integration of third party content capture in the Mediasite appliance (we need more details on this) -- please see this slide from the Webcast, also with mention of a successful UNLEASH Conference:
The saving grace: management continues to point to "some of the largest transactions in company history" while somewhat tempering the outlook with mention of weak state budgets - from the release:
  • The company currently expects to see future growth in billings and revenues due to a growing number of larger opportunities found both domestically and internationally. Opportunity growth is occurring through expansion of existing customer installations along with new installations. A number of key opportunities would represent some of the largest transactions the company has executed in its history. A key driver of this demand is a growing request for online education and training and an increased comfort level with blended online learning within existing curriculums. However, the company also remains concerned with existing state budget issues that are affecting a number of state universities in the U.S. and which could have an adverse effect on business in certain areas of the country.
The following slide highlights expected business drivers:

The drivers all make sense, especially knowing that Mediasite is an indispensable utility for countless customers and deployment of online video/learning tools should keep increasing given global secular trends. Here's additional color regarding the outlook:

So, "the moment of truth" we referred to in our earlier post this week really remains this summer. We are inclined to again share the quote we relayed in our 11/19/10 post, Mediasite Franchise Value Remains Unrecognized by Market, from the beginning of Chapter 8 in More than You Know by Michael J. Mauboussin:

Of course, we won't stick around forever -- we are all too cognizant of opportunity costs. While shares of our "asset heavy" REIT and container shipping companies have performed extremely well, Sonic Foundry remains stagnant over the past year despite generally negative fundamentals for the former categories and positive annualized fundamentals for the latter (reason: former recovering from extremely depressed/irrational levels; *shipping fundamentals now improving, although excess capacity remains risk).

If we don't see revenue scaling to $6-7 million per quarter -- which would suggest operating earnings per share of $0.70-1.00 per share (please see our 3/3/10 post) -- we may fold up our tent and go home. However, even acknowledging that forecasting is a speculative game, for the company to move the annual revenue needle to $25 million from $20 million seems within striking distance. Finally, we still believe our $20-30 fair value estimate for the Mediasite franchise -- based on reproduction cost -- is rational and supported by comparable M&A transactions. Please let us know if you think otherwise as we welcome substantiated, alternate viewpoints.

For now, we keep waiting.

Happy investing,

Jeffrey Walkenhorst

Disclosure: long SOFO.

© 2010 Jeffrey Walkenhorst
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