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DOW THEORY FORECASTS
7412 Calumet Ave., Hammond, IN 46324.
1 Year, 52 issues, $259. www.dowtheory.com.
Microsoft still a long-term buy
Richard Moroney: "Microsoft (Nasdaq MSFT $25) has launched a cable-TV software platform in an effort to get a piece of the burgeoning market for on-demand television services. The software will run set-top boxes and allow cable operators to package such services as pay-per-view, video on demand, content-purchasing options, digital video recording, and e-mail. Microsoft also announced the planned purchase of anti-virus software and technology from a Romanian company. In other news, the European Union said it would offer no deadline for the conclusion of its four-year antitrust investigation of Microsoft. Microsoft stock has lagged the market in recent months. But new-market expansion is starting to pay off as the company brings its marketing muscle to bear. The stock is a Focus List Buy and a Long-term Buy."
WALL STREET FORECASTER
250 Liston Rd., Ste. 700, Buffalo, NY 14223.
Monthly, 1 year, $99.
Includes weekly Hotline and monthly Portfolio supplement.
Newspapers survived the Internet bust
Patrick McKeough: "Dow Jones (NYSE DJ $45; WSSF Rating: Above average) publishes The Wall Street Journal and roughly 30 community newspapers. The company also publishes Barron's and Smart Money magazines, and provides newswire services.
In the first quarter of 2003, profits fell 46.4% to $0.82 a share (total $66.9 million) from $1.53 a share (total $129.8 million) a year earlier. However, if you exclude gains from asset sales and non-recurring charges, per-share profits jumped 50%, to $0.12 from $0.08 a share. Most of the gains came from an ongoing cost control program that saved Dow Jones roughly $80 million in 2002. Revenues fell 8.8%, to $358.2 million from $392.9 million, as the soft economy and Iraq-related fears cut advertising lineage at The Wall Street Journal by 11%.
Although the company's core newspaper business is struggling, its electronic publishing operations (which account for roughly a quarter of its total revenues) continue to grow. Revenues in the latest quarter rose 1.8% from a year earlier, while profits jumped 10.5%. WSJ.com, The Wall Street Journal's online site, is the Internet's largest paid subscription news site with 675,000 paid subscribers at March 31, 2003, up 5.5% from a year earlier.
The stock fell to $29.50 in October 2002, but has gained over 50% since then. It now trades for an expensive 52.9 times the $0.85 a share Dow Jones will probably make this year. But the company's high quality assets and cost cuts put it in a good position to grow quickly when the economy improves. The $1.00 dividend yields 2.2%.
Dow Jones is a buy.
New York Times (NYSE NYT $47; WSSF Rating: Above average) publishes The New York Times, The Boston Globe and 14 smaller daily newspapers. The company also owns eight television stations, two radio stations and over 40 Internet sites.
Profits in the three months ended March 31, 2003 rose 28.6%, to $0.45 a share (total $68.8 million) from $0.35 a share (total $54.5 million) a year earlier. If you disregard unusual item, per-share profits grew 10.3% to $0.43 from $0.39. Revenues rose 6.3%, to $783.7 million from $737.1 million.
The company recently paid $65 million for the 50% of the Paris-based International Herald Tribune that it did not already own. The purchase accounted for roughly a third of the first quarter revenue gains. A 5% rise in advertising revenues, particularly the entertainment and real estate segments, also contributed to the improved results; roughly two-thirds of the company's total revenues come from ad sales. Most of the gains occurred in the first two months of 2003. However, advertising revenues in March fell 1.6% as Iraq-related fears prompted many companies to cancel travel-related advertising and delay the launch of new products.
The stock now trades for 21.7 times its likely 2003 profits of $2.17 a share. The company just raised its annual dividend rate 7.4%, from $0.54 a share to $0.58. It now yields 1.2%.
New York Times is a buy."
STRATEGIC INVESTING
1905 Beacon St., Waban, MA 02468.
Monthly, 1 year, $157.
A correction should offer opportunity
for reasonable entry levels in many stocks
Richard Geist: "We are in the beginnings of a new bull market. Our emphasis now, however, is spurred by our belief that with the indexes having moved up so quickly in the past couple of months, in the near term Mr. Market is likely to give you another golden opportunity to reconsider your pessimistic outlook. A correction, or consolidation at least, should offer opportunities for reasonable entry levels in many stocks.
Many of the indexes are approaching the resistance levels of the March/April lows of 2001, which were significantly higher than both the bear market lows and the lows of October 2001. Typically in this kind of situation the market struggles for a few months to push through those resistance levels. Thus a correction or consolidation would not surprise us. If it does occur, the time will have come to buy on weakness in those stocks you have been too frightened to purchase.
The mainstream press will continue to echo the bears' valuation fears, but if you use what we believe is the Fed's formula for gauging valuations, the S&P 500 remains significantly under-priced relative to the 10 year note. As we continue to get calls asking how to calculate this figure, we'll repeat it once again. Take the consensus S&P 500 forward earnings forecast, which is now about $56, up from $52 a year and a half ago, and divide it by the yield on the 10 year note, 3.29 as we write, multiply by 100 and compare the results to the current level of the S&P 500 (987.52). The math goes like this: 56/3.29=17.21x100=1720.(987.52-1720)/1720=42.6% undervalued.
The forward P/E ratio of the S&P is a mere 17.6. Don't let the pundits frighten you by using the trailing P/E. That would be like using book value of an emerging company as a measure for determining company valuation, where the assets represent historical acquisition costs and have nothing to do with present or future value. At the height of the bubble, Microsoft's book value, according to this theory would have been around $6 per share!
You might also want to look at the difference between the yield on the S&P 500 and the yield on the 10 year note. To do this just invert the P/E ration and you'll find that the earnings yield on the S&P is 5.7 versus 3.29 on the 10 year note, clearly suggesting that you are better off buying stock than bonds at this stage of the market cycle.
Monetary policy remains extremely positive with low interest rates and inflation. In fact, Greenspan's latest statements suggest we have another interest rate cut coming soon. Do we need it? Probably not, but now that the Fed recognizes deflation is an issue and that fiscal and monetary policy should be used to stimulate growth, we'll generously accept any stimulus the Fed cares to offer.
Interpretation of the contrary sentiment surveys yield a less bullish outlook than last month, but with the volatility index moving up, earnings estimates increasing, and the job market still in limbo, we're not terribly concerned yet. We've been arguing for a year that a double dip recession was not in the cards, and (short of any major terrorist activity) we continue to stand by that prediction. And even our allies at the European Central Bank seem to be realizing that they better get on the growth train by lowering interest rates, which will bolster their economy.
So with valuations low, monetary policy accommodative, the economy picking up, and the market having reached the psychological level where the general public begins to dip its toe back into the water, we remain optimistic for the long term, while remaining cautious on the short term outlook But given all the money still on the sidelines, a correction here could spur further market advances. In the meantime, don't chase the stocks that have already moved; be patient and wait for a pull back, or if you must play, use only part of your cash to enter now.
Currently we like Tag-It Pacific (TAG), SFBC International (SFCC), Cubic Corporation (CUB on any pullback), Openwave (OPWV), Education Lending Group (EDLG on any pull back), SeeBeyond (SBYN), Stewart & Stevenson (SVC), DRS Technologies (DRS), Rita Medical Systems (RITA), Cryptologic (CRYP), Harris Interactive (HPOL), Sun Microsystems (SUNW), Applied Materials (AMAT), The Titan Corp. (TTN), Impax Labs (IPXL), and Qualcomm (QCOM). As during the past few months, Zi-Corp (ZICA) and Aura Systems (AURA) remain speculative buys."
PEARSON INVESTMENT LETTER
6431 Rubia Circle, Apollo Beach, FL 33572.
Published monthly for clients of Pearson Capital.
Recommended stocks for June
Walter Pearson's recommended stocks for June are: Pennsylvania Commerce Bancorp, Inc. (Nasdaq COBH $38.63), Sicor, Inc. (Nasdaq SCRI $21.14), Wilshire State Bank (Nasdaq WSBK $14.70), World Acceptance Corp. (Nasdaq WRLD $14.11), Capital One Financial Corp. (NYSE COF $48.17), Constelation Brands, Inc. (NYSE STZ $27.57), Intervest Bancshares Corp. (Nasdaq IBCA $11.50) and Mercantile Bank Corp. (Nasdaq MBWM $25.86).
Highlighted below is Capital One Financial Corp., a holding company that offers consumer financial products and services through its subsidiaries. The Company's primary business is consumer lending, with a focus on credit card lending, but including other consumer lending activities such as unsecured installment lending and automobile financing. The Company also offers credit card products through its principal subsidiary, Capital One Bank. Capital One F.S.B., a federally chartered savings bank, offers consumer lending and deposit and deposit products, and Capital One Auto Finance, Inc. offers automobile and other motor vehicle financing products. For the 6 months ended 06/02, interest income rose 4% to $22.7M. Net interest income after loan loss provision rose 61% to $9.6M. Net income rose 96% to $3.3M."
THE CONTRARY INVESTOR
309 South Willard St., Burlington, VT 05401.
Monthly, 1 year, $125.
Hydrogenics poised to outperform in
Investment and power generated worlds
Todd Wulfson and Michael Huffman: "Hydrogenics (Nasdaq HYGS $4.39, www.hydrogenics.com) is a "clean energy" company with a two-pronged strategy: the company makes fuel cell modules and provides fuel cell testing equipment and services to other industry participants. The strategy focuses on short-term results, so that internal cash flow will adequately fund further development.
In January 2003, HYGS nearly doubled the size of the testing and diagnostic business when it purchased Greenlight Power Technologies, the number two player after HYGS, for cash and stock valued at $19 million. In 2002, 36% of the company's US$15.8 million in revenues came from this division. Now operating under the Greenlight name, this division has 50 customers utilizing 370 stations. Orders have been received in 2003 from Ballard, DuPont, GM, Nissan, Toyota, Volvo, United Technologies and 3M.
It is expected that most of HYGS' future revenue growth will come from its line of PEM fuel cell power products. Fuel cells convert hydrogen into electricity. They may well be a critical ingredient of the decentralized power generation world in our future. HYGS has learned to focus on premium applications (where customers will pay up for quiet, low emission and flexible power generation) rather than basic research. Hydrogenics' low-pressure PEM fuel cells create efficiencies and allow applications not available to other PEM systems. The initial products are 20-kilowatt units. These can be linked together to create larger generators.
To further its goals, HYGS has established strategic relationships with key industry players. The idea is to leverage the partners' R&D, improve or create the product and then once again leverage the partners' sales capabilities. GM and HYGS have created this kind of relationship (GM now owns 24% of HYGS). GM is committed to the development of fuel cell technology as a clean power source for vehicles. We expect that GM will introduce fuel cells for stationary and back-up applications long before the technology makes sense for cars and trucks.
The March 31, 2003 balance sheet shows US$55 million in cash ($1.00 per share) and $0.5 million in debt. Cash used in the first quarter -- exclusive of acquisition and integration costs -- was $400,000. The company has a 2003 goal of positive operating cash flow. We expect revenues to double to $32 million. Hydrogenics is headquartered near Toronto and has facilities in British Columbia, Rochester, NY, Japan and Germany.
We feel that Hydrogenics is well positioned to outperform in both the investment and power generation worlds. It seems like it's a matter of "when," and not "if" it will happen. Hydrogenics' sustainable strategy means being around when the payoff comes.
Goal: US$8 in 18 months. $15 in 5 years.
Catalyst: Announcement of new Joint Venture or commercialization of a "premium product" application."
SUPERSTOCK INVESTOR
1900 Glades Rd., Ste. 441, Boca Raton, FL 33431.
Monthly, 1 year, $395.
Charles Schwab could eventually
become a takeover target
Charles LaLoggia: "I have followed Charles Schwab (NYSE SCH) for some time. I consider this not only a proxy for the market in general, but overall a very well run business that eventually could be a takeover target for a larger financial services company. If the tock were to move back to $8.50, around the level it was trading at before the Iraq War began, I would add it to the Master List of Recommended Stocks.
Schwab is one of the strongest franchises in financial services. The company provides securities brokerage and related financial services for a massive clientele base of over 8 million active accounts. Client assets totaled $762.6 billion on March 31, 2003. The Company has 374 domestic branch offices in 48 states, as well as a branch in Puerto Rico. It owns U.S. Trust Corporation, a wealth management business that provides fiduciary services and private banking services through 33 offices in 13 states. Other units include Charles Schwab Investment Management, Inc., the investment advisor for Schwab's proprietary mutual funds and Schwab Capital Markets L.P. (SCM), a market maker in Nasdaq and other securities. SCM executes trades primarily for broker-dealers and institutional clients. CyberTrader, Inc. is the Company's electronic trading technology and brokerage firm providing services to highly active online traders.
The stock has done well during the past couple of months, up 20 percent, in large part due to retail investors coming back into the stock market as a positive outcome to this latest conflict with Iraq became clearer. This is clearly evident from increased money flows into equity mutual funds and increased retail trading volumes. Average daily revenue trades for Schwab in April were 120,000, up 5 percent from March. Trading volume in the first few days in May increased to 141,000, but that is probably an unsustainable level as the summer months are upon us and volumes usually tend to wane, so at over $9 per share, Schwab is perhaps anticipating more earnings than it can deliver over the next several quarters.
I think that retail trading volume will also fizzle as much of the optimism based on declining geopolitical fears begins fading. While the Iraq war from a military point of view was successfully executed, the global terrorism problem looks to be very far from over. In addition, with war uncertainty largely out of the way, investors are once again focusing on a domestic economy that continues to sputter.
Lower interest rates in Schwab's case could be a factor driving the stock off its quick 20 percent run up. Schwab made upwards of 20% of its revenue -- off an already depressed base -- from money funds, and it is likely a significantly greater portion of net earning. If the Federal Reserve reduces rates at its next meeting, analysts will have to figure this into their Schwab earnings model. Lower rates could also mean lower numbers for its fee businesses.
Aside from these potential near-term negatives, Schwab is still fundamentally a solid story longer-term. I also think there is the possibility Schwab could be acquired given how flush full-service brokers are right now. Remember, Charles Schwab sold out to BankAmerica Corp. in the early 1980s, only to buy it back and take it public in 1987. Goldman Sachs (NYSE GS), Morgan Stanley (NYSE MWD) and Lehman Brothers (NYSE LEH) annihilated fourth-quarter estimates when numbers were reported in April. These big broker-dealers have made a killing in their fixed-income trading and might look to roll some of these profits into acquiring Schwab while it's at such a low level historically. Bear in mind that Schwab traded over $40 per share as late as March of 2000.
To reiterate what I think is the best approach here, we will probably get a better entry point for SCH if we are patient, possibly later in the summer when enthusiasm for this and other similar financial services companies hopefully decline. I may lift the recommended entry point for SCH at some point, but for now I think $8.50 is a level worth waiting for."
HENDERSHOT INVESTMENTS
11321 Trenton Court, Bristow, VA 20136.
1 year, 4 issues, $45.
Seeking healthy long-term returns?
Consider Johnson & Johnson
Ingrid Hendershot: "Johnson & Johnson (JNJ $54.35) is the world's most comprehensive and broadly based manufacturer of health care products, as well as a provider of related services for the consumer, pharmaceutical, and medical devices and diagnostics markets. The development of new and improved products is important to the company's success in all areas of its business. This competitive environment requires substantial investments in continuing research and in multiple sale forces. Johnson & Johnson has approximately 110,300 employees and more than 200 operating companies in 54 countries around the world, selling products in more than 175 countries.
Double-Digit Growth
Johnson & Johnson is a market leader in the health care business, selling everything from Band-Aids to artificial hips to pharmaceuticals. The company has an extraordinary record of consistent performance. Sales have grown steadily for decades, including every single year since the Great Depression. Earnings growth has also been remarkably consistent with double-digit average gains each year over the past century. In the past five years, sales increased at an 11% annual rate with earnings compounding at a healthy 21% rate, as profit margins steadily expanded due to successful ongoing cost control efforts and operational efficiencies.
Johnson & Johnson's long record of consistent growth may be attributed to its broadly diversified businesses, decentralized management, and long-term focus-all built on a foundation of strong values. In 1943, General Robert Wood Johnson, the son of the founder of the company, set forth a company credo with principles and high integrity standards that have guided JNJ ever since.
Pharmaceuticals represent the largest and fastest growing part of JNJ's business. A diversified pharmaceutical portfolio accounts for nearly half of sales and more than 60% of earnings. Medical devices will contribute significantly to future growth as JNJ's drug-coated stent, Cypher, was recently approved in the U.S. This new-generation stent dramatically reduces the re-blockage of coronary arteries.
Abundant Free Cash Flow
Johnson & Johnson defines free cash flow as the portion of operating cash flow that remains after the company has made the necessary investments through capital expenditures to support the growth of the business. In 2002, strong free cash flow of $6.2 billion provided the fuel for a $5 billion share repurchase program, acquisitions, and a dividend increase. Dividends have been increased for 41 consecutive years with a recent 17% hike.
Strong cash flow has enabled JNJ to supplement internal growth with acquisitions. During the first quarter, JNJ announced plans to acquire Scios, a biotech company, for approximately $2.4 billion. Scios is developing heart failure and arthritis drugs. This deal follows the $4.9 billion purchase of Centocor, a larger biotech firm in 1999, and the $10 billion purchase of Alza, a drug-delivery company in 2000. Even after the Scios acquisition is completed, JNJ expects to end 2003 with more than $4 billion in cash. Johnson & Johnson's strong internal generation of cash is why the firm is one of only a handful to boast of triple-A credit rating.
Stellar Return On Equity
Over the past decade, Johnson & Johnson's average return on shareholders' equity has consistently exceeded 20%, with a stellar return on equity of 29% last year. JNJ's investments in innovative products have helped the company achieve superior levels of capital-efficient, profitable growth. This has translated into generous rewards for investors, as JNJ's stock has risen over 17% annually in the past 10 years, almost twice the pace of the S&P 500.
In the first quarter, JNJ reported its first $2 billion earnings quarter. Double-digit earnings growth should continue for the full year of 2003 with EPS of about $2.60 expected. At current price levels, Johnson & Johnson appears reasonably valued. Investors seeking healthy long-term returns should consider Johnson & Johnson, a HI-quality company with a long record of double-digit sales, earnings and dividend growth, abundant free cash flow, and stellar returns on equity. Johnson & Johnson has provided a 59% total return over the last 3 years.
DEFAULTED BONDS NEWSLETTER
6175 NW 153rd Street, #201, Miami Lakes, FL 33014.
Monthly, 1 year, $495.
Battle looming over
vote by WorldCom's creditors
Richard Lehmann: "The WorldCom Inc. bankruptcy is headed for a vote by creditors with a plan reportedly acceptable to 90% of the creditors, by number if not dollars owed. Assuming a favorable outcome, confirmation of the plan is scheduled for August 25. A battle is looming then, since WorldCom's competitors, who are also creditors, will be objecting to the plan. Also, MCI creditors are claiming that the allocation of residual value between them and WorldCom creditors was understated, a result of the foggy accounting that went on at WorldCom.
As with all such bankruptcies, the principal currency of settlement will be stock in the new company, to be known as MCI. A valuation analysis by investment banker Lazard Freres & Co., advisor to the debtor, has estimated an enterprise value of the post-bankruptcy company between $10.5 to $13.5 billion (representing an average share price estimate of $20 to $30). While this may seem a goodly amount it must satisfy creditor claims totaling over $41 billion. Recoveries by bondholder class are as follows:
- WorldCom senior bondholders to receive stock representing a 35.9% recovery.
- MCI senior bondholders to receive a recovery valued at 80%.
- Intermedia senior bondholders to receive a recovery valued at 93.5%.
- WorldCom and MCI junior bondholders to get nothing.
- Intermedia junior bondholders to get a 46.4% recovery.
Two distressed bond buyer groups, Matlin Patterson Global Opportunity Partners LP and Financial Ventures LLC will receive shares in the company representing 17% and 12.6% respectively. The new company represents the consolidation of some 222 previous companies making up WorldCom. The assets and liabilities for these companies had to be pooled because they could not be unraveled due to a breakdown of the accounting at WorldCom.
WorldCom or the new MCI remains a major telephone carrier and therefore, a company to be watched. Its stock will likely be followed by numerous analysts and will have broad interest among institutional investors, unlike most post bankruptcy equities."
UPSIDE
7412 Calumet Ave., Hammond, IN 46324.
Monthly supplement to Dow Theory Forecasts.
Combo-platter stocks: Superior growth and value
Richard Moroney: "Not long ago, true-blue value stocks were the darlings of the market. Now growth stocks are stepping up to the plate. So far in 2003, the S&P SmallCap 600 Growth Index is up 6.4%, versus 5.1% for the value index. While growth stocks may continue to set the pace in the near-term, abandoning your value stocks seems premature.
One potentially profitable way to play the growth revival yet still keep an eye on valuation -- is to look for stocks that offer the best of both worlds. Companies that deliver superior growth at rock-bottom valuations have a good chance of outperforming in the year ahead. There is no shortage of value stocks based on price/earnings ratios. But it can be a challenge to find quality small stocks expected to generate better-than-average profit growth and trading at low P/E ratios.
Upside has done a good job of uncovering profit growers with attractive valuations. Our recommendations have an average forward P/E of 16, compared to 21 for the average stock in the S&P 600. Yet the average Upside stock is expected to post 26% profit growth this year, versus 23% for stocks in the S&P 600.
The five stocks reviewed below should post faster earnings growth than their industry group this year -- yet the shares trade at a discount to industry averages. Moreover, all five stocks trade at deep discounts to the S&P 600 based on current-year estimates. For example, Centene's forward P/E of 12 is highest among the stocks reviewed. But that's far below the average expected P/E of 21 for all stocks in the S&P 600. Also, all five rank well in our Quadrix stock-rating system.
Centene (Nasdaq CNTE $31) provides managed-care programs to people receiving benefits under Medicaid. The company -- operating plans in Wisconsin, Indiana, Texas and New Jersey -- should post sales of $720 to $730 million in 2003, up from $461 million last year. Excluding any near-term acquisitions, management expects earnings per share to range from $2.59 to $2.64. Organic membership growth should be 10% to 15% this year. Uncertainty surrounding Medicaid reimbursement rates will always hang over Centene. Moreover, increasing medical costs and lower-than-expected rate increases are always a risk. But the company's managed care programs, which lower Medicaid costs compared to traditional fee-for-service programs, should remain in strong demand. Despite its impressive operating performance, Centene trades at just 12 times the 2003 consensus estimate of $2.62 per share. That multiple is on the low end of its historical range. The stock is rated Best Buy.
First Cash Financial Services (Nasdaq FCFS $12) owns and operates 202 pawn and check-cashing stores in 11 states and Mexico. The company advances money against pledged tangible personal property such as jewelry, electronic gear, and musical equipment. First Cash posted March-quarter earnings of $0.36 per share, up 20% and a penny ahead of Wall Street expectations. Sales rose 20% on impressive 14% same-store sales growth. First Cash earns a 96 overall score in the Quadrix stock-rating system, keyed by good scores for Quality (83) and Earnings Estimates (80). The shares traded at nine time expected earnings per share of $1.34 for 2003 and only seven times estimates of $1.59 for 2004. Using the projected five-year earnings growth of 20% puts the PEG ratio at only 0.5. First Cash should be able to support a higher valuation given its profit momentum. Moreover, steady store expansion should drive sales growth. Over the past year, the First Cash has added 41 new locations. It plans to open another 30 to 40 by the end of 2003. A major risk to our bullish position is the possibility of regulation that would prohibit or restrict short-term advances, also called check lending. First Cash is being started as a Best Buy.
Flagstar Bancorp (NYSE FBC $19) has gained 238% since Upside initiated coverage two years ago. Even with the strong performance, the shares represent a compelling value. The current P/E is only 9, compared to 14 for the average small-cap regional bank. Flagstar operates 94 banking centers in Michigan and Indiana, 101 loan-origination offices in 21 states, and 15 correspondent lending offices across the U.S. In recent years, Flagstar has been aggressive in opening new offices. Loan growth has been stellar. During April, Flagstar closed $5.6 billion in residential mortgage loans, or $3 billion more than reported in April 2002, making it the highest level of monthly production ever. Flagstar cranks out some of the highest returns on equity (ROE) in its industry. Over the last five years, ROE has averaged 25%, versus 9% for its peers. The stock, which split 2-for-1 on May 16, is near its all-time high. Flagstar has further upside potential given its valuation and relative strength.
SFBC International (Nasdaq SFCC $15), a leading provider of specialty drug-development research to pharmaceutical and biotech companies has grown by leaps and bounds. Last year sales topped $65 million -- more than double the previous year. For 2003, the company expects sales to range from $82 to $85 million, keyed by strong growth in Canadian operations. Last year SFBC acquired Anapharm, at the time the largest privately held Canadian provider of drug-development services. Despite a tough operating backdrop, March-quarter earnings jumped 44%, to $0.26 per share, partly helped by a below-average tax rate of 14%. Sales, bolstered by acquisitions, surged 95% to $18.7 million. The company said internal growth was a solid 19%. Management reaffirmed 2003 earnings guidance of $1.28 to $1.33 per share. Using the low estimate implies 22% growth and a forward P/E of 12. An expansion of the P/E ratio to 17 -- the average for its peer group -- would imply a stock price of 22. The stock is rated Buy.
Sterling Financial (Nasdaq STSA $23) has branches throughout Washington, Idaho, Oregon and western Montana. At the end of the March quarter, total assets were $3.8 billion, up 27% from a year earlier. Sterling's recent results have been strong, highlighted by robust loan growth and improved returns on equity. March-quarter profits jumped 33% to $0.61 per share. Deposit growth was strong during the quarter, allowing the company to reduce its reliance on borrowings. Acquisitions have played a part in Sterling's growth. During the first quarter, Sterling acquired Empire Federal Bancorp, expanding the company's exposure in Montana and bolstering its mortgage-lending operations. Per-share earnings are expected to increase 18% for 2003 and another 10% in 2004. At 10 times expected 2003 earnings of $2.25 per share, the stock trades below industry averages. The stock, rated Best Buy, could surpass $26."
DOW THEORY FORECASTS
7412 Calumet Ave., Hammond, IN 46324.
Monthly, 1 year, $259.
Growth stocks that pay dividends
Richard Moroney: "Dividends are back in vogue. During the go-go market of the late 1990s, the tax benefits of capital gains, coupled with buoyant stock prices, put the spotlight on growth rather than income. But after three years of negative market returns, the security of dividends may appeal even to investors interested in growth.
The recent cut in dividend taxes makes cash payouts even more attractive. In the past, dividends were taxed at the ordinary-income rate while long-term capital gains were taxed at 20%. But now, most dividends and long-term capital gains will be taxed at the same 15% rate. The Forecasts believes companies will now be more likely to increase their dividends.
Regardless of market conditions, stocks that offer both capital gains potential and income are appropriate for most portfolios. The following six companies are consistent dividend growers with higher yields than the S&P 500 Index with payout ratios low enough to support future dividend increases. All six companies are projected to grow per-share earnings at double-digit rates.
A.J. Gallagher (NYSE AJG $27) increased its dividend in 17 of the last 18 years since it went public. The current yield of 2.7% is lower than the 10-year average of 2.8% and Gallagher has announced plans to use its excess cash flow to further boost the dividend. Gallagher is rated Buy and Long-Term Buy.
Citigroup (NYSE C $42) has posted annualized dividend growth of 27% over the last 15 years. Despite that aggressive growth, the company's payout ratio remains a comfortable 28%, and further increases are likely. The stock has been upgraded to a Focus List buy and also remains a Long-Term Buy.
Fifth Third Bank (Nasdaq FITB $58) has boosted its dividend every year for the last 29 years. The regional bank holding company has increased both per-share earnings and dividends at a 17% annualized rate since 1987. Fifth Third is a Long-Term Buy.
Johnson & Johnson (NYSE JNJ $54) backs up 40 years of dividend increases with an incredible 70 consecutive years of sales growth. Future sales and profit growth should be able to fund further dividend hikes. J&J is a Buy and a Long-Term Buy.
Pfizer (NYSE PFE $32) has averaged a 1.5% yield over the past 10 years. In the wake of recent price weakness, the stock now yields 1.9%. Pfizer increased its dividend in each of the last 36 years, and its current payout ratio of 38% leaves flexibility for both dividend increases and investment in the business. Pfizer is a Focus List Buy and a Long-Term Buy.
Wells Fargo (NYSE WFC $49) has posted 15 consecutive annual dividend increases. The bank holding company has solid internal revenue growth and returns on assets and equity, the kind of attributes that can support future dividend growth. Wells Fargo is a Focus List Buy and a Long-Term Buy."
THE TURNAROUND LETTER
Suite 801, 225 Friend Street, Boston, MA 02114.
Monthly, 1 year, $195.
Chemicals group:
Ready for a cyclical rebound?
George Putnam III: "You could perhaps say that the chemical industry has been caught in an inflation/deflation squeeze over the last few years. Its production costs have been going up as both the energy to run the plants and petroleum-based raw materials have become more expensive. At the same time, the worldwide economic weakness has depressed demand and prices for many chemical products.
There are signs, however, that things may be improving for the chemicals group. There is evidence that recent price increases in a number of products are holding up. Moreover, the cost of many petroleum-based raw materials may begin to decline in the wake of the conflict in Iraq. The declining dollar should also help the U.S. chemical industry. Finally, restructuring efforts undertaken during the downturn have made many companies more efficient, which will boost profits as business improves.
The stocks of the chemical companies tend to swing quite widely based on the industry's fortunes. Many of the stocks in the group peaked in 1998 or 1999 and have been in a state of decline ever since. But if industry fundamentals do indeed improve, these stocks could rebound quite sharply.
The following are a varied group of players in the chemical group, from the behemoths Dow and DuPont down to some of the niche players with relatively small market capitalizations. For the most part, these companies have been beating analysts' earnings expectations, and they are expected to be profitable during their next fiscal year.
Brady (BRC 33.00) makes more than 50,000 industrial identification and specialty coated-material products. It is restructuring to cut costs even as revenues have begun to pick up. The restructuring charges will dampen earnings in the short-term, but the savings will boost the stock down the road.
Cytec (CYT 32.01) began 2003 with the same operating momentum that it finished 2002. This maker of specialty building-block chemicals reported a 15.5% jump in first-quarter revenues to $167.4 million. During the quarter, the company completed a $100 million stock buyback program, and it has authorized another one.
DuPont (DD 41.23) has significantly changed the nature of its business in recent years with the sale of its Conoco energy business and the expansion of its life-sciences unit via the purchase of the 80% of Pioneer Hi-Bred it didn't already own. It has sold its pharmaceutical business and is considering options for its $6.3 billion revenue Textiles & Interiors unit. The stock has been basically flat for nearly three years, but it offers an attractive dividend yield in case you have to wait a little longer for an upturn.
Dow Chemical (DOW 31.36) is a leader in plastics, chemicals, hydrocarbons and herbicides and pesticides. Dow has also refocused its business with the sale of its pharmaceuticals, personal care and household products divisions. Today, plastics-related activities account for roughly 50% of sales. Dow is another attractive long-term holding with a good dividend.
H.B. Fuller (FUL 22.90) has been restructuring for the better part of the last eight years. Even though revenues in 2002 were about the same as in 1995, the company has been steadily profitable. And the balance sheet is pretty solid with only a minimal amount of long-term debt. With adhesives accounting for nearly 70% of revenues, Fuller would get quite a boost from a rebound in the cyclical durable goods and construction markets.
Imperial Chemical Industries (ICI 9.07) has struggled more than most of its peers in recent years, and being based largely offshore, it will not benefit from the falling dollar. But it has new top management that is likely to shake up the company. On an asset basis the stock looks cheap. ICI currently has a hefty dividend, but it may not last if the business fails to pick up soon.
Lubrizol (LZ 31.18) is the leading worldwide maker of additives for lubricants and fuels, such as additives for engine oils and transmission fluids. Cost cutting and the ability to implement higher prices for engine and manufacturing lubricants are beginning to have a positive effect.
Millennium Chemicals (MCO 11.78) operates three specialty chemical businesses that were spun off from Hanson PLC in 1996. Sales of titanium dioxide, used as a pigment in paints, paper and plastics, account for about three-fourths of total sales. While the company still needs to divest its interest in a troubled unit, Millennium offers significant leverage in a rebounding economy. (It is a previous recommendation, and we are making Millennium a "buy" again, up to 17).
Rohm & Haas (ROH 31.58) has reorganized into four groups: performance polymers; specialty chemicals; electronic materials; and salt products. There are signs that costs are going down and selling prices going up in a number of the company's lines of business. Rohm & Haas has raised its dividend for 25 consecutive years."
THE MONEYPAPER
555 Theodore Fremd Ave., Ste. B-103, Rye, NY 10580.
Monthly, 1 year, $99.
Baxter Int'l: Trading at a discount to its peers
Vita Nelson asked her 5 resident experts to come up with one of their favorite long-term holds. Baxter International, Inc. (BAX) appeared on two lists of long-term holds. BAX is a major international drug supply company specializing in drug delivery systems, bioscience products, anesthesia, vaccines, and dialysis equipment and treatment. Bob Briechle likes the relatively new CEO and growth-oriented staff at BAX; Pete Cirocco feels that this is a big company in a growing industry that is trading at a discount to its peers. He also thinks that earnings could grow by 12% going forward.
Here is Robert Briechle's overview on Baxter International, Inc. develops, makes, and sells a diversified line of products and services in the health-care field. "With 2002 sales of $8.1 billion, the firm is the largest pure-play medical technology company in the world in terms of sales and is a leading player in its three primary businesses -- blood therapies, renal dialysis, and medication delivery. BAX manufactures products that deliver fluids and drugs to patients: biopharmaceuticals for the treatment of hemophilia, immune deficiencies, and kidney disease. It products are used in hospitals, clinical and medical research labs, blood dialysis centers, rehabilitation centers, nursing homes, and doctor's offices, and by patients at home under a physician's supervision. BAX has operations in 28 countries and sells in over 100 countries. Intravenous systems accounted for 41% of 2002 revenues; blood therapies, 38%; and renal, 21%.
"After two years of solid results, earnings and the share price took a sharp downturn -- from last year's high of nearly $60 a share to the current $23.83 -- that began in the second quarter of 2002 owing to increased competition in the plasma products market and other areas. This resulted in a 12% year-over-year decline in earnings per share and lower expectations for 2003. Nonetheless, the share price appears attractive at this level in view of the long-term growth potential for plasma products that could show sales growth in the 7-8% range and earnings growth in the 12-13% range. Investors concerns and speculation about accounting issues appear to have been overblown. The firm has not been found to have deviated from accepted accounting principles and faces no particular structural or financial problems. The shares trade at roughly 12 times the 2003 consensus earnings estimate, as compared with 23 times for comparable large-cap medical technology firms.
"In fact, with the firm focused on re-established credibility and predictabilityand sales and earnings growth, the shares trade at a very appealing entry point. The product pipeline is growing, management is cleaning up some minor problems with financial reporting and, as well, cash flow, and the firm's finances show positive trends.
"Expectations are for operating cash flow generation of $1.3-$1.5 billion in 2003, with improving working capital and a diminishing debt/equity ratio that is moving down from the present 46% toward an expected 40%. Free cash flow this year will be between $500 million and $600 million.
"Although there may be some "bumps" in 2003, patient investors should view BAX shares as attractively priced for longer-term investment. The dividend had been increased for 11 years, but has remained unchanged for the past four; the increases are expected to resume next year. Note that the dividend is paid annually (not quarterly) in early January."
Editor's Note: Mr. Robert Briechle is Senior Vice President, AFA Financial, Inc., North Royalton, OH. Peter Cirocco is VP of Investments at PaineWebber. BAX offers a Direct Stock Purchase Plan. For more information on how you can purchase BAX and 1,000 other companies offering DRIPs visit www.moneypaper.com or www.directinvesting.com.
THE BLUE CHIP INVESTOR
575 Anton Boulevard, Ste. 570, Costa Mesa, CA 92626.
Monthly, 1 year, $249.
Aging population's need for healthcare
will aid growth for Cardinal Health
Peter Hughes: "Cardinal Health (CAH) is the nation's largest distributor of drugs and medical supplies. The company has a 31% shares of the drug distribution market. Cardinal provides over 500,000 different products from over 2,200 different suppliers, which makes its customers' purchasing much easier. Like a discount retailer, Cardinal has very low profit margins but achieves high returns on equity through rapid inventory turnover. The company has grown largely through acquisition and recently completed a $780M purchase of Syncor.
Although the company frequently issues shares to make acquisitions, management has shown willingness to return money to shareholders in the form of meaningful share repurchases. $500M was recently authorized for continued stock buybacks. Cardinal stock has declined 26% from its all-time high (set in 2002), despite continuing strong results. Future growth will come from further acquisitions, broadening the product line and gradual margin improvement. Growth will also be aided by the aging population's increasing need for health care."
OTC GROWTH STOCK WATCH
300 Chestnut St., Ste. 200, Needham, MA 02492.
Monthly, 1 year, $299.
Medifast: Room on the upside
Geoffrey Eiten: "With additional terrorist attacks on the rise and the terror alert system being raised to Code Orange, along with the value of the dollar continuing to slide, the markets have maintained remarkable resilience. Why? I have no idea, except for the fact that the overall economy may just have seen the worst of the slide, and is finally beginning to stabilize. Investors seem to have gotten used to living in an unsettled world.
Once the economy is relatively stable, economic growth should return on a very moderate level, with should cause market conditions to improve immensely. This will take a streak of positive economic news developments over a period of at least three months.
Looking at our portfolio, the stocks in OTC-GSW have outperformed the market as a whole, and this month's recommendation is no exception. Medifast, Inc. (Amex MED) has risen over 100% over the last couple of months. However, I still think there is plenty of room on the upside and this type of performance should continue over the longer term. With an aggressive advertising program in place, Medifast's growth rate, especially in this economy, has been nothing less than remarkable!
Medifast, Inc. produces, distributes, and sells weight and disease management products, sports nutrition and other consumable health and diet products. The Company operates through two of its wholly owned subsidiaries, Jason Pharmaceuticals, Inc. and Take Shape for Life, Inc. Medifast's product lines include weight and disease management, meal replacement and sports nutrition products manufactured in a modern, FDA-approved facility in Owings Mills, MD.
The Company recently launched the Take Shape for Life, Inc., a health network subsidiary that provides supervised weight and disease management and fitness programs to major clinics, corporations, and individuals. This program currently has 40 physicians and 1000 certified and trained health advisors.
MED, like its Medifast products, is on the fast track to weight loss success. With a growing top line and impressive earnings per share year over year, expect continued growth for Medifast in the near and long-term. As management enhances and expands its medical practitioner network through a growing Clinical Affairs department; further develops the Lifestyles physician compliance program that supports the practitioner's patient base; and expanding the Take Shape for Life Health Network, we expect a significantly improved balance sheet and increased profitability."
For more information telephone: 410-581-8042, fax: 410-581-8070 or visit the website: www.medifast.net.
BI RESEARCH
P.O. Box 133, Redding, CT 06875.
1 year, 8 issues, $110.
A saw-tooth climb
Thomas Bishop: "I think the bottom has been made, but it will be a saw-tooth climb from here. I still evaluate stocks on a case-by-case basis and the high-techs already look like they have discounted much of the recovery. Our stocks are still at relatively reasonable PE's for their growth rates. I think investors should be about 70% invested with 30% dry powder. Currently most attractive for purchase are Discovery Labs (DSCO), SFBC Intl. (SFCC), Great Basin Gold (GBGLF.OB) and Headwaters (HDWR), plus Lions Gate (LGF) at $2.10 and American Healthways (AMHC) at $24. Famous Dave's (DAVE) is a more speculative long-term Buy."
MOTLEY FOOL STOCK ADVISOR
7811 Montrose Road, Potomac, MD 20854.
Monthly, 1 year, $195.
First Health Group and Netflix
are selections by the Dueling Fools
The Dueling Fools, Tom Gardner and David Gardner each make a Stock of the Month selection in every issue. This month First Health Group, which operates in healthcare and Netflix, a DVD rental service by mail.
Tom Gardner chose "First Health Group (Nasdaq FHCC), an Illinois-based Preferred Provider Organization (PPO), blends recurring and high-margin subscription revenue (my preferred business model) with service to tends of millions of baby boomers (my preferred market segment) who want better medical care at a lower cost.
As a PPO, First Health essentially matches up patients with doctors across the country. More specifically, the company is charged with advising employers on the most cost-effective means of getting the best treatment for their employees.
And we're talking heavy hitters here. Organizations like McDonald's, AIG, Albertson's, and the National Postal Mail Handler's Union all turn to First Health to negotiate on their behalf with the more than 4,200 hospitals and 412,000 physicians in its nationwide network.
Simple Economics
As complex as the healthcare sector has become, it is nonetheless rooted firmly in the free-market dynamics of supply and demand. Our population is aging, leading to an increased demand for medical technology and services. And satisfying this demand won't be easy. After all, even the lifetime smoker, drinker and glutton for artificial, processed foods wants a shot at every healthy day possible.
It stands to reason, then, that supply invariably struggles to keep pace with demand for healthfulness and longevity. That's what's been driving double-digit annual increases in healthcare costs for the companies where we all work. Expect that to continue.
No Ordinary PPO
First Health distinguishes itself from other PPOs in key ways. First, it signs long-term contracts with healthcare providers and payors. Second, its quality of service has actually led to high renewal rates, and third, it simplifies the marketplace by packaging deals into a single, per-diem rate for all medical, surgical and intensive care unit days in hospitals.
Finally, First Health is in a prime position to fight down costs in the industry; its work even helps nab rogue hospital operators when they attempt methodically to overbill.
What Is It Worth?
True to my profile again, there's a valuation aspect to this story. Beginning with growth, over the past three years, First Health has grown revenues at a yearly rate of 18%.
Also, by my calculation, the company has generated around $125 million of free cash flow over the last year (this does not include the recently reported, stellar Q1 earnings).
So for my valuation, I've projected annual growth in cash flows between 15% and 20% over the next three years. Applying what I consider reasonable multiples to that growth suggests a wide valuation range of $3.2 billion to $4.9 billion.
First Health is valued today at $2.3 billion. Mix it all together, throw in the absence of share dilution by management, and over the next three years, I project an increase in shareholder value of between 40% and 115%.
Healthy, indeed."
David Gardner selected "Netflix (Nasdaq NFLX). Think of Netflix as Blockbuster Video for couch potatoes. Wait a minute -- you thought renting videos and DVDs at Blockbuster was about as couch potato as it gets? Not compared to Netflix. With its DVD rental service by mail, you don't ever have to get off your couch.
And No More Late Fees
Netflix boasts a library of 13,500 DVD titles, about five times the inventory of your typical video rental store. With Netflix, you order up to three DVDs; Netflix mails them to you, and you watch them when you like. Then, whenever you decide to send one back to Netflix in its enclosed pre-addressed, postage-paid mailer, you select another in its place.
That's the service, for $20 a month (actually, Netflix now offers four levels of memberships from $14 to $40 per month). Over a million people are already using Netflix, and Blockbuster and Wal-Mart are scrambling to compete. Reminds me of how Wal-Mart scrambled (too late) to compete with Amazon.com. In other words, good luck! No one's going to catch Netflix at this profitable business model.
Consider this from a Blockbuster spokeswoman just this week: "Frankly, we see online subscriptions as a nice business. We think the real winner will be a combination of an online and in-store service."
Frankly, I think you're wrong, but just keep telling yourself that. The longer you and others continue to underestimate Netflix, the better off we'll be.
But Does It Pay?
For Q1, Netflix reported sales of $56 million, 82% ahead of the same (year ago) quarter last year and 23% higher than the previous quarter (sequentially, as they say on the Street). The company's subscription business, probably my favorite type of business model (sound familiar, Tom?), served just over one million customers.
For the quarter, the company's average monthly churn, which includes both paying and free-trial customers who elect not to pay, was 5.8%. That represents a decline of 20% from 7.2% a year ago. More importantly, it's a new record low.
Despite improvements in revenues and churn, Netflix is still working toward profitability, and lost money for the quarter. Does this mean that Netflix is one of those ever-unprofitable dot-coms?
Nay, dear Fool. Despite the net loss, the cash flow provided by the company's operating activities tipped the scales at $12.8 million for the quarter and $46.4 million for the past 12 months.
All This And More
Here's the way I see it: The stock trades at $21.50 as I write. That puts the market cap at around $500 million. The company has a bit more than $100 million in the bank, so net of cash, the business itself is valued at around $400 million.
That's jut four hundred million dollars for a convenience-providing business that has a developing consumer brand, over a million customers already, a subscription business model and increasing cash flows. Plus -- and I can't stress this too much -- the company's managed by someone I respect a great deal, CEO Reed Hastings.
Moreover, the perceived threat posed by its (slow-on-the-uptake) competition has kept a lid on the stock price. And come to think of it, if and when the competition ever does get on the ball, that might not be such a bad thing. In Hastings' own words, "Increased competition will drive consumer interest in the category overall."
Remember, Tom, we heard much the same thing from Whole Foods CEO John Mackey regarding the much-ballyhooed threat of competition from the big chain grocers. I think they're both right.
And keep this in mind: Reed Hastings is no rookie. He really impressed us on our NPR radio show, and his first California start-up, Pure Altria Software, was a winner. In fact, it was ultimately scooped up by Rational Software for around $750 million.
Call That A Bargain
Again, this is a company that has money in the bank, a sound business model, solid leadership, and is working towards profitability.
More importantly, I think Netflix will generate about $60 million of cash flow this year. If I'm right, you're paying something like 7X this year's cash flow for Netflix today.
I'd call that a bargain and a likely double over the next three years. Take a look."
THE LANCZ LETTER
2400 N. Reynolds Rd., Toledo, OH 43615.
1 year, 8 to 10 issues, $250.
Microsoft's current price weakness
creates a buying opportunity
Alan Lancz: "This is the sixth time in the last 2-1/2 years that Microsoft Corp. (MSFT $23.75) has traded down to the low $20 a share level. In each of the past four years the stock has traded at the $20-23 a share level and within six months it has appreciated anywhere from 30-70%. We can not say that such gains will be made for investors buying near new lows now but every time we have bought the stock at these levels it has proven successful in the past. In addition, some of our most lucrative long term buys over the past two decades have been high quality leaders when their stock was depressed and out of favor. Microsoft's current price weakness is particularly interesting in light of the dramatic recent rally in the technology related stocks on the Nasdaq. The main reason for the weakness is the concern that Linux will become a huge threat to Microsoft. This, along with the news that CEO Steve Ballmer sold a huge amount of Microsoft stock for the first time in many years, has definitely pressured the stock and been the root of its recent underperformance. We feel Wall Street has overreacted to these events and this has created another buying opportunity in Microsoft near its low. First of all, Mr. Ballmer has acknowledged the "threat" of Linux in an email to MSFT's employees and to us this is a positive sign. It is critical for industry leaders to stay extremely knowledgeable about potential competitors before they make an impact. When Wall Street loved McDonalds stock in the $40 a share area we avoided it like the plague. McDonald's management failed to see the inroads competitors were making with higher quality and healthier foods. In other words they were resting on their laurels. It was not until new management came in cognizant of McDonald's past failures, and willing to make the necessary changes, that we developed an interest in the fast food leader. It also helped that the stock was down toward the low teens (from over forty) and totally disregarded on Wall Street. So when CEO Ballmer focuses on Linux we see that as a positive sign for Microsoft over the long term -- directly opposed to how Wall Street perceives it. Wall Street is only focusing on the negatives (i.e. first quarter comparisons will be difficult) and yet we see many positives over the more important long term. The company's new products are formidable with strong advances in the business software field, consumer market products like XBOX and its MSN Internet access offering and the potential of a strategic internet music alternative. Management has implemented stringent cost controls, which should help earnings comparisons beyond the aforementioned problematic FQ1 (September) quarter. The company has approximately $43B in cash and an enterprise value of 16x free cash flow. Management has declared a modest dividend that should be periodically enhanced, especially considering the new tax law. We like MSFT shares for investors with a time frame of more than 6-12 months. Our target price range is for the stock to trade back to the $30-35 a share level sometime within the next two years. We would limit purchases up to $25 a share and buy aggressively on any further weakness."
GROWTH STOCK OUTLOOK
P.O. Box 15381, Chevy Chase, MD 20825.
1 year, 24 issues, $235.
Lawson Products: Revenues up 11 consecutive
years, profits up 42%, balance sheet strong
Charles Allmon: "Founded in 1952, Lawson Products (Nasdaq LAWS $24.80) distributes over 900,000 products for the commercial, industrial, maintenance, repair and replacement marketplace. They also serve the original equipment marketplace including the automotive, appliance, aerospace, construction, and transportation industries.
In his April comment to shareholders, Robert J. Washlow, chairman and CEO, spoke of the tough year in 2002: "The past year posed challenges in every market served by the Lawson Family of Business."
"We continued to make significant investments in our business during the year. Those investments had the effect of holding our earnings down to the reported level."
"Our facilities and product lines were expanded. In addition to continuing our 29-year history of paying quarterly dividends, we repurchased an additional 196,250 shares of Lawson stock. And, by year-end, Lawson was again debt-free."
"After achieving improvements in the United States during the first four months of the year, we noticed that certain MRO industry segments we serve were experiencing declines in their businesses. These circumstances led us to review the overall performance of our field sales forces. We decided to focus our time, energy, talent, and resources on those sales representatives and field managers who share our desire for increased growth and market penetration, and in some cases terminate our relationship with those who did not."
"Mid-year, a series of goal-based measurements tied to appropriate incentives were developed for sales representatives and sales managers. A revised hiring process and a new education curriculum were developed. The implementation of these programs began during the last quarter of 2002."
"We enjoyed respectable growth and increased profitability in our OEM business segment during 2002. We continue to expand the distribution side of that segment. We also began to upgrade our production equipment with additional computer-aided manufacturing technology. Our goal is to reposition the manufacturing operation to effectively produce short-run, high-tolerance products needed by our customers on a short lead-time basis. This capability will complement our capacity to manufacture products in longer production runs."
"In the third quarter, we directed a good deal of attention toward our inside sales group. New people were and continue to be added. We completed the relocation of this group to a new, better-designed facility. We have enjoyed growth each month thereafter and are now capable of servicing each of our MRO business units with the assistance of inside sales professionals."
"We have developed stronger management teams and have adopted new business models in the United Kingdom and in Mexico, where we are engaged primarily in large account business. In many cases, we have assisted our customers by significantly reducing their inventory investment and the number of their suppliers. We have also taken responsibility for product lines outside of our more typical offerings. In some instances, we have established a full-time presence inside the facilities of customers. These undertakings are working well and we are now seeing the potential of profitability in these businesses."
"Our Canadian MRO operations, including the sale and distribution of the product line of Lawson, Cronatron and Kent Automotive, had a good year in 2002. We are nearing completion of a 33,000 square foot expansion in Mississauga, ON. This will nearly double the size of our distribution center and will accommodate the needs of all of our Canadian MRO and OEM businesses."
"The Kent Automotive and C.B. Lynn business units produced healthy sales increase in 2002, each exceeding its sales goals. At Drummond American, two divisions were established during 2002. The J.I. Holcomb division was formally established to provide drain maintenance services and to provide specialized products for that purpose. At years end, the Guidon division was established to service boilers and cooling towers and to provide specialized products for that service."
"The planned expansions of our facilities in the United States were completed during 2002. These expansions have added an aggregate of 160,000 square feet of space to our facilities in Des Plaines, Dallas, Fairfield and Cleveland. All are now fully operational, yielding approximately 1.1 million square feet of efficient warehouse, distribution and office space across North America and the United Kingdom."
"We are paying particular attention to managing, motivating, educating and assisting our field sales forces. Through these sales professionals, the Lawson Family of Businesses is proving the most comprehensive, responsive and overall cost-effective service to customers in keeping their businesses running."
"The year 2002 saw us expand our position in a number of geographic markets and industries by using an array of alternative market channels. It saw us increase our product lines and service offerings while we improved our purchasing, warehousing and distribution networks."
"On 12/31/02 total assets were $225,831,000, current assets $129,761,000, current liabilities $31,723,000, cash and short term marketable securities $8,287,000, no long term debt, shares outstanding 9,494,000, shareholder equity $162,343,000 ($17.10 per share), return on shareholder equity 7.7%, negative cash flow. {Company address: 1666 East Touhy Ave., Des Plaines, IL 60018. (847) 827-9666.}"
Allmon's Comment: "Lawson is the type of company which provides items needed by American industry on an everyday basis. Therefore, it seems likely that Lawson will continue steady growth well into the future. Revenues in 2002 could approach $400 million, a new record. I would look for earnings in the $1.45-$1.55 range.
Balance sheet is quite strong with a 4.1 current ratio and no long term debt. However, there is an overhang of $20.6 million in accrued liabilities under security bonus plans. Return on shareholder equity is low, but this should change as profits rise. At year-end 2002, Lawson sold 1.5 times book value. Anytime you see Lawson share available at 1.2 times book value, buy Lawson Products. Be alert!"
INVESTMENT QUALITY TRENDS
7440 Girard Ave., Ste. 4, La Jolla, CA 92037.
1 year, 24 issues, $310. Email: $265/yr.
Mercury General: Historically undervalued
Joseph McKittrick: "Since its founding in 1961, Mercury General (MCY) has become one of the leading independent agency writers of automobile insurance in California. Current policy lines include commercial automobile insurance, homeowners insurance, mechanical breakdown coverage, and umbrella coverage. Although Californians still comprise the majority share of MCY's customer base, the company has made moves to expand into several other states since 1990. After the acquisition of American Fidelity Insurance Group in 1996, MCY added a large number of customers from Oklahoma and Texas. Other earlier expansion, which included Georgia and Illinois, has been augmented by growth into Virginia and New York.
The chart of MCY shows the share price moving out of a half-decade period of depression. Although significant movement has taken place since year 2000 lows, share price continues to be affected by a number of factors. Cyclical revenues remain a necessary component of the insurance business as the industry fluctuates between extremes of overcapacity/low premiums and under-capacity/high premiums. Adding to the effect are natural disasters, which can often be seasonal and cause a commensurate increase in claims.
Earlier this year, shareholders learned that California (where 87.5% of net premiums are derived) completed an audit of 1993-1996 tax returns with an unfavorable ruling against Mercury. The ruling stemmed from deductions of management and interest expenses. Additional tax trouble came from the Franchise Tax Board as it disallowed dividend-received deductions for tax years after December 1997. If the FTB has its way, this decision will cost MCY $7.4 million plus interest for 1997-1998 and $9.9 million plus interest for 2000. Finally, the FTB also recently announced an audit of MCY's 2001 tax returns. Although the complexity of these issues far exceeds the scope of this article, it should be noted that MCY "strongly disagrees with the positions taken by the FTB." With no additional provision for loss factored into budgeted tax liabilities, it seems that management is exceedingly confident in impending victory or inexplicably unprepared.
In 1999, EPS began a steady decrease from a high of $3.22 in the pervious year to a low of $1.21 in 2002. This year should mark a turnaround for Mercury, which has recently found approval from regulators for several rate increases. In March of last year, MCY increased automobile rates by 4.1%. In California, an additional 6.9% increase in private passenger automobile insurance became effective in November, 2002. In Florida, MCY increased private passenger and automobile insurance by 10.1%. The effects of the increases began to be felt by the third quarter of 2002 which saw a 29.4% increase in premiums earned. Additionally Mercury experienced growth in premiums written by approximately 28.5% in California and 104% in Florida during the third quarter of 2002. Loss as a percentage of premiums earned (loss ratio) increased slightly from 71.3% to 76.6%, but overall loss frequency trends remained flat.
Interesting Qualities To Note: 1. Mercury added 220,000 policies in 2002. 2. MCY has network of over 2,700 brokers and agents. 3. 86% of automobile premiums are from California. 4. Telephone # is: 323-937-1060; Internet: http://www.mercuryinsurance.com.
At a recent price of $46 MCY is historically undervalued with a downside risk of only 4% to a low price of $44 and high yield of 3.0%. From current levels MCY has a 91% upside potential to an overvalue price of $88, low yield of 1.5%. Low debt and a price trading close to 2x the current book value provide important indicators of value. Other problems notwithstanding, increasing policies and the rates charged for them should have a manifest impact on fiscal 2003 earnings. Additionally, should the company emerge successfully from its bout with California Tax officials (as it expects), we would not be surprised to see share price move in reaction to the corresponding diminished risk the company faces."
The Peter Dag PORTFOLIO STRATEGY & MANAGEMENT
65 Lakefront Dr., Akron, OH 44319.
1 year, 24 issues, $389.
Stocks are likely to pause
George Dagnino: "The market has been and still is very strong. However, the unfavorable seasonality suggests stocks are likely to pause. We are expecting some consolidation in the broad averages. Investing in rising relative strength sectors and stocks is a well-proven strategy during such times.
We are recommending New Jersey Resources Corporation (NYSE NJR), a energy services holding company providing retail and wholesale natural gas and related energy services to customers from the Gulf Coast to New England and Canada.
The chart of its price performance vs. the S&P 500 proves the attractiveness of this well managed company. Its relative strength performance over the past 5 years is simply outstanding."
APOLLO SMALL CAP STOCK REPORT
10680 Treena St., Ste. 163, San Diego, CA 92131.
Monthly, 1 year, $99.
RailAmerica: "Short Line" railroad
Burgess Hallums: "Based in Boca Raton, FL, RailAmerica (RRA $7.59) is a small cap value company in the transportation sector. If you were playing the board game Monopoly, RRA would be the Short Line railroad on the same row as Broadwalk and Park Place. This is because RailAmerica primarily operates railroads where the maximum travel distance is 350 miles, in other words, "short lines."
With ownerships and interests in 49 railroads in the US, Canada, and Australia, RailAmerica spans 12,900 rail miles. In an attempt to reduce its 188% debt ratio, RRA is in the process of selling its Chilean railroad interests. It should be noted that the Company has historically generated gains through asset sales, primarily track and land of which the company owns 8,300 miles and 63,000 acres of land, respectively.
The company's railroads transport such items as railroad equipment, agricultural products, forest and paper products, and iron and copper ores.
From a technical perspective, RailAmerica has one of the better looking charts in the market. The stock price has been pushing higher since about mid-February when the stock reached its 52 week low of $4.44. Closing at $7.59 on May 31, the stock price has pushed above both its 50-day and 200-day moving averages, which are both good signs. Relative strength stands at 57 and rising, which is another good sign, as is the current P/E ratio of 11, middle of the track for RRA.
The stock is valued at an optimistic $15, based upon 2004 earnings estimates, or nearly double the current trading price.
Fundamentally, the company has produced same quarter earnings increases in each of the past four quarters.
We have two areas of concern. First is the heavy debt load. These fears were somewhat eliminated by the May 22 announcement by Standard & Poor's Rating Service that affirmed RailAmerica's corporate credit rating and reported that the company's "outlook is stable."
Our second fear is an $8.11 resistance level on the stocks price. After bouncing off this price in early May, the stock quickly depreciated to $6.11. However, it is again climbing. While Apollo feels the stock is a buy at its current level, we feel it becomes a stronger buy once the $8.11 resistance is pierced.
One additional positive note: the book value of the company is $9.45, or nearly 25% higher than the current price per share. This alone may be a solid reason for adding the stock to your portfolio. Apollo has added RailAmerica to its aggressive, Mercury, portfolio."
THE PERSONAL CAPITALIST
6911 S 66th East Ave., Ste. 301, Tulsa, OK 74133.
1 year, 24 issues, $195.
Best opportunity for investors in years
The right horses to ride
"We remain pleased with the current market action. The advance has the potential to top the 10,000 level on the DJIA before the summer concludes. This is the best opportunity for investors in several years. We believe that most will look back at Labor Day and wish they hadn't missed the strong advance.
Here is a brief updates on some of our portfolio holdings: Microsoft (MSFT), the world's largest software company, is a powerhouse. The company has some $53 billion in cash and investments. In our opinion, the stock is undervalued. Sure its peak growth years are behind it simply because the PC market is mature. To revitalize growth, the company is "ramping up" R&D in non-PC areas, from game consoles to PDAs to set-top boxes. It obviously has ample funds to do this. Eleven analysts agree with us and rate the stock a "Buy." Sixteen rate it as a "Buy/Hold." We will hold our shares.
Oil/Energy Shares. Drillers are doing better. In fact, all our energy-related stocks have moved up since the March 12th market low, some spectacularly. Oil has held most of its prewar price. High energy prices are good for exploration, production, and field service companies. Perhaps the demand for oil may turn out better than many expect. We have lean inventories now, as the summer driving season begins which creates additional demand. Smith Barney's analyst now expects crude oil to maintain a price of $28.50 per barrel. Natural gas will be important as shortages are being predicted, causing acceleration in exploration activity. Russia has more oil reserves than any other non-OPEC nation and bears watching. We continue to be very enthusiastic over the future of the fuel cell. We feel our selections HYGS and PLUG will be the "right horses to ride" as investors begin to realize that hydrogen is the fuel of the future. Crash research by auto and oil companies will accelerate usage. We see competition among auto companies (GM, DCX, Honda, Toyota and Ford) and concentrated research by the military helping to bring this about. Fuel cells are already being used in cities, proving that stationary fuel cells have tremendous potential in many uses beyond autos. The hydrogen economy is coming at a very fast pace. Every subscriber should own shares of HYGS and PLUG.
Precious Metals. With improved relative strength in the diversified metals and mining area, our stocks look good (FCX, NEM, ABX). China started allowing individuals to invest in gold in June. This could have a major impact on world gold markets since the Chinese love gold and have used it as a store of value for hundreds of years. We are taking a more constructive stance on gold and expect to see it average $355 per ounce in 2003. Our stocks have done well since March and look good going forward. We like our selection of companies in this sector and will continue to hold our shares."
THE MONEY SHOW DIGEST
Published weekly by InterShow
1258 N. Palm Ave., Sarasota, FL 34236.
www.MoneyShowDigest.com.
Roundup of Advisory Newsletters
Steven Halpern brings investors the latest investment ideas and market forecasts from the nation's leading investment advisors. Many of the spotlighted newsletters are featured speakers at the Money Show Investment Conferences. Here is a sampling from the current issue of The Money Show Digest.
Standard & Poor's Mid-Year Outlook
Standard & Poor's truly stands out in the investment business. It has historically kept a stable of award-winning analysts, and published what is considered among the highest quality, independent research on Wall Street -- all with no conflicts of interest. Its publication, The Outlook, offers a 12-month forecast at the start and in the middle of each year. Here is their mid-year outlook, featuring their market expectations and their favorite sectors and individual stocks.
"The long winter of investor discontent seems over. After three consecutive down years, the S&P 500 appears poised to post a double-digit gain in 2003. Several factors have led us to this conclusion. The first is precedent: A four-year decline is extremely rare. The last time the S&P 500 posted a fourth consecutive year of negative returns was in 1932. Although the global economy has problems today, they are not even close to those of that Depression year. Another historical precedent that argues for higher stock prices is that 2003 is the third year of the four-year US presidential cycle. Since the end of World War II, the S&P 500 has never experienced a decline in the third year of this cycle. The reason, apparent again this year, is that elected officials do all in their power to boost the economy in advance of elections.
"That brings us to the second reason we expect stocks to rise this year -- an improving economy. Fiscal stimulus, in the form of the latest tax cut, should begin to be felt in July as employees see the effects of lower income tax withholding rates and many parents receive checks reflecting the increased child tax credit. Overall, the tax cut should boost real growth in US gross domestic product to above 4% for several quarters, says our chief economist David Wyss.
"The other factor in the improving US economy is monetary stimulus. With interest rates at four-decade lows thanks to the Fed's stream of rate cuts that began in January 2001, the cost of financing everything is more reasonable. Consumers have been the primary beneficiaries of low rates so far, but we expect capital spending to pick up in the second half of 2003 as shortlife equipment (such as computers and other technology) put into service in the late 1990s reaches obsolescence.
"Also, the conclusion of the war in Iraq means an end to the uncertainty that restrained some business spending earlier this year. Despite the positives, the economic picture still has some nasty elements. Aside from replacement of short-life goods, businesses are not buying much equipment. Capacity utilization in manufacturing is at a 20-year low in the US, and outside this country overcapacity is even greater. In addition, unemployment remains stubbornly high. But both employment and capital spending should gradually improve as the economy strengthens, and are likely to be much less of a problem this time next year. The third reason that we expect a positive year for stocks is the action of the market itself. After struggling within a 10-month trading range, the S&P 500 has broken out decisively.
"S&P chief technical analyst Mark Arbeter observes that the breakout indicates the trend has switched from neutral to bullish. Arbeter sees strong volume trends on both the NYSE and Nasdaq as a sign that stocks are under accumulation, another indication of further gains ahead. We believe that the S&P 500 will end the year at 1030, for a 17% 12-month gain. By the middle of 2004, we expect the `500' to reach 1105. As a result, we advise keeping 65% of your investment portfolio in stocks. We would hold 15% in bonds, primarily short-term issues, as interest rates are likely to rise. Keep 20% in cash. History, an improving economy and technical factors all presage gains ahead."
S&P's Favorite Sectors and Stocks
"Cable operators have begun to reap the rewards of heavy expenditures for advanced system upgrades, with more than $70 billion spent over the past eight years. Some of our picks in broadcasting and cable include Comcast (Nasdaq CMCSA), Hispanic Broadcasting (NYSE HSP) Univision (NYSE UVN), and Westwood One (NYSE WON). Univision is planning to acquire Hispanic Broadcasting. In addition, publishing is on an upswing as newspaper and magazine ads have strengthened recently. Some of our choices in this industry are Gannett Co. (NYSE GCI), Meredith Corp. (NYSE MDP), and Belo Corp. (NYSE BLC).
"Healthcare distributors are benefiting from favorable consumption trends. We see operating margins in the industry continuing to widen, with cost controls helping to reduce operating costs as a percentage of revenues. Some of our highly ranked distributors are AmerisourceBergen (NYSE ABC), Cardinal Health (NYSE CAH), McKesson (NYSE MCK), and Patterson Dental (Nasdaq PDCO). We also remain positive on selected biotech issues. Some strong buys in this group are Amgen (Nasdaq AMGN), Millennium (Nasdaq MLNM), Martek Biosciences (Nasdaq MATK), and Medimmune (Nasdaq MEDI).
"We regard integrated oil and gas as a safe haven. These stocks are relatively safe investments, owing to their conservative accounting practices and steady cash flows. Our top picks are ExxonMobil (NYSE XOM) and Total S.A. (NYSE TOT). We also find oil and gas drilling to be an attractive area due to strong industry fundamentals. Some names we like are Global Santa Fe (NYSE GSF), Nabors Industries (NYSE NBR), and Ensco International (NYSE ESV).
"Computer services companies tend to have significant recurring revenues, notable operational leverage and solid balance sheets. Among our industry favorites are Affiliated Computer Services (NYSE ACS), Computer Sciences (NYSE CSC), First Data (NYSE FDC), and Sabre Holdings (NYSE TSG). In addition, the systems software sector is a key play. Many software vendors and customers are currently focusing on Web services, with particular emphasis on the integration of disparate systems and applications. Our top pick is Microsoft (Nasdaq MSFT), followed by Sybase (NYSE SY), CheckPoint (Nasdaq CHKP), and Symantec (Nasdaq SYMC)."
CSX: Board a Blue-Chip Train
The Prudent Speculator: "Not since 1939 has the third year of the Presidential cycle seen the S&P 500 suffer a decline and 2003 is on course to continue this trend," notes John Buckingham, editor of the highly successful The Prudent Speculator. "With interest in equities just starting to pick up, a ton of money still residing on the sidelines, and investor-friendly legislation, we can't help but still be bullish on the near- and long-term prospects of our undervalued stocks."
"Although high fuel costs and severe winter weather impacted the bottom line in the first quarter, we continue to like CSX Corp. (NYSE CSX), the owner of the largest freight rail network in the Eastern US. The company provides rail transportation services over a 23,000 route-mile network in 23 states, the District of Columbia, and two Canadian provinces. The firm also provides intermodal and global container terminal operations through other subsidiaries. In addition, the company has a 42% economic interest in Conrail, the primary freight railroad system serving the Northeast US. As many are aware, former CSX chairman and CEO John Snow was appointed Secretary of the Treasury by President Bush in February.
"Operating profits in the first quarter equaled $0.20 a share on revenues of $2.02 billion. While the numbers were not that exciting, given that operating earnings totaled $0.32 per share in the year-ago period, they did come in better than expectations as analysts were looking for net income of $0.17 and revenues of $2.0 billion. New CEO Michael Ward indicated that he expects second quarter earnings to be `a little better than the $0.60 in earnings per share of a year ago.' In addition, CFO Paul Goodwin said that CSX is still on track to see free cash flow (after capital expenditures of $1 billion to $1.1 billion) generation of $300 million for all of 2003. With traffic volumes likely to pick up as the economy improves and CSX having become much more efficient, we think the company will deliver health earnings growth over the next few years. Consensus estimates for earnings are $2.26 a share this year and $2.78 next. Because financially-sound CSX trades for 1.1 times book value and yields 1.2%, we would board this blue-chip train up to $33."
Insight into Biovail
Jim Collins has spent some four decades following the markets, developing a proprietary, momentum-based method of screening all listed issues to determine which ones are most likely to be tomorrow's leaders. The latest buys in his portfolio range from the design store Bombay (NYSE BBA) to the Russian telecom, Vimpel (NYSE VIP), and Telecom Argentina (NYSE TEO) to his latest featured pick, Biovail (NYSE BVF), which specializes in drug delivery technology.
"Biovail is a pharmaceutical company that applies proprietary drug delivery technologies to create controlled-release versions of existing drug products. The firm owns a number of advanced drug delivery technologies that can improve convenience or performance of existing drug formulations, including techniques that reduce the frequency of dosing as well as rapid dissolving that allows patients to take pills without the use of water to aid swallowing. In addition to a core portfolio of products targeting the cardiovascular, central nervous system, and pain management areas, the company has three products in early launch or development stages that present multi-hundred million-dollar revenue opportunities for Biovail.
"Cardizem LA is a calcium channel blocker for the treatment of hypertension and angina (chest pain). Wellbutrin XL is a controlled-release version of the well-known drug used for the treatment of clinical depression. The product is awaiting marketing approval and has the potential to launch in the second half of 2003. Tramadol XL is a controlled-release analgesic used for the management of moderately severe chronic pain. This product is in late-stage development and is expected to achieve marketing approval in the US in 2004.
"Biovail has marketing partnerships with GlaxoSmithKline, Forest Laboratories, and Reliant Pharmaceuticals. The company is also in the process of building its internal sales force to support its new product launches. For the quarter ended March 2003, the company reported earnings of $0.39 per share, a 22% increase over the prior year. Revenues increased 23% to $191 million. In 2002, the stock fell from over $50 a share to a low of $19. Since that time, it has risen to a new 52-week high. The stock receives an `A' rating for accumulation and distribution and has a relative strength ranking of 87 out of a possible 100."
Editor's Note: Bull & Bear readers can receive The Money Show Digest -- free of charge. Log on to www.MoneyShow.com and sign up for your free weekly digest of newsletters by Steve Halpern, former editor of The Dick Davis Digest. Monetary Digest readers and their guests are invited to attend the Atlantic City Money Show, August 7-9, 2003 and the San Francisco Money Show, October 16-18th -- free of charge. To register call 1-800-970-4355 or register at www.MoneyShow.com.
Russ Kaplan's HEARTLAND ADVISER
1016 North 47th Ave., Ste. 11, Omaha, NE 68132.
Monthly, 1 year, $150.
Revenge of the Dinosaurs
Russ Kaplan: "We at Heartland Adviser are often criticized for picking stocks that most investors at the time consider over the hill. The Wall Street Journal recently examined which companies have gained the most in market value since March 24, 2000, the date when the Standard & Poor 500 peaked, and from which it still has a long way to recover. The majority of these companies, General Electric (GE), Citigroup (C), Microsoft (MSFT), Pfizer (PFE), IBM (IBM), and J.P. Morgan Chase (JPM) are all companies recommended in Heartland Adviser and currently appear in our model portfolio.
The past does not predict the future. Just because a company has declined in value or is in a mature industry does not mean it is doomed to oblivion. All of these companies have been able to adjust to the times and come up with superior products. Such companies are able to do so because they have all the right resources in place.
IBM Mainframe
Investment advisers often underestimate the ability of established companies to keep pace with the times. When a new product hits the streets, the old product is written off prematurely. Take the mainframe computer, for one. We can't tell you how many times we were assaulted for our IBM "Buy" recommendations. Everywhere we turned someone else was telling us the personal computer was the wave of the future and the IBM was doomed. One analyst said twelve years ago that mainframes would cease to exist.
They were wrong on two accounts. IBM adapted by developing a successful line of personal computers. Also, mainframes are going strong. IBM has recently moved into lead over Hewlett Packard in the high-end computer market (computers costing more than $250,000). As the Wall Street Journal stated on May 12, "The mainframe has been the least afflicted product in the depressed high-end computer market. Last year, as the market for $250,000 plus systems dropped 22% to $16 billion, IBM's mainframe sales fell just 10%."
Does this sound like a doomed industry to you?"
THE PRIMARY TREND
700 North Water St., Milwaukee, WI 53202.
Monthly, 1 year, $80.
Hold core position in Intel
Barry Arnold: "Intel Corp. (Nasdaq INTC $20.82; 0.4%) recently tightened its revenue guidance for the second quarter ending June 30. INTC now expects revenues to be between $6.6 billion and $6.8 billion, compared to its previously forecasted range of $6.4-$7.0 billion. Wall street applauded the news by bidding INTC shares up to $23.
We continue to hold INTC common as a leader in the large-cap technology arena. INTC shares have jumped by 50% during the market's latest rekindled love affair with large Nasdaq issues, and we would venture to say that INTC's latest price move is way ahead of the fundamental improvement at the company. Some profits can be taken, but a core position in INTC common should be maintained."
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