PacSun (PSUN) Getting a Makeover

I had Pacific Sun (PSUN) on a solid balance sheet, low P/Sales screen, but failed to act on it as other retailers with similar characteristics started moving (CHS, CHIC). But a little bit belatedly, PSUN has been getting a re-rating lately. It has gone from $1.39 on April 8th to a high of $4.25 today (205%).

Unlike Talbots which rallied inexplicably last year when it got a little debt relief (but who was going to buy their lousy clothes) and provided a decent short opportunity, the same is not necessarily true for PSUN because it has a better balance sheet.

But having a decent balance sheet in the retail space is no guarantee that hard times won't catch you out. Select Comfort (SCSS) is a great example of a once "market darling" with a little bit of cash set aside for a rainy day, failing to provision sufficiently for when the rains came. It was amazing how quickly its financial position changed from one of relative strength to one of "where's the cash going to come from."

Incidentally, SCSS has had a nice rally from $0.19 to as high as $1.40 (636%) - wow, wish I had been on that one.

Disclosure: No personal or professional position in any stocks mentioned.

Do I Trust Them?

Do I trust companies? No! Directors? No! Management? Who are you kidding!

I can't tell you how many times I have seen companies beat the number this quarter, but miss on revenues. If that isn't a fudge I don't know what is.

Usually, they beat on both the top and bottom line. But this time around they are beating only on the bottom line. Demand is evaporating, but somehow they manage to meet the number. Come on. I call accounting shenanigans, but there again, what is new.

Risk is Back

The VIX is trending down, investors are looking at their cash yielding 0%, and the world looks as though it might emerge later this year. What is a good investor to do? Buy, of course!

So says the market. My concern is that the financial crisis and related recession have scared the consumer witless (not withstanding having also destroyed his wealth and taken his job), and convinced the patient they need to live their lives a little differently (which incidentally is a good thing).

Recovery may be taking shoot, but it is going to be subdued as it faces a cavalcade of transitional headwinds (deleveraging US consumer, more cautious attitude toward risk, higher taxes, a moribund financial sector, govt funding issues). Look to the lost decade for guidance.

Contrarian Asset Play - Coal-Based Utilities

I don't even know the space, but it doesn't take a scholar to work out that coal-based utilities are persona non grata right now (they are the nuclear power plants of the new century). In classic Wall St fashion, the market has fled (and will continue to flee) the space, thereby abandoning what will eventually be highly undervalued assets and a great contrarian play.

Are We Getting Set Up?

I can speculate as much as I like about the future, but the fact remains, on most levels, the future remains unknown. This is especially true of trading and investing. When you make a decision (whether it is a buy or a sell) you just don't know if it is going to be a good decision or a bad decision. As such, I don't know whether the present rally is genuine, or whether it is simply a ruse. I can't help but feel we are getting set-up for a reversal though. We could come in tomorrow, a new day and a new month, and suddenly something that hasn't been important before is the all new "important." Do I believe in some complicitous cartel orchestrating these things? No. But sometimes you have to wonder because the price action is just so shonky. For the record, I'm surprised the market is so sanguine about the risks associated with a flu pandemic. If nothing else, it has the ability to disrupt regular discourse for a period of time. And even if it does peter out, my suspicion is that it will rear its head again during the next Northern flu season.

Economic Recovery, Inc. (ERII)

Took a quick look at Economic Recovery (ERII). Nice little company. From Yahoo, the company "engages in the design, development, manufacture, and sale of energy recovery devices for sea water reverse osmosis desalination worldwide. The company markets its energy recovery devices...to engineering and construction firms, and original equipment manufacturers." Like the space. Desalination holds tremendous potential in a water starved world where most of the globe's population lives within 200 miles of the coast. Company exhibits nice "leader" traits - high margins, strong growth, but it also exhibits the one thing I always struggle with with growth companies - a high valuation. The irrepressible laws of diminishing return inevitably weigh on high multiple assets. Because growth rates and margins are not sustainable ad infinitum in a competitive world (although analysts generally extrapolate them), multiple compression will inevitably set-in at some point. Fighting multiple compression even as growth continues to be cranked out, is ultimately a losers game - just look at any ex-growth stock (INTC, MSFT, YHOO, EBAY, etc.). The bottom line is that valuation counts. But this one is worth keeping an eye on - especially because it is so small and there is the potential there being a large opportunity.

Disclosure: No personal or professional position.

Do You Hear It?

Do you hear that big sucking sound? That is the sound of hope sucking people into this market. It is going to be interesting to see how this pans out - how long, how far, how much volume.

CB Richard Ellis (CBG)

I used to own CBG in the SMID accounts, but sold it as the wheels fell off. Lots of regret there. Regret that I didn't sell it a lot earlier! In any case. This stock has been on a tear since renegotiating its debt. Up from a low of $2.34 on March 20 to around $6.74 presently. Now that is a nice move. But with the wheels yet to fully fall off the CRE market, a highly leveraged balance sheet, and integration issues still with Tramell Crow - I'm not sure I would want to enter that trade at this time. There is still a world of hurt to wash up on CRE shores, but I guess someone has to clean up the mess and CBG has the largest position in the real estate services market. The problem is, they drank the kool-aid and will suffer from their debt hubris and acquisition fever for some time to come. With Jones Lang missing today, I'd be a little careful going into earnings tomorrow.

Disclosure: No personal or professional position.

Been Losing Ground In Last Few Days

We've had a huge run in the SMID cap portfolios this year, in spite of being long the market all year.

Relative Performance of US Small-Mid Cap BRI vs. S&P 1000 as of 4/28/09
QTD 1.46%
YTD 9.05%
TTM 2.73%
2Yr 4.35%
3Yr 3.81%

But I have given a little back lately in the wake of the market continuing to rise and am losing ground again today (I began selling into the rally when the Standard and Poors 500 went through 850, and am of the mind to continue selling into any rally and put on inverse ETFs, especially if it goes crazy).

The market has absorbed the swine flu fears and is powering higher with tremendous momentum behind it. We've experienced a sea-change in sentiment and there is a sense that those on the sidelines and those short the market are getting squeezed back into it. As such it has the potential to see explosive action on the upside.

Article by Willem Buiter on his FT blog encapsulates my thoughts and concerns (http://blogs.ft.com/maverecon/2009/04/green-shoots-grounds-for-cautious-pessimism/) and indicates where I am at.

Focus on Focus (FMCN)

Added Focus Media (FMCN) to the SMID accounts today. The primary rationale is that this is an undervalued asset with the potential for a re-rating event in the next month or so. The market is pricing the stock as though its acquisition by SINA is not going through. I don't know whether that is the case or not (the smoke indicates so). But on the chance that it does get done, then FMCN is worth about $10-$13 based on SINA's current price of $29 (SINA share ratio at .365 yields approximately $10.58 of value for FMCN shareholders). What is left of FMCN will be sitting on approximatley $1.00 in cash and a residual business that probably isn't worth much: $10.58 + $1.00 + $0.25 = $11.83.

Don't get me wrong. FMCN is a mess. Gone are the days when it was cranking out massive growth rates and monster margins. It was a charade supported by Goldman who did a real deal on shareholders all the way up. There is not only smoke, but fire all around. The deal sure doesn't look as though it is going through by the share price. But all the analysts say they think it will and SINA has reaffirmed its commitment to the deal. Fosan has taken a 28% stake in the company (which throws a spanner in the works), but it is unclear what its intentions are. SINA at $29 looks ok.

But as I have said before, I am not a great fan of China right now, and I sure don't trust the companies nor the govt stats that come out of the country. Short interest is 20m shares down from 23m shares a few months ago (about 16%...which is a concern). Vision China's disappointing report today and negativity surrounding FMCN could point to reasons given for scuppering the deal.

Disclosure: Own FMCN in professional accounts.

Let The Sun Rain Down

Looked at Sunpower (SPWRA) on March 24th and modeled much reduced earnings and margins going forward. After reporting a few days ago, I see that 2009 earnings have been revised down from $2.03 to $1.36...my estimate was $1.31) and 2010 from $3.00 to $2.33 (my estimate is $1.81). I like solar long term (although I think it will exhibit highly cyclical characteristics similar to semiconductors) and the firm is a leader in its space, and it is off 79% from its high, so I am thinking its time to sharpen the pencil. Apparently polysilicon is still plentiful but demand for panels has stabilized. Additionally, funding coming through from govt programs could help free up capital for the sector going forward. Be watching.

Disclaimer: No position in this stock personally or professionally.

Immucor (BLUD) and Meridian Biosciences (VIVO)

Had these two on my radar screen for quite a while. BLUD took a pounding last week when it was subpoened by the Department of Justice in an antitrust probe of the blood reagents industry...ouch! Like the company, like its current valuation, like its business position, but an antitrust probe really hurts, even if nothing eventuates (lots of smoke). Worth keeping an eye on though. VIVO took a hit recently on earnings and revised guidance. But it brought a few insiders out of the woodwork and that is always encouraging. Like the company's business, like the balance sheet, but don't like high valuations.

Disclaimer: No position in either of these stocks personally or professionally.

Itron (ITRI) - Water

Itron (ITRI) is looking interesting in the "utility meter theme" space, but I don't like its debt load and I think that is what is weighing this stock down (relative to Badger Meter). Operating margins are weak in this sector and these companies/stocks always feel expensive. That having been said, you would be getting ITRI at more than 50% off, and when things recover, it will fly again. Need to go and look at their debt maturity schedule to see what calls they have on their cash flows. Market is factoring is positive revenue and earnings growth for this year and next year (could be a little optimistic and a little sticky in revising down).


Disclaimer: No position in this stock personally or professionally.

Treading Water

Market is consolidating its recent gains. Several names that I can think of are consolidating at higher levels after nice bounces: EBAY, NVDA, CHIC, CAKE, VCLK, MAT, MSFT, GOOG, AAPL, SWIR, NVTL. A bunch of junk continues to run: LF, SCSS, RSH (actually I think RSH is a sleeper with real value in its network but at $13.40 "I don't think so"), MTSN, CROX.


Disclaimer: I have a personal position in VCLK, but no position in any of the other stocks either personally or professionally.

The Second Derivative

The market has been responding to the 2nd derivative of decline recently - celebrating the fact that the economy is falling apart less slowly (and showing relief that global implosion is a much reduced probability). I can see the market staying positive through the 2nd and even into the 3rd quarters as it remains hopeful of a recovery (newsflow will likely highlight slowing declines). But the rubber will meet the road in the 3rd and 4th quarters as the market's courage is tested by whether a recovery really is likely or renewed concern over continuing weakness (ongoing deleveraging, rising (albeit at a slower pace) unemployment, ongoing debt/solveny issues among financial institutions, consumers, etc.). Q. How much more rally is left in this market? Ans. Potentially quite a bit. If the market remains in its current positive disposition, then it is quite possible to see 1000-1100 on the SandP 500. I think we're currently in the middle of a long term trading range of roughly 700-1100.

Tightly Coupled System

This is an anecdotal observation. It seems to me that the SMID cap marketplace has changed from a reasonably tightly coupled system to a much more free-wheeling one (I know I am not using these terms in a technically correct sense, but they convey the idea of what I am trying to get across). This relates to the observation that in the old days, ie. prior to August 2007, the daily relative performance of the SMID cap strategy vs the Standard & Poors 1000 was pretty stable and never diverged by much more than 20-30bp, even on a big day. This was the general norm, except that you would always go into earnings season hoping that the skew would be one of upside surprises (vs downside surprises). In contrast, it seems to me that daily relative performance gyrations of +/- 50-100bp are not uncommon now and this seems to be the new normal (at least in my space).

Mindray (MR) down but not attractive...yet

Mindray (MR) off as much as 15% today on a downgrade from Credit Suisse. But I missed it at $18 and will sit and watch. The news is not encouraging (March orders weaker than Jan and Feb...ouch!) and I am not a great bull on China right now. I also missed China Med (CMED) below $14 (had a big run-up over $20), but I've got no interest in chasing and am very cautious on CMED (smoke surrounds that company). MR seems like the higher quality play.


Disclaimer: No position in these stocks either personally or professionally.

RF Micro Devices (RFMD) in my sights

This company has been a perennial underperformer and therefore a disappointment to me. The stock has rallied off its low of $0.70 on December 12th to around $2.85 presently (300%+ gain). Balance sheet concerns (the company has levered up in recent years backing off its debt against a large cash stash...garnered when it went public and not from operating profits) and evaporating market demand for its products undercut the company, leading to the stock falling from a high of $7.46 in October 2007. Technically, the current level ($2.85-$3.15) forms a resistance barrier, with the next resistance barrier around $4. Personally, I think there are assets here that are worth more than $3, but I am not sure whether the company will ever get back in a position where it can demonstrate that fact. To their credit management has been chopping into the cost structure (belatedly...boy is it frustrating to watch tech companies wallow in a state of cost structure denial, just because they have the cash to do so) and is putting the company in a position to take advantage of any improvement in its markets. I'm just not sure those improvements are going to come along any time soon. Nokia might be interested, but they've got their hands full with their own problems right now. Apparently RFMD have developed a new process for improving the efficiency of producing LED bulbs (certainly sounds promising, but still at least two years away from commercialization, and it is unclear whether they own the intellectual property on it). It seems that just as you are about to pull the trigger and sell something, some new piece of "exciting" information crops up to defer the decision (hope springs eternal). Stock is undervalued relative to peer SWKS, but not so against other peer also-rans TQNT and ANAD. It has the cash to survive and is getting its internal house in order. Much will depend upon the external opportunities in extending its RF chips beyond handhelds and if the China hope is overdone, and whether there is any value in the LED opportunity.

Disclaimer: At the time of posting, I had a professional position in this stock but sold it before the end of the trading day.

One of many dilemmas

One dilemma I have been wrestling with is to what extent is the future economic performance of the economy factored into current equity/asset valuations. With equity prices off over 58% at their lows, an awful lot of future bad news was being factored in. This largest decline since the Depression made sense to me because we were dealing with the largest economic decline since the Depression (in addition to a financial crisis of global proportions). But the question is did we overshoot on the downside and what is a reasonable level for equities given interest rates, growth prospects and a greater appreciation for risk. I do a lot of back of the envelope calculations in order to gauge perspective and am a great believer in normalizing things, especially in the midst of an extreme event. As such back in January when I put pen to paper and tried calculating a ballpark fair value number for the Standard & Poors 500, I came up with normalized EPS of $65 and a normalized PE multiple of about 15 to arrive at a ballpark fair value of somewhere between 900-975 [Note: this calculation was done in the midst of downward earnings revisions taking S&P 500 earnings to $40 and multiples of 8 being thrown around as reasonable - pointing to levels of 320-500 on the Standard & Poors].

P.S. The divergence between all the positive information coming out of China and the performance of the FXI recently may be telling of something. Keep an eye on that.

Disclaimer: I have a personal position in the FXI.

Are We Happy Yet?

The market (or at least Ed Hyman at ISI) is declaring the recession over. I'm somewhat skeptical. It seems to me that you don't have a 5% decline in GDP over two quarters (and counting) and then turnaround on a dime. There is a lot of momentum built up on the downside. I'm of the opinion that the deleveraging of the economy will weigh on the economy for quite some time (and I just less sure as to how long it will weigh on markets given the 60% haircut taken already). The rally itself is a function of relief that financial doomsday is no longer on the table, the very real possibility that we had significant overshoot on the downside (fear in September, October, November and March was overwhelming), and the fact that many players (hedge funds specifically) are underweight the market (whether short or on the sidelines) and are being forced back into the market. The market is shaking off bad news that seems to be cascading through the system, which speaks to a market looking past the current travails and seeing better days ahead. I would consider myself more in the L shaped recession camp at this point, and think that that optimism is a little premature (make that a lot premature). Also for the record, the reflation trade has worked pretty well off the low, but for my money, inflation (or reflation) is not likely for at least another year or two, or three.

Liquidity v Solvency

Bronte Capital brought this home to me the other day with an excellent post (http://brontecapital.blogspot.com/2009/04/liquidity-and-banks-primer.html). My takeaway is that the banks (that are likely insolvent technically - Citigroup and probably Bank of America of the big boys) will continue in a zombie state fending off runs with a hydrant of liquidity (care of the Fed) and slowly recapitalize over time. This to me looks somewhat reminiscent of the Japanese experience. Solvency and liquidity are interrelated, but the dynamic surrounding a bank (or company) plays out differently in each circumstance. What struck me though was the fact that a technically insolvent bank (or company) can continue operations so long as it maintains the confidence (forebearance) of its creditors and has sufficient liquidity to meet any concerns.

Whereto Housing

Couple of thoughts on the housing market. Looks like we are pretty close to the bottom in new homes sales (in fact I think we have seen significant overshoot on the downside). But housing prices will continue to struggle as overhang from inventory in the existing house market and from shadow inventory (foreclosures withheld from the market) are likely to continue to weigh on home prices. Calculated Risk is a great source for following and getting insight to what is going on in the space. Naked Capitalism featured an interesting article the other day on the demographic trends in housing with a decidedly bearish tone. Definitely worth a peak (http://www.nakedcapitalism.com/2009/04/will-demographic-trends-impede-recovery.html?showComment=1240221420000).

Die Englische Schweinhund

One of the first thoughts that popped into my mind when the swine flu arose last week was the refrain from the old "Battle" comic books of the 70s "die English pig dog." (http://fanboy.frothersunite.com/battle.html) Don't ask me why, but those are the funny associations that arise in everyday life. I also liked Commando comics as well (http://www.barelyhangingon.co.uk/commando/pages/home.htm). I haven't thought of those things in years, then out of the blue the memory is aroused.

Swine Fears - What to do? What to do? That is the question!

History and probability are probably on the side of this swine flu thing being a non-event (relatively speaking). But it reminds me of the subprime crisis. Initial reaction was contained and managable. But just like subprime had knock-on effects, a flu pandemic has the capacity for systemic risk. The risk in not moving to the sidelines when the future is murky is following the market down as greater fears are realized. With the market up more than 30% since its lows, it seems to me that the current situation is skewed to the downside. My sense is that the market is going with the historic probabilities and not capitulating to fear. And I wonder whether it is making the same misstake again as it did with subprime. Pandemics are low probability events at the very end of the distribution. Unfortunately, that is the catastrophe zone. In the end I am not sure whether it much matters whether this swine flu fear spreads, as it has the potential to arrest the upside momentum, leading to a rolling over of the market.

Cheesecake (CAKE) in a pickle

Actually, Cheesecake (CAKE) isn't in a pickle so much as I am in a pickle about CAKE. Sentiment among the analyst set has been divided (good article on Seeking Alpha describing the changes in the last month http://seekingalpha.com/article/132847-cheesecake-factory-why-the-moving-price-target) about the stock, but the stock's price action has been one way in the last month or so (up from a low of $6.84 on March 9th to a high of $18.11 on Friday). After having sat on this one for more than 3 years (enduring a significant deterioration in the firm's performance) I decided it was time to exit after such a big move. Here is my pickle. When I looked at the earnings power of the company, it pretty much struggled to produce much more than $1 in EPS even in its best times over the last five years (as such if I normalize long term earnings power around $1 and give it a normalized multiple of 15, that equates to a $15 target price...they're expecting EPS of $0.64 in 2009 and $0.74 in 2010...those numbers will obviously go up). Add to that the fact that they are only adding one more restaurant this year, the Discretionary sector has been on an absolute tear in the SMID cap space this year, and all of this in the face of rising unemployment, and I am somewhaat sanguine about the company's prospects over the next year. That having been said, the stock is trading at a reasonable discount on a P/Sales basis to its better peers (YUM) and I believe its new menus (lower portions = lower costs) along with the chance for a resumption to adding new restaurants at some point in the future (obviously not at the same rate as in the past, but still), point to a return to growth and an improvement in operating margins. All of which could lead to a re-rating of the stock on a P/Sales basis, and a price somewhere in the range of $25-$30 over the next 3-5 years. Obviously a lot needs to go right for that to happen (and a lot has already been factored in just recently...just as a lot of bad things were factored in on the way down), but that is the pickle I am in. And that pickle is something called regret, and regret is something that weighs heavily on most investors psychological disposition.

P.S. From Wikipedia. Regret (often also called opportunity loss) is defined as the difference between one's actual payoff and the payoff in a better position that he could have got if a different course of action had been chosen.

P.P.S. I also didn't like the increase in the firm's financial risk as it levered up to buyback stock over the past three years (although it appears they have gone back to managing this business more conservatively by paying back some debt and making their expense structure more competitive...it is amazing what can happen when you get rid of the investment bankers).

Disclaimer: No position in this stock personally or professionally.